NETWORK CN INC - Quarter Report: 2008 September (Form 10-Q)
U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
|
x
|
QUARTERLY
REPORT PURSUANT TO
SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the quarterly
period ended September 30,
2008
|
o
|
TRANSITION
REPORT PURSUANT
TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from ____ to ____
Commission
file number 000-30264
NETWORK CN
INC.
(Exact
name of Registrant as specified in its charter)
|
Delaware
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90-0370486
|
|
(State
or Other Jurisdiction of
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(I.R.S.
Employer
|
|
Incorporation
or Organization)
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Identification
Number)
|
21/F.,
Chinachem Century Tower, 178 Gloucester Road, Wanchai, Hong
Kong
(Address
of principal executive offices)
(852)
2833-2186
(Registrant’s
Telephone Number, Including International Code and Area Code)
Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes x No¨
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ¨ | Accelerated filer ¨ | Non- accelerated filer x | Smaller reporting company ¨ |
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes¨ No x
As of
November 5, 2008, 71,641,608 shares of the Registrant’s common stock, par value
$0.001 per share, were outstanding.
NETWORK CN INC. AND SUBSIDIARIES
FORM
10-Q
INDEX
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Page
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PART I. FINANCIAL INFORMATION
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4
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5
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6
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7
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40
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62
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62
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PART
II. OTHER INFORMATION
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64
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64
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84
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84
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84
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85
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86
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All
financial information in this Quarterly Report on Form 10-Q for the quarter
ended September 30, 2008 (“Quarterly Report”) is in United States dollars,
referred to as “U.S. Dollars” or “$”.
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
quarterly report on Form 10-Q (“Quarterly Report”) contains forward-looking
statements about our business, financial condition and prospects based on our
current expectations, assumptions, estimates and projections about us and our
industry. These forward-looking statements are subject to known and unknown
risks, uncertainties and other factors that may cause our actual results, levels
of activity, performance and achievements to be materially
different from or worse than our expectations. These risks, uncertainties
and other factors include those listed under Part I- Item 3 “Quantitative
and Qualitative Disclosure About Market Risk” and Part II - Item
1A “Risk Factors" and elsewhere in this Quarterly Report, and some of which
we may not know. Forward-looking statements are all statements that concern
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are other than statements of
historical fact, including, but not limited to, those that are identified by the
use of terminology such as "may", "will", "should", "expects", "plans",
"anticipates", "believes", "estimates", "predicts", "potential", "continue" or
the negative of these terms or other comparable terminology.
Unless
otherwise required by law, we assume no obligation to update or otherwise revise
the forward-looking statements in this Quarterly Report, whether as a result of
new information, future events or otherwise. Because of these risks,
uncertainties and assumptions, the forward-looking events and circumstances
discussed in this Quarterly Report might not occur in the way we expect, or at
all. Accordingly, you should not place undue reliance on any forward-looking
information. Also, forward-looking statements represent our management's beliefs
and assumptions only as of the date of this Quarterly Report. You should read
this Quarterly Report on Form 10-Q and the documents that we have filed as
exhibits to this Quarterly Report completely and with the understanding
that future results could differ materially from those contemplated by the
forward-looking statements.
