NETWORK
CN INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
FOR
THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(UNAUDITED)
|
|
|
For
the Three
Months
Ended
March
31, 2007
|
|
For
the Three
Months
Ended
March
31, 2006
|
|
|
REVENUE
|
|
|
|
|
|
|
Revenue
- tour services
|
|
$
|
2,375,828
|
|
$
|
-
|
|
|
Revenue
- advertising services
|
|
|
393,899 |
|
|
-
|
|
|
Revenue
- hotel management
|
|
|
-
|
|
|
83,407
|
|
|
Revenue
- related parties
|
|
|
- |
|
|
105,855 |
|
|
Revenue,
Net
|
|
|
2,769,727 |
|
|
189,262 |
|
| |
|
|
|
|
|
|
|
|
COSTS
AND EXPENSES
|
|
|
|
|
|
|
|
|
Cost
of tour services
|
|
|
2,364,924
|
|
|
-
|
|
|
Cost
of advertising services
|
|
|
246,682
|
|
|
-
|
|
|
Professional
fees
|
|
|
2,776,490
|
|
|
91,805
|
|
|
Payroll
|
|
|
337,394
|
|
|
170,351
|
|
|
Other
selling, general & admin.
|
|
|
281,084
|
|
|
176,948
|
|
|
Total
Costs and Expenses
|
|
|
6,006,574
|
|
|
439,104
|
|
| |
|
|
|
|
|
|
|
|
LOSS
FROM OPERATIONS
|
|
|
(3,236,847
|
)
|
|
(249,842
|
)
|
| |
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSES)
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
5,516
|
|
|
6,698
|
|
|
Interest
expense
|
|
|
(317
|
)
|
|
-
|
|
|
Other
income
|
|
|
2,642
|
|
|
-
|
|
|
Total
Other Income
|
|
|
7,841
|
|
|
6,698
|
|
| |
|
|
|
|
|
|
|
|
LOSS
BEFORE INCOME TAXES AND MINORITY INTEREST
|
|
|
(3,229,006
|
)
|
|
(243,144
|
)
|
|
Minority
interest
|
|
|
14,611
|
|
|
1,694
|
|
|
Income
taxes
|
|
|
-
|
|
|
(7,372
|
)
|
| |
|
|
|
|
|
|
|
|
NET
LOSS
|
|
|
(3,214,395
|
)
|
|
(248,822
|
)
|
| |
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE LOSS
|
|
|
|
|
|
|
|
|
Foreign
currency translation loss
|
|
|
(6,892
|
)
|
|
-
|
|
|
COMPREHENSIVE
LOSS
|
|
$
|
(3,221,287
|
)
|
$
|
(248,822
|
)
|
| |
|
|
|
|
|
|
|
|
NET
LOSS PER COMMON SHARE - BASIC AND DILUTED
|
|
$
|
(0.05
|
)
|
$
|
(0.01
|
)
|
| |
|
|
|
|
|
|
|
|
WEIGHTED
AVERAG SHARES OUTSTANDING - BASIC AND DILUTED
|
|
|
67,520,718
|
|
|
33,698,739
|
|
See
accompanying notes to condensed consolidated financial statements.
NETWORK
CN INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR
THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(UNAUDITED)
|
|
|
2007
|
|
2006
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(3,214,395
|
)
|
$
|
(248,822
|
)
|
|
Adjustments
to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
90,193
|
|
|
64,515
|
|
|
Stock
and option issued for services
|
|
|
1,230,212
|
|
|
30,625
|
|
|
Provision
for doubtful debts
|
|
|
-
|
|
|
3,927
|
|
|
Minority
interest
|
|
|
(14,611
|
)
|
|
(1,694
|
)
|
|
(Increase)
decrease in :
|
|
|
|
|
|
|
|
|
Prepaid
expenses
|
|
|
(145,429
|
)
|
|
40,326
|
|
|
Accounts
receivable
|
|
|
(65,970
|
)
|
|
(183,057
|
)
|
|
Increase
(decrease) in :
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
|
355,767
|
|
|
(19,149
|
)
|
|
Tax
payable
|
|
|
-
|
|
|
(196
|
)
|
|
Net
Cash Used in Operating Activities
|
|
|
(1,764,233
|
)
|
|
(313,525
|
)
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Earnest
deposit paid
|
|
|
-
|
|
|
(1,038,461
|
)
|
|
Sales
proceeds from disposal of affiliate
|
|
|
-
|
|
|
3,000,000
|
|
|
Purchase
of property and equipment
|
|
|
(8,141
|
)
|
|
(7,240
|
)
|
|
Acquisition
of a subsidiary, net
|
|
|
(45,999
|
)
|
|
-
|
|
|
Net
Cash Provided by (Used in) Investing Activities
|
|
|
(54,140
|
)
|
|
1,954,299
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Due
to related parties
|
|
|
-
|
|
|
(533,678
|
)
|
|
Due
from directors
|
|
|
-
|
|
|
(6,863
|
)
|
|
Stock
issued for cash, net of placement fees
|
|
|
-
|
|
|
3,600,000
|
|
|
Payments
on capital lease
|
|
|
(2,340
|
)
|
|
(2,340
|
)
|
|
Net
Cash Provided by (Used in) Financing Activities
|
|
|
(2,340
|
)
|
|
3,057,119
|
|
|
|
|
EFFECT
OF EXCHANGE RATE ON CASH
|
|
|
(12,463
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
INCREASE
(DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
(1,833,176
|
)
|
|
4,697,893
|
|
| |
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS - BEGINNING OF PERIOD
|
|
|
2,898,523
|
|
|
85,919
|
|
| |
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS - END OF PERIOD
|
|
$
|
1,065,347
|
|
$
|
4,783,812
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
317
|
|
$
|
4,933
|
|
| |
|
|
|
|
|
|
|
| SUPPLEMENTAL
DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES: |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| In
January 2007, the Company acquired 100% equity interest of
Quo
Advertising. The Company issued 300,000 shares of the Company's
common
stock with a fair value of $843,600 as part of the
consideration. |
|
|
|
|
|
|
|
See
accompanying notes to condensed consolidated financial statements.
NETWORK
CN INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS
OF MARCH 31, 2007
(UNAUDITED)
|
NOTE
1
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES AND
ORGANIZATION
|
The
accompanying unaudited condensed consolidated financial statements
have been
prepared in accordance with generally accepted accounting principles
and the
rules and regulations of the Securities and Exchange Commission for
interim
financial information. Accordingly, they do not include all the information
and
footnotes necessary for a comprehensive presentation of financial
position and
results of operations.
It
is
management’s opinion, however, that all material adjustments (consisting of
normal recurring adjustments) have been made which are necessary
for a fair
financial statements presentation. The results for the interim period
are not
necessarily indicative of the results to be expected for the year.
For
further information, refer to the consolidated financial statements
and
footnotes included in the Company’s Form 10-KSB for the year ended December 31,
2006 filed with the Commission on April 2, 2007.
(A)
Nature of Operations and Organization
Network
CN Inc. and subsidiaries (the “Company”) include:
|
|
•
|
NCN
Group Limited (“NCN BVI”, a wholly owned subsidiary incorporated in the
British Virgin Islands on June 23, 2001)
|
|
|
•
|
NCN
Group Management Limited (“NCN HK”, a wholly owned subsidiary of NCN BVI
incorporated in Hong Kong on July 28, 2000)
|
|
|
•
|
NCN
Management Services Limited (“NCN Management”, a wholly owned subsidiary
of NCN BVI incorporated in the British Virgin Islands on
May 4, 2006)
|
|
|
•
|
NCN
Asset Management Services Limited (a wholly owned subsidiary
of NCN BVI
incorporated in the British Virgin Islands on May 4, 2006)
|
|
|
•
|
NCN
Travel Services Limited (a wholly owned subsidiary of NCN
BVI incorporated
in the British Virgin Islands on May 4, 2006)
|
|
|
•
|
NCN
Financial Services Limited (a wholly owned subsidiary of
NCN BVI
incorporated in the British Virgin Islands on May 10, 2006)
|
|
|
•
|
NCN
Media Services Limited (“NCN Media”, a wholly owned subsidiary of NCN BVI
incorporated in the British Virgin Islands on May 4, 2006)
|
|
|
•
|
NCN
Hotels Investment Limited (a wholly owned subsidiary of
NCN Management
incorporated in the British Virgin Islands on November
1,
2001)
|
|
|
•
|
NCN
Pacific Hotels Limited (a wholly owned subsidiary of NCN
Management
incorporated in the British Virgin Islands on July 6, 2006)
|
|
|
•
|
Teda
(Beijing) Hotels Management Limited (“Teda BJ”, a wholly owned subsidiary
of NCN BVI incorporated in the People’s Republic of China in November
2004)
|
|
|
•
|
NCN
Landmark International Hotel Group Limited (“NCN Landmark”, a 60% owned
subsidiary of NCN BVI incorporated in the British Virgin
Islands on August
17, 2004)
|
|
|
•
|
Landmark
International Hotel Development Limited (“Landmark Development”, a 51%
owned subsidiary of NCN Landmark incorporated in the British
Virgin
Islands on October 7, 2005)
|
|
|
•
|
Beijing
NCN Landmark Hotel Management Limited (“Beijing Landmark”, a 100% owned
subsidiary of NCN Landmark incorporated in the People’s Republic of China
on November 13, 2006)
|
|
|
•
|
Guangdong
Tianma International Travel Service Co., Ltd. (“Tianma”, a 55% owned
subsidiary of NCN Management incorporated in the People’s Republic of
China on November 23, 1985)
|
|
|
•
|
Crown
Winner International Limited (“Crown Winner”, a 100% owned subsidiary of
NCN Media incorporated in Hong Kong on September 16,
2006)
|
|
|
•
|
Shanghai
Quo Advertising Company Limited (“Quo Advertising”, a 100% owned
subsidiary of Crown Winner incorporated in the People’s Republic of China
on March 7, 1997)
|
| |
•
|
NCN
Huamin Management Consultancy (Beijing) Company Limited
(“NCN Huamin”, a
100% owned subsidiary of NCN BVI incorporated in the People’s Republic of
China on March 7, 2007)
|
The
Company provides management services to hotels and resorts located
in China,
travel agency services and marketing communications consultancy services
to
customers in China.
(B)
Principles of Consolidation
The
accompanying consolidated financial statements for 2007 include the
accounts of
Network CN Inc., NCN BVI and its nine wholly owned subsidiaries,
NCN BVI’s 60%
owned subsidiary NCN Landmark, and NCN Landmark’s 51% owned subsidiary Landmark
Development from October 7, 2005 and NCN Landmark’s 100% owned subsidiary
Beijing Landmark from November 13, 2006, NCN Management’s 55% owned subsidiary
Tianma from June 16, 2006, NCN Media’s 100% owned subsidiaries Crown Winner and
Quo Advertising from January 31, 2007 together with NCN BVI’s 100% wholly owned
subsidiary NCN Huamin from March 7, 2007. After change of directorship in
May 2006, the Company determined to dispose of Teda BJ and began
winding down
operations. We treated it as discontinued operations in the fourth
quarter of
2006. Landmark Development became dormant at the end of 2006 and
its
shareholders are taking steps to wind up the subsidiary in 2007.
The
accompanying consolidated financial statements for 2006 include the
accounts of
Network CN Inc., NCN BVI and its three wholly owned subsidiaries,
NCN BVI’s 60%
owned subsidiary NCN Landmark, and NCN Landmark’s 51% owned subsidiary Landmark
Development from October 7, 2005.
All
significant intercompany transactions and balances have been eliminated
in
consolidation.
(C)
Use of Estimates
In
preparing financial statements in conformity with generally accepted
accounting
principles, 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 at the date of the financial statements and
revenues and
expenses during the reported period. Actual results could differ
from those
estimates.
(D)
Property and Equipment
Property
and equipment are stated at cost, less accumulated depreciation.
Depreciation is
provided using the straight-line method over estimated the useful
life of the
assets from three to five years. Repairs and maintenance on property and
equipment are expensed as incurred.
(E)
Long-Lived Assets
The
Company accounts for long-lived assets under Statement of Financial
Accounting
Standards Nos. 142 and 144 “Accounting for Goodwill and Other Intangible Assets”
and “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS 142 and
144”). In accordance with SFAS 142 and 144, long-lived assets, goodwill
and
certain identifiable intangible assets held and used by the Company
are reviewed
for impairment whenever events or changes in circumstances indicate
that the
carrying amount of an asset may not be recoverable. For the purposes
of
evaluating the recoverability of long-lived assets, goodwill and
intangible
assets, the recoverability test is performed using undiscounted net
cash flows
related to the long-lived assets.
(F)
Cash and Cash Equivalents
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.
(G)
Revenue Recognition
In
relation to hotel and resort management services, the Company recognizes
revenue
in the period when the services are rendered and earned, and collection
is
reasonably assured.
In
relation to travel agency services, the Company recognizes services-based
revenue when the services have been performed. 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, rental
car
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 at this time. For air-tickets, Tianma
normally
books a block of air-tickets with airlines in advance and pays full
amount 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 have to sell the air-tickets to
other travel
agents or customers. For hotels, meals and transport, Tianma usually
pays 50-60%
deposit upfront. After completion of tours, the remaining balance
will be
settled.
2. Tianma,
through its sub-agents, advertises tour and travel packages at the
price 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 of the tour and the costs of the
tour) for a
particular tour is reached, Tianma will contact the customers for
tour
confirmation and request for 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 to such providers.
Tianma
is
the principal in such transactions and is 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.
In
relation to marketing communications consultancy services, the Company
recognizes service fees income when the service is performed. Advertising
revenue is earned as the advertisements are either aired or
published.
(H)
Earnings (Loss) per Share
Basic
earnings (loss) per common share are computed by dividing the net
income (loss)
applicable to common stock stockholders 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 effect of 364,173 and 61,579 warrants and options
outstanding
was not included in diluted loss per share as of March 31, 2007 and
2006 as the
effect was anti-dilutive.
(I)
Foreign Currency Translation
The
Company’s assets and liabilities that are denominated in foreign currencies
are
translated into the currency of U.S. dollars using the exchange rates
at the
balance sheet date. For revenues and expenses, the average exchange
rate during
the period was used to translate Hong Kong dollars and Chinese renminbi
into
U.S. dollars. Capital accounts were translated at their historical
exchange
rates when the capital transactions occurred. Net gains and losses
resulting
from translation of foreign currency financial statements are included
in the
statements of stockholders’ equity as other comprehensive income or (loss).
Foreign currency transaction gains and losses are included in the
consolidated
income (loss).
(J)
Income Taxes
The
Company accounts for income taxes under the Statement of Financial
Accounting
Standards No. 109 “Accounting for Income Taxes” (“SFAS 109”). Under SFAS 109,
deferred tax assets and liabilities are recognized for the future
tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax
bases. 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 settled. 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.
(K)
Business Segments
The
Company’s operating segments are organized internally primarily by the type
of
services performed. Currently the Company has four operating segments:
hotel
management, travel agency, advertising agency and investment holding.
(L)
Stock-Based Compensation
In
December 2004, the FASB issued Statement of Financial Accounting
Standard No.
123R, Share-Based Payment ("SFAS 123R"), a revision to Statement
of Financial
Accounting Standard No. 123, Accounting for Stock-Based Compensation
("SFAS
123"), and superseding APB Opinion No. 25, Accounting for Stock Issued
to
Employees (“APB 25”) and its related implementation guidance. SFAS 123R
establishes standards for the accounting for transactions in which
an entity
exchanges its equity instruments for goods or services, including
obtaining
employee services in share-based payment transactions. SFAS 123R
applies to all
awards granted after the required effective date and to awards modified,
repurchased, or cancelled after that date. Adoption of the provisions
of SFAS
123R is effective as of the beginning of the first interim or annual
reporting
period that begins after December 15, 2005.