PART
I – FINANCIAL INFORMATION
Item 1. Financial Statements
NETWORK CN INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
Note
|
As
of
September
30,
2008
(Unaudited)
|
As
of
December
31,
2007
(Audited)
(Restated)(1)
|
||||||||||
|
ASSETS
|
||||||||||||
|
Current
Assets
|
||||||||||||
|
Cash
|
$ | 10,041,572 | $ | 2,233,528 | ||||||||
|
Accounts receivable, net
|
1,397,952 | 1,093,142 | ||||||||||
|
Prepayments for advertising operating rights,
net
|
7 | 4,971,254 | 13,636,178 | |||||||||
|
Prepaid expenses and other current
assets
|
6,566,043 | 3,101,699 | ||||||||||
|
Total Current Assets
|
22,976,821 | 20,064,547 | ||||||||||
|
Equipment,
Net
|
5,702,498 | 257,403 | ||||||||||
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Intangible
Assets, Net
|
8 | 7,860,451 | 6,114,550 | |||||||||
|
Deferred
Charges, Net
|
1,357,494 | 670,843 | ||||||||||
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TOTAL ASSETS
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$ | 37,897,264 | $ | 27,107,343 | ||||||||
|
LIABILITIES AND STOCKHOLDERS’
EQUITY
|
||||||||||||
|
Current
Liabilities
|
||||||||||||
|
Accounts payable, accrued expenses and other
payables
|
$ | 5,630,078 | $ | 3,490,586 | ||||||||
|
Current liabilities from discontinued
operations
|
3,655 | 3,655 | ||||||||||
|
12%
convertible promissory note, net
|
9 | - | 4,740,796 | |||||||||
|
Total Current Liabilities
|
5,633,733 | 8,235,037 | ||||||||||
|
3%
Convertible Promissory Notes Due 2011, Net
|
9 | 29,463,745 | 7,885,496 | |||||||||
|
TOTAL LIABILITIES
|
35,097,478 | 16,120,533 | ||||||||||
|
COMMITMENTS
AND CONTINGENCIES
|
10 | |||||||||||
|
MINORITY
INTERESTS
|
133,388 | 347,874 | ||||||||||
|
STOCKHOLDERS’
EQUITY
|
||||||||||||
|
Preferred
stock, $0.001 par value, 5,000,000 shares authorized
None
issued and outstanding
|
- | - | ||||||||||
|
Common
stock, $0.001 par value, 800,000,000 shares authorized
Issued
and outstanding: 71,611,608 and 69,151,608 as of
September
30, 2008 and December 31, 2007 respectively
|
71,612 | 69,152 | ||||||||||
|
Additional
paid-in capital
|
11 | 58,725,898 | 35,673,586 | |||||||||
|
Accumulated
deficit
|
(57,903,100 | ) | (25,169,099 | ) | ||||||||
|
Accumulated
other comprehensive income
|
1,771,988 | 65,297 | ||||||||||
|
TOTAL
STOCKHOLDERS’ EQUITY
|
2,666,398 | 10,638,936 | ||||||||||
|
TOTAL LIABILITIES AND STOCKHOLDERS’
EQUITY
|
$ | 37,897,264 | $ | 27,107,343 | ||||||||
|
(1)
|
See
Note 4 – Restatement and
Reclassification
|
The
accompanying notes are an integral part of the condensed consolidated financial
statements.
NETWORK CN INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND
2007
(Unaudited)
|
For
the Three Months ended
|
For
the Nine Months Ended
|
|||||||||||||||||||
|
Note
|
September
30,
2008
|
September
30,
2007
|
September
30,
2008
|
September
30,
2007
|
||||||||||||||||
|
REVENUES
|
||||||||||||||||||||
|
Advertising
services
|
$ | 2,520,474 | $ | 466,071 | $ | 4,158,529 | $ | 965,995 | ||||||||||||
|
COST
OF REVENUES
|
||||||||||||||||||||
|
Cost
of advertising services
|
5,651,467 | 350,325 | 14,258,071 | 706,698 | ||||||||||||||||
|
GROSS
(LOSS) PROFIT
|
(3,130,993 | ) | 115,746 | (10,099,542 | ) | 259,297 | ||||||||||||||
|
OPERATING
EXPENSES
|
||||||||||||||||||||
|
Selling
and marketing
|
656,114 | 105,847 | 2,120,397 | 225,092 | ||||||||||||||||
|
General
and administrative
|
4,408,534 | 3,215,893 | 9,929,559 | 8,500,827 | ||||||||||||||||
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Non-cash
impairment charges
|
7 | 5,671,782 | - | 5,671,782 | - | |||||||||||||||
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Total Operating Expenses
|
10,736,430 | 3,321,740 | 17,721,738 | 8,725,919 | ||||||||||||||||
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LOSS
FROM OPERATIONS
|
(13,867,423 | ) | (3,205,994 | ) | (27,821,280 | ) | (8,466,622 | ) | ||||||||||||
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OTHER
INCOME
|
||||||||||||||||||||
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Interest
income
|
21,257 | 2,989 | 61,412 | 11,933 | ||||||||||||||||
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Other
income
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- | - | 4 | 74 | ||||||||||||||||
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Total Other Income
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21,257 | 2,989 | 61,416 | 12,007 | ||||||||||||||||
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INTEREST
EXPENSE
|
||||||||||||||||||||
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Amortization
of deferred charges and debt discount
|
9 | 1,392,116 | - | 4,091,104 | - | |||||||||||||||
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Interest
expense
|
383,334 | - | 1,109,125 | 421 | ||||||||||||||||
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Total Interest Expense
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1,775,450 | - | 5,200,229 | 421 | ||||||||||||||||
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NET
LOSS BEFORE INCOME TAXES AND MINORITY INTERESTS
|
(15,621,616 | ) | (3,203,005 | ) | (32,960,093 | ) | (8,455,036 | ) | ||||||||||||
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Income
taxes
|
- | - | - | - | ||||||||||||||||
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Minority
interests
|
75,209 | (4,014 | ) | 183,452 | (4,014 | ) | ||||||||||||||
|
NET
LOSS FROM CONTINUING OPERATIONS
|
(15,546,407 | ) | (3,207,019 | ) | (32,776,641 | ) | (8,459,050 | ) | ||||||||||||
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DISCONTINUED
OPPERATIONS
|
||||||||||||||||||||
|
Income
(loss) from discontinued operations, net of income taxes and
minority
interests
|
14 | 5,956 | 3,025 | (23,445 | ) | (121,869 | ) | |||||||||||||
|
Gain
from disposal of discontinued operations
|
14 | 66,085 | - | 66,085 | - | |||||||||||||||
|
NET
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
|
72,041 | 3,025 | 42,640 | (121,869 | ) | |||||||||||||||
|
NET
LOSS
|
$ | (15,474,366 | ) | $ | (3,203,994 | ) | $ | (32,734,001 | ) | $ | (8,580,919 | ) | ||||||||
|
OTHER
COMPREHENSIVE INCOME
|
||||||||||||||||||||
|
Foreign
currency translation gain (loss)
|
78,276 | (10,517 | ) | 1,706,691 | 1,937 | |||||||||||||||
|
COMPREHENSIVE
LOSS
|
$ | (15,396,090 | ) | $ | (3,214,511 | ) | $ | (31,027,310 | ) | $ | (8,578,982 | ) | ||||||||
|
NET
INOME (LOSS) PER COMMON SHARE – BASIC AND DILUTED
|
||||||||||||||||||||
|
Loss
per common share from continuing operations
|
13 | $ | (0.22 | ) | $ | (0.05 | ) | $ | (0.46 | ) | $ | (0.13 | ) | |||||||
|
Income
(loss) per common share from discontinued operations
|
13 | 0.00 | 0.00 | 0.00 | (0.00 | ) | ||||||||||||||
|
Net
loss per common share – basic and diluted
|
13 | $ | (0.22 | ) | $ | (0.05 | ) | $ | (0.46 | ) | $ | (0.13 | ) | |||||||
|
WEIGHTED
AVERAGE SHARES OUTSTANDING – BASIC AND DILUTED
|
13 | 71,597,478 | 68,947,906 | 71,563,688 | 68,355,391 | |||||||||||||||
The
accompanying notes are an integral part of the condensed consolidated financial
statements.