Prior
to
December 15, 2005, the Company accounted for its stock plans under
the
provisions of APB 25 and FASB Interpretation (FIN) No. 44, Accounting
for
Certain Transactions Involving Stock Compensation - an Interpretation
of APB 25
(“FIN 44”) and made pro forma footnote disclosures as required by Statement
of
Financial Accounting Standards No. 148, Accounting For Stock-Based
Compensation - Transition and Disclosure
(“SFAS
148”),
which
amends SFAS 123. The Company adopted SFAS 123R, effective December
15, 2005
using a modified prospective application, as permitted under SFAS
123R.
Accordingly, prior period amounts have not been restated. Under this
application, the Company is required to record compensation expense
for all
awards granted after the date of adoption and for the unvested portion
of
previously granted awards that remain outstanding at the date of
adoption. SFAS
123R requires that the cost resulting from all share-based payment
transactions
be recognized in the financial statements. SFAS 123R establishes
fair value as
the measurement objective in accounting for share-based payment arrangements
and
requires us to apply a fair value based measurement method in accounting
for
generally all share based payment transactions with employees.
The
modified prospective transition method of SFAS 123R requires the
presentation of
pro forma information, for periods presented prior to the adoption
of SFAS 123R,
regarding net income and net income per share as if the Company had
accounted
for stock options issued to employees under the fair value method
of SFAS 123R.
For pro forma purposes, fair value of stock option was estimated
using the
Black-Scholes option valuation model. The fair value of all of the
Company’s
share-based awards was estimated assuming no expected dividends and
estimates of
expected life, volatility and risk-free interest rate at the time
of
grant.
For
the
period
ended
March 31, 2007, the Company recognized $1,230,212 as expense for
stock, options
and warrants issued to consultants.
(M)
New Pronouncements
In
February 2006, the FASB issued SFAS No. 155, Accounting for Certain
Hybrid
Financial Instruments (“SFAS 155”), which amends SFAS No. 133, Accounting for
Derivatives Instruments and Hedging Activities (“SFAS 133”) and SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of
Liabilities (“SFAS 140”). SFAS 155 amends SFAS 133 to narrow the scope exception
for interest-only and principal-only strips on debt instruments to
include only
such strips representing rights to receive a specified portion of
the
contractual interest or principal cash flows. SFAS 155 also amends
SFAS 140 to
allow qualifying special-purpose entities to hold a passive derivative
financial
instrument pertaining to beneficial interests that itself is a derivative
instrument. The Company is currently evaluating the impact of this
new Standard,
but believes that it will not have a material impact on the Company’s financial
position.
In
July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes—an Interpretation of FASB Statement 109 (“FIN 48”),
which clarifies the accounting for uncertainty in tax positions.
This
Interpretation provides that the tax effects from an uncertain tax
position can
be recognized in the Company’s financial statements, only if the position is
more likely than not of being sustained on audit, based on the technical
merits
of the position. The provisions of FIN 48 are effective as of the
beginning of
fiscal 2007, with the cumulative effect of the change in accounting
principle
recorded as an adjustment to opening retained earnings. The Company
is currently
evaluating the impact of adopting FIN 48 on its financial statements.
In
September 2006, FASB issued Statement 157, Fair Value Measurements (“SFAS
157”). This statement defines fair value and establishes a framework
for
measuring fair value in generally accepted accounting principles
(GAAP). More
precisely, this statement sets forth a standard definition of fair
value as it
applies to assets or liabilities, the principal market (or most advantageous
market) for determining fair value (price), the market participants,
inputs and
the application of the derived fair value to those assets and liabilities.
The
effective date of this pronouncement is for all full fiscal and interim
periods
beginning after November 15, 2007. The Company is currently evaluating the
impact of adopting SFAS 157 on its financial statements.
In
September 2006, FASB issued Statement 158, Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”), which amend
FASB Statements No. 87, 88, 106 and 132R. This statement requires employers
to recognize the over-funded or under-funded status of a defined
benefit
postretirement plan as an asset or liability in its financial statements
and to
recognize changes in that funded status in the year in which the
changes occur.
The effective date for the Company would be for any full fiscal years
ending
after December 15, 2006. The Company is currently evaluating the impact of
adopting SFAS 158 on its financial statements.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial
Assets and Financial Liabilities (“SFAS 159”) which permits entities to choose
to measure many financial instruments and certain other items at
fair value that
are not currently required to be measured at fair value. SFAS 159
will become
effective for us on January 1, 2008. The Company is currently evaluating
the
impact of adopting SFAS 159 on our financial position, cash flows,
and results
of operations.
The
condensed consolidated statement of operations for the period ended
March 31,
2006 has been reclassified to conform to the 2007 presentation. The
reclassification did not have an effect on total revenues, total
expenses, loss
from operations, net loss and net loss per share.
|
NOTE
3
|
ACQUISITION
OF A SUBSIDIARY
|
On
January 31, 2007, the Company consummated the acquisition of 100%
equity
interest of Quo Advertising, an advertising agency headquartered
in Shanghai,
China pursuant to a Purchase and Sales Agreement and Trust Agreements
with Lina
Zhang and Qinxiu Zhang dated January 24, 2007. The Company paid $64,000
in cash
and issued 300,000 shares of the Company’s common stock with a fair value of
$843,600 in exchange for 100% of the shares of capital stock of Quo
Advertising.
The total consideration was $907,600.
The
Company has allocated the purchase price to the assets acquired and
liabilities
assumed based on the estimated fair values as follows:
|
Cash
|
|
|
18,001
|
|
|
Accounts
receivable
|
|
|
83,791
|
|
|
Prepayments
and other current assets
|
|
|
298,559
|
|
|
Property
and Equipment
|
|
|
15,114
|
|
|
Liabilities
assumed
|
|
|
(44,405
|
)
|
|
Intangible
right
|
|
|
536,540
|
|
|
Total
purchase price
|
|
|
907,600
|
|
The
results of operations of Quo Advertising have been included in the
Company's
consolidated statement of operations since the completion of the
acquisition on
January 31, 2007. The table below summarizes the unaudited pro forma
information
of the results of operations as though the acquisitions had been
completed as of
January 1, 2007.
|
|
|
Three
Months Ended
March
31, 2007
|
|
|
Revenues
|
|
$
|
2,769,790
|
|
|
Gross
profit
|
|
$
|
85,333
|
|
|
Loss
before income taxes and MI
|
|
$
|
(3,331,166
|
)
|
|
Net
loss
|
|
$
|
(3,316,555
|
)
|
|
Net
loss per share
|
|
|
|
|
|
Basic and
diluted
|
|
$
|
(0.05
|
)
|
The
following table set forth information for intangible rights subject
to
amortization and intangible rights not subject to amortization:
| |
|
As
at
March
31, 2007
|
|
|
Amortized
intangible rights
|
|
|
|
|
Gross
carrying amount
|
|
$
|
7,239,201
|
|
|
Less:
accumulated amortization
|
|
|
(611,940
|
)
|
|
Less:
provision for impairment loss
|
|
|
(195,192
|
)
|
| Amortization
intangible rights - net |
|
|
6,432,069
|
|
| |
|
|
|
|
| Unamortized
intangible rights |
|
|
815,902
|
|
| |
|
|
|
|
| Intangible
rights, net |
|
$
|
7,247,971
|
|
The
increase in amortized intangible rights is a result of acquisition
of Quo
Advertising. Refer to Note 3. The amount is amortized over a period
of 20 years.
Amortization expense for the three months ended March 31, 2007 and
2006 was
$79,471 and $58,554, respectively.
|
NOTE
5
|
RELATED
PARTY TRANSACTIONS
|
During
the three months ended March 31, 2007 and 2006, the Company received
management
fee of $0 and $105,855 respectively from two properties it managed
that were
owned by a stockholder.
During
the three months ended March 31, 2007 and 2006, the Company paid
rent of $0 and
$13,548 respectively for office premises leased from a company owned
by a
director and stockholder.