NETWORK CN INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(Unaudited)
|
For
the Nine Months Ended
|
||||||||
|
September
30,
2008
|
September
30,
2007
|
|||||||
|
CASH FLOWS FROM OPERATING
ACTIVITIES:
|
$ | $ | ||||||
|
Net
loss from continuing operations
|
(32,776,641 | ) | (8,459,050 | ) | ||||
|
Net
income (loss) from discontinued operations
|
42,640 | (121,869 | ) | |||||
|
Net
loss
|
(32,734,001 | ) | (8,580,919 | ) | ||||
|
Adjustments
to reconcile net loss to net cash used in operating activities, including
discontinued operations:
|
||||||||
|
Depreciation and amortization:
|
||||||||
|
Equipment
and intangible assets
|
1,427,317 | 321,278 | ||||||
|
Deferred
charges and debt discount
|
4,091,105 | - | ||||||
|
Stock-based compensation for
service
|
2,476,469 | 4,477,566 | ||||||
|
Loss on disposal of
equipment
|
88,340 | - | ||||||
|
Allowance for doubtful debt for other
receivables
|
1,411,287 | 10,716 | ||||||
|
Non-cash impairment
charges
|
5,671,782 | - | ||||||
|
Minority interests
|
(122,723 | ) | 3,147 | |||||
|
Gain from disposal of discontinued
operations
|
(66,085 | ) | - | |||||
|
Changes
in operating assets and liabilities, net of effects from
acquisitions:
|
||||||||
|
Accounts
receivable
|
(1,346,591 | ) | (842,149 | ) | ||||
|
Prepayments for advertising operating rights
|
2,288,156 | - | ||||||
|
Prepaid expenses and other current
assets
|
(2,316,952 | ) | (2,445,651 | ) | ||||
|
Accounts payable, accrued expenses and
other payables
|
3,121,568 | 5,051,781 | ||||||
|
Net cash used in operating
activities
|
(16,010,328 | ) | (2,004,231 | ) | ||||
|
CASH FLOWS FROM INVESTING
ACTIVITIES:
|
||||||||
|
Purchase
of equipment
|
(3,469,003 | ) | (58,491 | ) | ||||
|
Proceeds
from sales of equipment
|
1,789 | - | ||||||
|
Net
cash used in acquisition of subsidiaries, net
|
(2,708,928 | ) | (318,156 | ) | ||||
|
Proceeds
from disposal of discontinued operations, net of cash disposed
of
|
(472,827 | ) | - | |||||
|
Net cash used in investing
activities
|
(6,648,969 | ) | (376,647 | ) | ||||
|
CASH FLOWS FROM FINANCING
ACTIVITIES:
|
||||||||
|
Proceeds
from issuance of 3% convertible promissory note, net of
costs
|
33,900,000 | - | ||||||
|
Repayment
of 12% convertible promissory note
|
(5,000,000 | ) | - | |||||
|
Stock
issued in placement for cash, net of costs
|
- | 1,500,000 | ||||||
|
Warrant
issued for services
|
- | 22,500 | ||||||
|
Repayment
of capital lease obligation
|
- | (3,120 | ) | |||||
|
Net cash provided by financing
activities
|
28,900,000 | 1,519,380 | ||||||
|
EFFECT
OF EXCHANGE RATE CHANGES ON CASH
|
1,567,341 | (1,978 | ) | |||||
|
NET
INCREASE (DECREASE) IN CASH
|
7,808,044 | (863,476 | ) | |||||
|
CASH,
BEGINNING OF PERIOD
|
2,233,528 | 2,898,523 | ||||||
|
CASH, END OF PERIOD
|
$ | 10,041,572 | $ | 2,035,047 | ||||
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
||||||||
|
Cash
paid during the period for:
|
||||||||
|
Income taxes
|
$ | - | $ | - | ||||
|
Interest
paid for 12% convertible promissory note
|
$ | 69,041 | $ | - | ||||
|
Interest
paid for capital lease arrangement
|
$ | - | $ | 423 | ||||
|
Non-cash
activities:
|
||||||||
|
Issuance of common stock for acquisition of subsidiaries (Note 6)
|
$ | 3,738,000 | $ | - | ||||
SUPPLEMENTAL
DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:
In
January 2008, the Company acquired 100% equity interest of Cityhorizon
Limited (“Cityhorizon BVI”), a British Virgin Islands company. The Company
issued 1,500,000 shares of restricted common stock of par value of $0.001 each,
totaling $3,738,000 as part of the consideration.
The
accompanying notes are an integral part of the condensed consolidated financial
statements.
NETWORK CN INC. AND SUBSIDARIES
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL
STATEMENTS
(UNAUDITED)
NOTE
1. INTERIM FINANCIAL
STATEMENT
The
accompanying unaudited condensed consolidated financial statements of Network CN
Inc., its subsidiaries and variable interest entities (collectively “NCN” or the
“Company”) have been prepared in accordance with generally accepted accounting
principles in the United States (“GAAP”) 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 our financial position and results of
operations.
The
condensed consolidated financial statements for the three and nine months ended
September 30, 2008 and 2007 were not audited. 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 full fiscal year. The year-end condensed
balance sheet data was derived from audited financial statements, but does not
include all disclosures required by accounting principles generally accepted in
the United States of America.
The
accompanying unaudited condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and notes
thereto included in the Company’s Annual Report on Form 10-KSB, Form 10-KSB/A
(Amendment No. 1) and Form 10-KSB/A (Amendment No. 2) for the fiscal year ended
December 31, 2007, previously filed with the Securities and Exchange Commission
on March 24, 2008, August 11, 2008 and October 22, 2008
respectively.