The
Company currently has four operating segments. Each segment operates
exclusively
in Asia. The Company’s Hotel Management segment provides management services to
hotels and resorts in Asia. The Travel Agency segment provides travel
agency
services in China. The Advertising Agency segment provides marketing
communications consultancy services to customers in China. The Real
Estate
Investments segment that used to invest in real estate development
projects had
been discontinued since October 2005 and was sold in April 2006.
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, 2007
|
|
Hotel
Management
|
|
Travel
Agency
|
|
Advertising
Agency
|
|
Investment
Holding
|
|
Total
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
-
|
|
$
|
2,375,828
|
|
$
|
393,899
|
|
$
|
-
|
|
$
|
2,769,727
|
|
|
Net
income (loss) from continuing operations
|
|
|
(71,248
|
)
|
|
(33,199
|
)
|
|
98,327
|
|
|
(3,230,727
|
)
|
|
(3,236,847
|
)
|
|
Depreciation
and amortization
|
|
|
1,237
|
|
|
360
|
|
|
353
|
|
|
88,243
|
|
|
90,193
|
|
|
Assets
|
|
|
127,637
|
|
|
854,196
|
|
|
755,422
|
|
|
8,020,054
|
|
|
9,757,309
|
|
|
Capital
Expenditure
|
|
|
-
|
|
|
(1,546
|
)
|
|
2,712
|
|
|
6,975
|
|
|
8,141
|
|
|
For
the Three Months Ended
March
31,
2006
|
|
Hotel
Management
|
|
Real
Estate
Investments
|
|
|
|
Total
|
|
| |
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
189,262
|
|
$
|
-
|
|
|
|
|
$
|
189,262
|
|
|
Net
loss from continuing operations
|
|
|
(243,144 |
) |
|
-
|
|
|
|
|
|
(243,144 |
) |
|
Depreciation
and amortization
|
|
|
64,515
|
|
|
-
|
|
|
|
|
|
64,515
|
|
|
Assets
|
|
|
6,649,354
|
|
|
2,420,130
|
|
|
|
|
|
9,069,484
|
|
|
Capital
Expenditure
|
|
|
7,240
|
|
|
-
|
|
|
|
|
|
7,240
|
|
|
NOTE
7
|
STOCKHOLDERS’
EQUITY
|
(A)
In
February 2006, the Company issued an option to purchase up to 225,000
shares of
our common stock to our legal counsel at an exercise price of $0.10
per share.
So long as our counsels’ relationship with us continues, the shares underlying
the option shall vest and become exercisable in accordance with the
following
schedule: one-twelfth (1/12) of the shares subject to the option
shall vest and
become exercisable on each month anniversary of the date of issuance.
The option
may be exercised for 120 days after termination of the consulting
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
weighted average assumptions: expected dividend 0%, volatility 147%,
a risk-free
rate of 4.5% and an expected life of one (1) year. The value recognized
during
the period was approximately $1,317. The options were exercised in
April
2007.
(B)
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 $0.7
per share. The
shares underlying the option shall vest and become exercisable in
accordance
with the following schedule: one-fourth (1/4) of the shares subject
to the
warrant shall vest and become exercisable around every 45 days starting
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
weighted average assumptions: expected dividend 0%, volatility 192%,
a risk-free
rate of 4.5% and an expected life of one (1) year. The value recognized
during
the period was approximately $10,145.
(C)
In
January 2007, the Company issued 300,000 shares of restricted common
stock of
the Company with a fair value $843,600 as part of the consideration
to the
seller in the acquisition of Quo Advertising.
|
NOTE
8
|
COMMITMENTS
AND CONTINGENCIES
|
Contingent
liabilities
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, 2007 and
the
management’s opinion as to the likelihood of loss in respect of loss
contingency.
The
Company’s 55%-owned subsidiary, Tianma, is a defendant to proceedings brought
in
the Guangzhou Yuexiu District Court. The proceedings were finalized
on October
9, 2006. The facts surrounding the proceeding were 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 ($275,000) 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
($262,500) 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 the chance of
overturning the court’s decision is high. 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, 2007.
(A)
On
February 27, 2007, the company entered into a common stock purchase
agreement for the private placement of 500,000 shares of restricted
common stock
at $3 per share for an aggregate amount of $1,500,000. The shares
were issued in
April 2007.
(B)
In February 2006, the Company issued an option to
purchase up to 225,000 shares of our common stock to our legal counsel.
The
options were exercised in April 2007.
(C)
In April 2007, the company
issued 45,000 shares at fair value of $18,000 to consultants for
services.
(D)
In April 2007, the Company issued 377,260 bonus
shares to its directors and officers for services.
(E)
On April 24, 2007, Quo Advertising entered into a
business agreement with Shanghai Qian Ming Advertising Company Limited
(“Qian
Ming”) to construct, manage and operate up to 85 LED outdoor advertising
panels
at Lujiazui Financial District of Pudong, Shanghai for six years.
The Company
agreed to pay Qian Ming a deposit of $130,000 to obtain requisite
governmental
approvals. In addition, the Company also agreed to pay Qian Ming
installation
and operating expenses of $661,000 in each of 2007 and 2008 and 10%
increment
from 2009 to 2012. The deposit is refundable if the relevant governmental
approvals are not obtained, or it may be applied to the 2007 fee.
(F) On
April 26, 2007, Quo Advertising entered into a business agreement
with Shanghai
Yukang Advertising Company Limited (“Yukang Advertising”) to act as Yukang
Advertising’s exclusive agent to place advertisement on two digital video
billboards in Shanghai, China for a 5 hour time slot per day during
the period
beginning July 1, 2007 and ending June 30, 2009. The Company agreed
to pay to
Yukang Advertising an aggregate of $520,000 in each of 2007 and
2008.
Item
2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
CAUTIONARY
STATEMENTS
The
following discussion and analysis should be read in conjunction with
the
Company’s Consolidated Financial Statements and the Notes thereto included
in
Part I, Item 1 of this Report. All amounts are expressed in U.S.
dollars. The
following discussion regarding the Company and its business and operations
contains “forward-looking statements” within the meaning of Private Securities
Litigation Reform Act 1995. These statements consist of any statement
other than
a recitation of historical fact and can be identified by the use
of
forward-looking terminology such as “may”, “expect”, “anticipate”, “estimate” or
“continue” or the negative thereof or other variations thereon or comparable
terminology. In particular, these include statements relating to
our expectation
that we will continue to have adequate liquidity of cash flow from
operations.
The other risks and uncertainties are described above under “Risks and
Uncertainties”. All forward-looking statements herein are speculative and there
are certain risks and uncertainties that could cause actual events
or results to
differ from those referred to in such forward looking statements,
including the
risk factors discussed in this Report. The Company does not have
a policy of
updating or revising forward-looking statements and should not assume
that
silence by management of the Company over time means that actual
events are
bearing out as estimated in such forward looking statements.
OVERVIEW
Network
CN Inc. (“we” or “the Company”), originally incorporated on September 10, 1993,
is a Delaware company with headquarters in the Hong Kong SAR, the
People’s
Republic of China (“the PRC” or “China”). It was led by different management
teams in the past, engaging in different ventures. The Company was
previously
known under various names, the latest former name being Teda Travel
Group Inc.
On August 1, 2006, in order to better reflect the Company’s vision under the
expanded management team, the Company changed its name to “Network CN
Inc.”
Our
business vision and plan is to build a nationwide information/entertainment
network in the PRC. To achieve this goal, we have set out to build
and run a
Media Network, a Hotel Network and an e-Network. A Hotel Network
has already
been established, and the Company is working to expand it to cover
all major
cities in the PRC. The Hotel Network also includes our travel subsidiary,
Guangdong Tianma International Travel Service Co., Ltd. (“Tianma”), that we
acquired in 2006. We earned substantially all of our revenues in
the first
quarter of 2007 from our Hotel Network through the provision of travel
agency
services to customers both inside and outside of the PRC. During
the latter half
of 2006, we adjusted our focus to building a Media Network, and took
the first
step in November 2006 by securing a media-related contract regarding
the
installation and management of outdoor LED advertising video panels.
In January
2007, we acquired Shanghai Quo Advertising Company Limited (“Quo Advertising”),
an advertising agency in Shanghai, China. In the first quarter of
2007, we have
generated revenues from our Media Network and we anticipate that
we will begin
to realize earnings from the installation and management of LED advertising
video panels beginning in the second quarter of 2007. At the same
time, the
Company is actively pursuing the development of an e-Network via
the Internet.
We
believe that the Company is well positioned to take the growth opportunities
in
China.
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 April 2, 2007.
Critical
Accounting Policies
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 make adjustments 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 as a result
of the need
to make estimates about the effect of matters that are inherently
uncertain.
(i)
Property and Equipment
Property
and equipment are stated at cost, less accumulated depreciation.
Depreciation is
provided using the straight-line method over estimated the useful
life of the
assets from three to five years. Repairs and maintenance on property and
equipment are expensed as incurred.
(ii)
Long-Lived Assets
The
Company accounts for long-lived assets under Statements of Financial
Accounting
Standard Nos. 142 and 144, Accounting for Goodwill and Other Intangible
Assets
and Accounting for Impairment or Disposal of Long-Lived Assets (“SFAS 142 and
144”). In accordance with SFAS 142 and 144, long-lived assets, goodwill
and
certain identifiable intangible assets held and used by the Company
are reviewed
for impairment whenever events or changes in circumstances indicate
that the
carrying amount of an asset may not be recoverable. For the purposes
of
evaluating the recoverability of long-lived assets, goodwill and
intangible
assets, the recoverability test is performed using undiscounted net
cash flows
related to the long-lived assets.
(iii)
Revenue Recognition
In
relation to hotel and resort management services, the Company recognizes
revenue
in the period when the services are rendered and earned, and collection
is
reasonably assured.
In
relation to travel agency services, the Company recognizes services-based
revenue when the services have been performed. 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, rental
car
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 at this time. For air-tickets, Tianma
normally
books a block of air-tickets with airlines in advance and pays full
amount 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 have to sell the air-tickets to
other travel
agents or customers. For hotels, meals and transport, Tianma usually
pays 50-60%
deposit upfront. After completion of tours, the remaining balance
will be
settled.
2. Tianma,
through its sub-agents, advertises tour and travel packages at the
price 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 of the tour and the costs of the
tour) for a
particular tour is reached, Tianma will contact the customers for
tour
confirmation and request for 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 to such providers.
Tianma
is
the principal in such transactions and is 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.
In
relation to marketing communications consultancy services, the Company
recognizes service fees income when the service is performed. Advertising
revenue is earned as the advertisements are either aired or
published.
(iv)
Foreign Currency Translation
The
Company’s assets and liabilities that are denominated in foreign currencies
are
translated into the currency of U.S. dollars using the exchange rates
at the
balance sheet date. For revenues and expenses, the average exchange
rate during
the period was used to translate Hong Kong dollars and Chinese renminbi
into
U.S. dollars. Capital accounts were translated at their historical
exchange
rates when the capital transactions occurred. Net gains and losses
resulting
from translation of foreign currency financial statements are included
in the
statements of stockholders’ equity as other comprehensive income or (loss).
Foreign currency transaction gains and losses are included in the
consolidated
income (loss).
(v)
Income Taxes
The
Company accounts for income taxes under the Statement of Financial
Accounting
Standards No. 109, Accounting for Income Taxes
(“SFAS
109”).
Under
SFAS 109, deferred tax assets and liabilities are recognized for
the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax
bases. 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 settled. 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.
(vi)
Stock-Based Compensation
In
December 2004, the Statement of Financial Accounting Standard No.
123R,
Share-Based Payment ("SFAS 123R"), a revision to Statement of Financial
Accounting Standard No. 123, Accounting for Stock-Based Compensation
("SFAS
123"), and superseding APB Opinion No. 25, Accounting for Stock Issued
to
Employees (“APB 25”) and its related implementation guidance. SFAS 123R
establishes standards for the accounting for transactions in which
an entity
exchanges its equity instruments for goods or services, including
obtaining
employee services in share-based payment transactions. SFAS 123R
applies to all
awards granted after the required effective date and to awards modified,
repurchased, or cancelled after that date. Adoption of the provisions
of SFAS
123R is effective as of the beginning of the first interim or annual
reporting
period that begins after December 15, 2005.
Prior
to
December 15, 2005, the Company accounted for its stock plans under
the
provisions of APB 25 and FASB Interpretation (FIN) No. 44, Accounting
for
Certain Transactions Involving Stock Compensation - an Interpretation
of APB 25
(“FIN 44”) and made pro forma footnote disclosures as required by Statement
of
Financial Accounting Standards No. 148, Accounting For Stock-Based
Compensation - Transition and Disclosure
(“SFAS
148”),
which
amends SFAS 123. The Company adopted SFAS 123R, effective December
15, 2005
using a modified prospective application, as permitted under SFAS
123R.
Accordingly, prior period amounts have not been restated. Under this
application, the Company is required to record compensation expense
for all
awards granted after the date of adoption and for the unvested portion
of
previously granted awards that remain outstanding at the date of
adoption. SFAS
123R requires that the cost resulting from all share-based payment
transactions
be recognized in the financial statements. SFAS 123R establishes
fair value as
the measurement objective in accounting for share-based payment arrangements
and
requires us to apply a fair value based measurement method in accounting
for
generally all share based payment transactions with employees.
The
modified prospective transition method of SFAS 123R requires the
presentation of
pro forma information, for periods presented prior to the adoption
of SFAS 123R,
regarding net income and net income per share as if the Company had
accounted
for stock options issued to employees under the fair value method
of SFAS 123R.
For pro forma purposes, fair value of stock option was estimated
using the
Black-Scholes option valuation model. The fair value of all of the
Company’s
share-based awards was estimated assuming no expected dividends and
estimates of
expected life, volatility and risk-free interest rate at the time
of
grant.
For
the
period
ended
March 31, 2007, the Company recognized $1,230,212 as expense for
stock options
and warrants issued to consultants.
Consolidated
Results of Operations
For
the three months ended March 31, 2007 and March 31, 2006
Revenues.
Revenues
for the three months ended March 31, 2007 were $2,769,727 as compared
to
revenues of $189,262 for the same period in 2006, a sharp increase
of
$2,580,465, or 1,363%. The increase was due to the inclusion of the
revenue of
Tianma, a subsidiary acquired in June 2006 and Quo Advertising, a
subsidiary
acquired in January 2007. Revenues from Tianma for this period were
$2,375,828
and accounted for 86% of the Company’s total revenues. Revenues from Quo
Advertising for this period were $393,899 and accounted for 14% of
the Company’s
total revenues. Revenues from property management for this period
were $0, a
decrease of $189,262 as compared to the same period last year. The
decrease was
due to a decreased number of hotel properties managed (from eighteen
hotel
properties managed as of March 31, 2006 to five hotel properties
as of March 31,
2007). Among
the
five hotels, the constructions of three hotels are not completed
yet. For the
remaining two, one was under financial difficulties while the Company
has
dispute with the hotel management of the other one. Therefore no
hotel
management revenue was recorded in the period.The decrease was not
otherwise material given the significant revenues generated by Tianma
and Quo
Advertising.
Cost
of Tour Services. Cost
of
tour services for the three months ended March 31, 2007 was $2,364,924
as
compared to cost of tour services of $0 for the same period last
year. The
increase was due to the acquisition of Tianma in June, 2006. The
majority of Tianma's expenses directly related to the generation
of Tianma's
tour revenues were grouped under this category, with immaterial amounts
grouped
under Professional Fees, Payroll and Other Selling, General & Administrative
Expenses.
Cost
of Advertising Services. Cost
of
advertising services for the three months ended March 31, 2007 was
$246,682 as
compared to cost of advertising services of $0 for the same period
last year.