NOTE
2. ORGANIZATION AND PRINCIPAL
ACTIVITIES
Network
CN Inc., originally incorporated on September 10, 1993, is a Delaware
corporation with headquarters in the Hong Kong Special Administrative Region,
the People’s Republic of China (the “PRC” or “China”). The Company is focused on
building a nationwide media network in China.
During
the three months ended September 30, 2008, the Company disposed of its entire
travel network. Accordingly, such business has been classified as discontinued
operations for all periods presented. (See Note 14 – Discontinued Operations for
details).
Details
of the Company’s principal subsidiaries and variable interest entities as of
September 30, 2008 are described in Note 5 – Subsidiaries and Variable Interest
Entities.
NOTE
3. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
(A) Basis of
Preparation
These
financial statements were prepared on a going concern basis. The Company has
determined that the going concern basis of preparation is appropriate based on
its estimates and judgments of future performance of the Company, future events
and projected cash flows. At each balance sheet date, the Company evaluates its
estimates and judgments as part of its going concern assessment. Based on its
assessment, the Company believes there are sufficient financial and cash
resources to finance the Company as a going concern in the next twelve months.
Accordingly, management has prepared the financial statements on a going concern
basis.
(B) Principles of
Consolidation
The
condensed consolidated financial statements include the financial statements of
Network CN Inc., its subsidiaries and variable interest entities. Variable
interest entities are those entities in which the Company, through contractual
arrangements, bears the risks of, and enjoys the rewards normally associated
with ownership of the entities, and therefore the Company is the primary
beneficiary of these entities. In accordance with FASB Interpretation No. 46R
Consolidation of Variable Interest Entities ("FIN 46R"), the primary
beneficiary is required to consolidate the variable interest entities for
financial reporting purposes. All significant intercompany transactions and
balances have been eliminated upon consolidation.
(C) Use of
Estimates
In
preparing condensed consolidated financial statements in conformity with GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities as of the date of the financial statements and the
reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates. Differences from those estimates are
reported in the period they become known and are disclosed to the extent they
are material to the condensed consolidated financial statements taken as a
whole.
(D) Cash and Cash
Equivalents
Cash
includes cash on hand, cash accounts, and interest bearing savings accounts
placed with banks and financial institutions. For the purposes of the cash flow
statements, the Company considers all highly liquid investments with original
maturities of three months or less at the time of purchase to be cash
equivalents. As of September 30, 2008 and 2007, the Company had no cash
equivalents.
(E) Allowance for Doubtful
Accounts
Allowance
for doubtful accounts is made against accounts receivable to the extent they are
considered to be doubtful. Accounts receivable in the balance sheet are stated
net of such allowance. The Company records its allowance for doubtful accounts
based upon its assessment of various factors. The Company considers historical
experience, the age of the accounts receivable balances, the credit quality of
its customers, current economic conditions, and other factors that may affect
customers’ ability to pay to determine the level of allowance
required.
(F) Prepayments for Advertising Operating Rights
Prepayments
for advertising operating rights are measured at cost less accumulated
amortization and impairment losses. Cost includes prepaid expenses directly
attributable to the acquisition of advertising operating rights. Such prepaid
expenses are in general charged to the consolidated statements of
operations on a straight-line basis over the operating period. All the costs
expected to be amortized after 12 months of the balance sheet date are
classified as non-current assets.
An
impairment loss is recognized when the carrying amount of the prepayments for
advertising operating rights exceeds the sum of the undiscounted cash flows
expected to be generated from the advertising operating right’s use and eventual
disposition. An impairment loss is measured as the amount by which the carrying
amount exceeds the fair value of the asset calculated using a discounted cash
flow analysis.
(G) Equipment, Net
Equipment
is stated at cost less accumulated depreciation. Depreciation is provided using
the straight-line method over the estimated useful life as follows:
|
Media
display equipment
|
|
5 -
7 years
|
|
Office
equipment
|
|
3 - 5
years
|
|
Furniture
and fixtures
|
|
3 -
5 years
|
|
Leasehold
improvements
|
|
Over
the unexpired lease
terms
|
Construction
in progress is carried at cost less impairment losses, if any. It relates to
construction of media display equipment. No provision for depreciation is made
on construction in progress until the relevant assets are completed and put into
use.