The increase was due to the acquisition of Quo Advertising in January,
2007.
Total
Expenses. Our
total
expenses during the three months ended March 31, 2007 were $3,394,968,
compared
to expenses of $439,104 for the same period last year, an increase
of
$2,955,864, or 673%. The increase was primarily attributable to a
material
increase in professional fees in connection with more stock issued
for services
during the current period than in the previous period. The Company
expects
consistent increases in professional fees in the next quarter to
support the
acquisition of potential projects currently under negotiations.
Professional
fees.
Professional fees for the three months ended March 31, 2007 were
$2,776,490 as
compared to $91,805 for the same period last year, an increase of
$2,684,685 or
2,924%. The increase was due to more stock issued for services during
the
current period than in the previous period.
Payroll.
Payroll
for the three months ended March 31, 2007 was $337,394 as compared
to $170,351
for the same period last year, an increase of $167,043 or 98%. The
increase was
due to the addition of several employees, including a Managing Director
and a
General Manager.
Other
Selling, General and Administrative Expenses. Other
selling, general and administrative expenses for the three months
ended March
31, 2007 were $281,084 as compared to $176,948 for the same period
last year, an
increase of $104,136 or 59%. The increase was due to additional overseas
traveling and entertainment expenses incurred in the current period.
Loss
from Operations. The
Company incurred a loss from operations of $3,236,847 for the three
months ended
March 31, 2007 as compared to a loss of $249,842 in the previous
period. The
increase in loss of $2,987,005 was mainly due to increase in professional
fees
and payroll as explained above.
Income
Taxes. The
Company derives its income in the PRC and is subject to income tax
in the PRC.
Income tax expenses charged to the consolidated income statement
for the three
months ended March 31, 2007 was $0 as compared to $7,372 for the
period ended
March 31, 2006 as the Company and its subsidiaries operated at a
loss during the
period.
Net
Loss. The
Company recorded a net loss of $3,214,395 as compared to a net loss
of $248,822
for the same period last year, an increase of $2,965,573 or 1,192%.
That was
mainly due to increase of professional fee and payroll during the
period.
Consolidated
Financial Condition
Liquidity
and Capital Resources
The
cash
and cash equivalents as of March 31, 2007 were $1,065,347 as compared
with
$4,783,812 as of March 31, 2006, a sharp decrease of $3,718,465.
The decrease
was attributable to the following activities:
Net
cash
utilized by operating activities as of March 31, 2007 was $1,764,233,
an
increase of $1,450,708 as compared with $313,525 in the same period
of 2006. The
net cash outflow was mainly attributable to an increase in professional
fee and
payroll.
Net
cash
used in investing activities for the period ended March 31, 2007
was $54,140,
compared with net cash provided by investing activities $1,954,299
in the same
period of 2006. The decrease of $2,008,439 was mainly attributable
to sales
proceeds from disposal of affiliate of $3,000,000 received in 2006.
Net
cash
used in financing activities was $2,340 for the period ended March
31, 2007,
compared with $3,057,119 provided by financing activities in the
same period of
2006. The decrease was primarily attributable to $3.6 million of
stock issued
for private placement received in 2006.
Working
Capital Requirements
We
had
cash of $1,065,347 at March 31, 2007 and our current assets totaled
$2,409,519.
Our current liabilities at March 31, 2007 were $1,409,612, so we
had working
capital of $999,907. We have no long-term liabilities as of March
31, 2007.
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, 2007, we acquired assets of $8,141, which was financed through
working
capital. As of March 31, 2007, we had no other significant capital
expenditure
commitments except the following: (i) the Company obtained the right
to install
120 roadside LED panels in the Changning district of Shanghai pursuant
to a
business agreement with Guiding Media Advertising Limited and (ii)
the Company
also obtained the rights to install further LED panels and two mega-sized
digital billboards in the Huangpu district of Shanghai, Nanjing and
Wuhan.
Following the end of the period covered by this report, the Company
obtained the
rights to install 85 roadside LED panels in Lujiazui Financial District
of
Pudong, Shanghai. As of May 15, 2007, we have the right to install
a total of
625 roadside LED panels and 2 mega-sized digital billboards in China.
The
Company estimates that the capital investment including installation
costs for
each roadside LED panel is approximately $25,000 to $30,000, while
that for each
mega-sized digital billboard is about $800,000 to $1,000,000. As
such, the total
capital expenditure for the Projects will be approximately $19 million.
On April
26, 2007, Quo Advertising entered into a business agreement with
Shanghai Yukang
Advertising Company Limited (“Yukang Advertising”) and agreed to pay to Yukang
Advertising an aggregate of $520,000 in each of 2007 and 2008. In
addition to
the funds raised through private placements in 2006, the Company
is considering
issuing new equity securities as well as arranging debt instruments
to finance
the 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
the finance for the capital expenditure.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet financing arrangements.
RISKS
AND UNCERTAINTIES
We
are
subject to various risks that could have a negative effect on the
Company and
its financial condition. You should understand that these risks could
cause
results to differ materially from those expressed in forward looking
statements
contained in this report and in other Company communications. Because
there is
no way to determine in advance whether, or to what extent, any present
uncertainty will ultimately influence our business, you should give
equal weight
to each of the following:
RISKS
RELATED TO OPERATING A 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 and our liquidity
and
access to capital and our ability to operate our business.
The
PRC
economy differs from the economies of most developed countries in
many respects,
including the amount 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 the allocation of resources, controlling
payment
of foreign currency-denominated obligations, setting monetary policy
and
providing preferential treatment to particular industries or companies.
Since
late 2003, the PRC government 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 the ability
to access to
capital and operate our business.
Since
2003, mainland banks were ordered to continually increase their deposits
as
reserves, bringing the total reserve ratio up to 11% by May 15 2007,
to reduce
their lending power in an effort to cool down the economic overheating.
The
overheating of China’s economy can be shown by the 2007 first-quarter economic
figures, by reporting a high trade surplus and high rates of lending
and
suggesting a possible rebound in fixed direct investment. As a result,
the
central bank is under pressure to impose more stringent limitations
on the
ability of commercial banks to make loans and raise interest rates,
in order to
slow down China’s economy.
The
benchmark CSI 300 stock index, which tracks A shares in both Shanghai
and
Shenzhen, has risen about 70 percent to date this year. Excess liquidity,
possibly leading to asset bubbles, is a major risk the mainland government
has
tried to deal with in recent months. The mainland government has
tried to
control prices in the property sector by reinforcing the Land Appreciation
Tax.
The latest report showed that the economy expanded 11.1% in the first
quarter of
2007 compared with 10.4% a year earlier, while inflation reached
a two-year high
of 3.3% in March 2007. The stronger-than-expected growth was driven
mainly by a
trade surplus that almost doubled to US$46.4 billion in the first
three months.
New loans
made
by
commercial banks during the first quarter were up to RMB 1.4 trillion,
almost
half the total in the whole year of 2006. In order to cool down the
bubbling
equity market, we expect the China government will keep on increasing
the
reserve ratio for mainland banks until there are indications of control
in
overheating in equity market and inflation. These actions, as well
as future
actions and policies of the PRC government, could materially affect
our
liquidity and the ability to access to capital and operate our
business.
Our
operations in China may be adversely affected by changes in the policies
of the
Chinese government.
The
political environment in the PRC may adversely affect the Company’s business
operations. The 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, and foreign investment. 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 at March 16 2007 to
introduce a new uniform taxation regime in the PRC. Both resident
and
non-resident enterprises deriving income from the PRC are 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%. Although we still
enjoy
certain tax incentives applicable to Foreign-Invested Enterprises
prior to the
introduction of the EIT Law have been revoked, the current lower
EIT rate will
be phased up to 25% after a five-year period. Moreover, we may not
enjoy further
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
Chinese 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. As a result, it could
require the
Company 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 affect the Company’s
operations.
Recently,
the Chinese economy has experienced periods of rapid expansion. During
this
period, there have been high rates of inflation and deflation. As
a result, the
PRC government adopted various corrective measures designed to restrict
the
availability of credit or regulate growth and contain inflation.
While inflation
has moderated
since 1995, high inflation may 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, 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 (USD), and remitted outside of the PRC. Effective
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 Chinese 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 is 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 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 mainland 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 syndrome, 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 Asia 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. As a result,
higher operating expenses may severely restrict the level of economic
activity,
or otherwise effect products, services and usage levels of the Company’s
services in effected areas. This may result in a material effect
on the
Company’s business and prospects.
Because
our assets are located overseas, stockholders may not receive distributions
that
they would otherwise be entitled to if we were declared bankruptcy
or
insolvency.
Because
the Company’s assets are located overseas, 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 receive
the distributions on liquidation that they are otherwise entitled
to under U.S.
bankruptcy law.
If
any of our PRC affiliates 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
Quo
Advertising. 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 and Quo Advertising 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 only allows foreign investors to run traveling
business
in China if the foreign investors have at least three years of traveling
operations record outside China 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, the foreign investors
are
restricted from running outbound travel services. In order to penetrate
into
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,
Tianma
is currently owned by one PRC citizen designated by us and this subsidiary
to
directly operate our traveling agent business.
Since
2005, the Chinese government allows 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
own directly
100% of an advertising business in China. Our advertising business
subsequent to
our fiscal year is currently provided through our contractual arrangements
with
our PRC operating subsidiary Quo Advertising. Quo Advertising is
currently owned
by two PRC citizens designated by us and directly operates our advertising
network projects.
We
have
been and will continue to be dependent on these PRC operating subsidiaries
to
operate our traveling agent and advertising business for 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 air ticketing, 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 air ticketing, 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, air-ticketing, 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.
In
particular, the Civil Aviation Administration of China, or CAAC,
regulates
pricing of air tickets as well as commissions payable to air-ticketing
agencies.
If restrictive policies are adopted by CAAC or any of its regional
branches, our
air ticketing revenues may also 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 counsel that our arrangements
with our
affiliated Chinese entities are valid under current PRC laws and
regulations.
However, we cannot assure you 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 27 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 &
Quo Advertising, and 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
you could be affected.
The
PRC tax authorities may require us to pay additional taxes in connection
with
our acquisitions of offshore entities that conducted 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 you 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 agency
and
advertising businesses. If our contractual arrangements with our
affiliated
Chinese personnel are violated, our related businesses will be damaged.
As
mentioned earlier, we depend on contractual arrangements to run our
advertising
and traveling businesses in China. These contractual arrangements
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 contractual arrangements. Should
such a
situation occur, we may be unable to enforce these contractual arrangements
and
unable to enforce our control over our operating subsidiaries to
conduct our
business.
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.
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
Shanghai,
Nanjing and Wuhan to manage and operate LED outdoor advertising video
panels and
mega-sized digital video billboards through Quo Advertising. We anticipate
entering 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 the 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
are
allowed to operate in China since 2005, exposing us to even greater
competition.
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 managing
these problems through the acquisition of well-established advertising
company
like Quo Advertising. We can provide no guarantee that we will be
able to
compete against new or existing competitors to generate profit.
If
we cannot enter into further agreements for roadside LED video panels
and
mega-sized digital video billboards in other major cities in China,
we may be
unable to grow our revenue base to generate higher levels of
revenue.
We
are
continuing our 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-sized digital video billboards
in China.
We have concluded four agreements and are currently searching for
more
opportunities. However, if we are unable to enter into any new agreements,
or
costs are high, we may be unable to convince our advertisers to purchase
more
advertising time for higher levels of revenue.
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-sized digital video billboards. The desire of advertisers
to advertise
on our out-of-home media networks depends on the coverage of the
networks, the
desirability of the locations of the LED’s and billboards, our brand name and
charging rate. If we are unable to provide the advertising services
to suit the
needs of our advertisers, we may be unable to attract them to purchase
our
advertising time.
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 time from us 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,
we face
uncertainties whether we may be able to generate 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-sized 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-sized digital video billboard. However, we cannot provide any
guarantee
that we can obtain all the relevant government approvals for all
of our
installations in the PRC. If such approvals are not granted, we will
be unable
to install LEDs 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-sized roadside LED video panels.
We also use
mega-sized 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.
We
face significant competition, and if we do not compete successfully
against new
and existing competitors, we may lose our market share, and our profitability
may be adversely affected.
We
compete with other advertising companies in China. We compete for
advertising
clients primarily based on network size and coverage, location, price,
the range
of services that we offer and our brand name. We also face competition
from
other out-of-home television advertising networks for access to the
most
desirable locations in cities in China. Individual buildings, hotels,
restaurants and other commercial locations may decide to independently
use
third-party technology providers to install and operate their own
flat-panel
television advertising screens. We also compete for overall advertising
spending
with other alternative advertising media companies, such as Internet,
street
furniture, billboard, frame and public transport advertising companies,
along
with traditional advertising media, such as newspapers, television,
magazines
and radio.
In
the
future, we may also face competition from new entrants into the out-of-home
television advertising sector. Our sector is characterized by low
fixed costs
and, as is customary in the advertising industry, we do not have
exclusive
arrangements with our advertising clients. These two factors present
potential
entrants to our sector of the advertising industry with low entry
barriers. As
of December 10, 2005, wholly foreign-owned advertising companies are
allowed to operate in China, which may expose us to increased competition
from
international advertising media companies attracted to opportunities
in China.
Increased
competition could reduce our operating margins, profitability and
result in a
loss of market share. Some of our existing and potential competitors
may have
competitive advantages, such as greater financial marketing and exclusive
arrangements with desirable locations. Others may successfully mimic
and adopt
our business model. Moreover, increased competition will provide
advertisers
with a wider range of media and advertising service alternatives,
which could
lead to lower prices and decreased revenues, gross margins and profits.
We
cannot guarantee that we will be able to compete against new or existing
competitors.
RISKS
RELATED TO OUR HOTEL 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 hotel business.
The
travel industry is highly competitive, which may influence our ability
to
compete with other hotel and timeshare properties for customers.
We
operate in markets that contain numerous competitors. Our hotel management
companies compete with major hotel chains and independent operators
in regional
markets. 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 common to the hotel and
travel-related industry.
The
profitability of the hotel and travel-related industry that we operate
in may be
affected by a number of factors, including:
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(1)
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the
availability of and demand for hotel rooms and apartments;
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(2)
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International
and regional economic conditions;
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(3)
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the
desirability of particular locations and changes in travel
patterns of
domestic and foreign travelers;
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(4)
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taxes
and government regulations that influence or determine
wages, prices,
interest rates, and other costs;
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(5)
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the
availability of capital to allow us and potential hotel
owners and joint
venture partners to fund investments;
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(6)
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increases
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, and therefore
the
prices we are able to obtain, for hotel rooms and corporate apartments.
The
uncertain pace of the lodging 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. Business and leisure travel decreased and 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. Weaker hotel performance reduced management fees and
gave rise to
losses and closures in connection with some hotels that we manage,
which, in
turn, has had an impact on our financial performance. 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
lodging 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 hotel occupants. In recent years,
our business
has been hurt by decreases in travel resulting from SARS and downturns
in global
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.
Our
growth strategy depends upon third-party owners and operators. Future
arrangements with these third parties may be less favorable.
Our
present growth strategy for the development of additional lodging
facilities
entails entering into and maintaining various arrangements with property
owners.
The terms of our management agreements for each of our lodging facilities
are
influenced by contract terms offered by our competitors. We cannot
guarantee
that any of our current arrangements will continue. Moreover, we
may not be able
to enter into future collaborations, or renew any agreements in the
future, on
terms that are as favorable to us as those under existing collaborations
and
agreements.
We
may have disputes with the owners of the hotels that we manage.
Consistent
with our focus on hotel management, we generally do not own any of
our lodging
properties. The nature of our responsibilities under our management
agreements
to manage each hotel and enforce the standards required under the
management
agreements may be subject to interpretation and may give rise to
disagreements.
We seek to resolve any disagreements in order to develop and maintain
good
relations with current and potential hotel owners and joint venture
partners,
but have not always been able to do so. Failure to resolve such disagreements
may result in litigation.
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.
Our
ability to grow our management systems is subject to the range of
risks
associated with real estate investments.
Our
ability to sustain continued growth through management agreements
for new or
existing hotels is affected, and may potentially be limited, by a
variety of
factors influencing real estate development generally. These include
site
availability, financing, planning, zoning and other local approvals.
Other
limitations may be imposed by market and submarket factors, such
as projected
room occupancy, growth in demand opposite projected supply, territorial
restrictions in our management agreements, and cost of construction
and
anticipated room rate structure.
In
the event of damage or other potential losses involving properties
that we own
or manage, potential losses may not be covered by insurance. We are
not aware
that the Company is responsible for insuring the properties that
it manages, as
such hotel properties are usually insured by its respective owners.
We
have
comprehensive property and liability insurance policies with coverage
features
and insured limits to the hotels that we believe are customary. Market
forces
beyond our control may nonetheless limit both the scope of property
and
liability insurance coverage that we can obtain and our ability to
obtain
coverage at reasonable rates. There are certain types of losses,
generally of a
catastrophic nature, such as earthquakes and floods or terrorist
acts that may
be uninsurable or may be too expensive to insure. As a result, we
may not be
successful in obtaining insurance without increases in cost or decreases
in
coverage levels. In addition, we may carry insurance coverage that,
in the event
of a substantial loss, would not be sufficient to pay the full current
market
value or current replacement cost of our lost investment or that
of hotel
owners, or in some cases could also result in certain losses being
uninsured. As
a result, we could lose all, or a portion of, the capital we have
invested in a
property, as well as the anticipated future revenue from the property.
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 hotel rooms and corporate apartments, or limit the prices that
we are able
to obtain for them, both of which could adversely affect our revenues.
Our
quarterly 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.
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 consumer 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 services will be offered at individual service outlets located
in our
hotel chain, 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 Hotel 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 candidates, 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 in the United
States and
other developed countries. In addition, relative 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 do
not develop, 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 is lower in China than those
in the
United States and other developed countries. Since the Internet is
not yet a
well-proven 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
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.
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.
All
of
our operations are or will be conducted through Tianma and Quo Advertising,
which we collectively refer to as our PRC operating subsidiaries,
and through
our contractual arrangements with several of our consolidated affiliates
in
China.
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. All of our advertising business is currently provided through
Quo
Advertising, which is currently owned by two PRC citizens designated
by us. Quo
Advertising holds the requisite licenses to provide advertising services
in
China. We continue to be dependent on Quo Advertising to operate
our advertising
business for the near future. We have entered into agreements with
the
shareholders of Quo Advertising, which provide us with the substantial
ability
to control Quo Advertising and its future subsidiaries.
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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•
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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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•
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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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•
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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 with our PRC operating affiliates
and their
subsidiaries and 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.
These contractual arrangements may not be as effective in providing
us with
control over Tianma and Quo Advertising and their subsidiaries as
direct
ownership. Currently, if our PRC operating affiliates or any of their
subsidiaries and shareholders fails to perform their respective obligations
under these contractual 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 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, 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 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.
Our
business operations may be affected by legislative or regulatory
changes.
There
are
no existing PRC laws or regulations that define or regulate out-of-home
television. It has been reported that the relevant PRC government
authorities
are currently considering adopting new regulations governing out-of-home
television advertising. We cannot predict the timing and effects
of such new
regulations. 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%-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 ability to compete in the advertising industry
in China.
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 determine to finance Tianma or Quo Advertising by means of capital
contributions. These capital contributions to Tianma or Quo Advertising
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, our ability to use the proceeds of this offering and to
capitalize
our PRC operations would be negatively affect our liquidity and ability
to
expand the business.
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 Chin Tong Hui who is our founder,
Chairman and
Chief Executive Officer, and Daniel Kuen Kwok 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.
Our
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 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 and Quo Advertising. 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 operation, 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 and Quo
Advertising.
Although
we had conducted due diligence with respect to the acquisition of
Tianma and Quo
Advertising, 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.
The
unaudited pro forma financial information included in this annual
report may
differ significantly from the actual consolidated financial
information.
The
results of operations of Tianma have been included in our consolidated
statement
of operations since the completion of the acquisition on June 16,
2006. It may
contain some adjustments that are based on estimates. We did not
intend to show
how Tianma would have actually performed if the acquisition had in
fact occurred
from the beginning of the fiscal year or to project the results of
operations or
financial position.
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 report that are not residents of the United States.
We
need additional funds to expand our business through 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 require funding for
capital
investment in acquiring target companies and carrying out numerous
projects. To
raise funds, we need to issue new equity, 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
our adequacy
in the internal control measures over our financial reporting, as
required by
Section 404
of the U.S. Sarbanes-Oxley Act, for the fiscal year ending
December 31,
2007, we may be adversely affected.
As
a
public company, we are subject to report our internal control structure
and
procedures for financial reporting in our annual reports on Form
10-KSB, as a
requirement of Section 404 of the U.S. Sarbanes-Oxley Act of 2002 by the
U.S. Securities and Exchange Commission (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.
The
auditor's report is required for financial year ending December 31,
2008. It is possible that our management cannot attest our effectiveness
in
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 accountants
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 NASD has adopted rules
that require that in recommending an investment to a customer, a
broker-dealer
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 that their customers buy our common stock,
which may
limit your ability to buy and sell our stock and 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
declared by
the Board of Directors out of funds available. 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.
Item
3. Controls and Procedures
As
required by Rule 13a-15 under the Exchange Act, as of the end of
the period
covered by this quarterly report, being March 31, 2007, we have carried
out an
evaluation of the effectiveness of the design and operation of our
company's
disclosure controls and procedures. This evaluation was carried out
under the
supervision and with the participation of our company's management,
including
our company's Chief Executive Officer along with our company's Chief
Financial
Officer. Based upon that evaluation, our company's Chief Executive
Officer along
with our company's Chief Financial Officer concluded that our company's
disclosure controls and procedures are effective as at the end of
the period
covered by this report. There have been no significant changes in
our company's
internal controls over financial reporting that occurred during our
most recent
fiscal quarter that have materially affected, or are reasonably likely
to
materially affect our internal controls over financial reporting.
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 is 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.
PART
II - OTHER INFORMATION
Item
1. Legal Proceedings
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, 2007 and
the
management’s opinion as to the likelihood of loss in respect of loss
contingency.
The
Company’s 55%-owned subsidiary, Tianma, is a defendant to proceedings brought
in
the Guangzhou Yuexiu District Court. The proceedings were finalized
on October
9, 2006. The facts surrounding the proceeding were 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 ($275,000) 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 ($262,500)
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 the chance of
overturning the court’s decision is high. 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, 2007.
Item2.
Unregistered Sales of Equity Securities and Use of Proceeds
In
January 2007, the Company issued 300,000 shares of restricted common
stock with
a fair value of $843,600 as part of the purchase consideration for
acquisition
of Quo Advertising.
Item
3. Default Upon Senior Securities
None.
Item
4. Submission of Matters to a Vote of Security Holders
None.
None.
Exhibit
No. Description
|
31.1
|
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
|
|
|
|
31.2
|
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
|
|
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of
the Sarbanes-Oxley Act of 2002
|
|
|
|
32.2
|
Certification
pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of
the Sarbanes-Oxley Act of 2002
|
In
accordance with the requirements of the Exchange Act, the Registrant
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 18, 2007
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By:
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/s/
GODFREY CHIN TONG HUI
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Godfrey
Chin Tong Hui,
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Chief
Executive Officer
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Date:
May 18, 2007
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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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EXHIBIT
INDEX
|
31.1
|
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
|
|
|
|
31.2
|
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
|
|
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of
the Sarbanes-Oxley Act of 2002
|
|
|
|
32.2
|
Certification
pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of
the Sarbanes-Oxley Act of 2002
|
58