When
equipment is retired or otherwise disposed of, the related cost and accumulated
depreciation are removed from the respective accounts, and any gain or loss is
reflected in the statement of operations. Repairs and maintenance costs on
equipment are expensed as incurred.
(H) Intangible Assets, Net
Intangible
assets are stated at cost less accumulated amortization and provision for
impairment loss. Intangible assets that have indefinite useful lives are not
amortized. Other intangible assets with finite useful lives are amortized on a
straight-line basis over their estimated useful lives of 16 months to 20 years.
The amortization methods and estimated useful lives of intangible assets are
reviewed regularly.
(I) Impairment of Long-Lived
Assets
Long-lived
assets, including intangible assets with definite lives, are reviewed for
impairment whenever events or changes in circumstance indicate that the carrying
amount of the assets may not be recoverable. An intangible asset that is not
subject to amortization is reviewed for impairment annually or more frequently
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. An impairment loss is recognized when the
carrying amount of a long-lived asset and intangible asset exceeds the sum of
the undiscounted cash flows expected to be generated from the asset’s use and
eventual disposition. An impairment loss is measured as the amount by which the
carrying amount exceeds the fair value of the asset calculated using a
discounted cash flow analysis.
(J) Deferred Charges,
Net
Deferred
charges are fees and expenses directly related to the issuance of convertible
promissory notes, including placement agents’ fee. Deferred charges are
capitalized and amortized over the life of the convertible promissory notes
using the effective yield method. Amortization of deferred charges is included
in interest expense on the consolidated statement of operations while the
unamortized balance is included in deferred charges on the consolidated balance
sheet.
(K) Convertible Promissory Notes and
Warrants
In 2007,
the Company issued 12% convertible promissory note and warrants and 3%
convertible promissory notes and warrants. In 2008, the Company issued
additional 3% convertible promissory notes and warrants. As of September 30,
2008 and December 31, 2007, the warrants and embedded conversion feature were
classified as equity under Emerging Issues Task Force (“EITF”) Issue No. 00-19
“Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock” and met the other criteria in paragraph 11(a) of Statement of
Financial Accounting Standards (“SFAS”) No.133 “Accounting for Derivative
Instruments and Hedging Activities”. Such classification will be
reassessed at each balance sheet date. The Company allocated the proceeds of the
convertible promissory notes between convertible promissory notes and the
financial instruments related to warrants associated with convertible promissory
notes based on their relative fair values at the commitment date. The fair value
of the financial instruments related to warrants associated with convertible
promissory notes was determined utilizing the Black-Scholes option pricing model
and the respective allocated proceeds to the warrants is recorded in additional
paid-in capital. The embedded beneficial conversion feature associated with
convertible promissory notes was recognized and measured by allocating a portion
of the proceeds equal to the intrinsic value of that feature to additional
paid-in capital in accordance with EITF Issue No. 98-5 “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio” and EITF Issue No. 00-27 “Application of Issue No. 98-5 to
Certain Convertible Instruments”.
The
portion of debt discount resulting from the allocation of proceeds to the
financial instruments related to warrants associated with convertible promissory
notes is being amortized to interest expense over the life of the convertible
promissory notes, using the effective yield method. For the portion of debt
discount resulting from the allocation of proceeds to the beneficial conversion
feature, it is amortized to interest expense over the term of the notes from the
respective dates of issuance, using the effective yield method.
(L) Early Redemption of
Convertible Promissory Notes
Should
early redemption of convertible promissory notes occur, the unamortized portion
of the associated deferred charges and debt discount would be fully written off
and any early redemption premium will be recognized as expense upon its
occurrence. All related charges, if material, would be aggregated and included
in a separate line “charges on early redemption of convertible promissory
notes”. Such an expense would be included in ordinary activities on the
consolidated statement of operations as required by SFAS No.145 “Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections”.
Pursuant
to the provisions of agreements in connection with the 3% convertible promissory
notes, in the event of a default, or if the Company’s actual EPS in any fiscal
year is less than 80% of the respective EPS target, certain investors may
require the Company to redeem the 3% Convertible Promissory Notes at 100% of the
principal amount, plus any accrued and unpaid interest, plus an amount
representing a 20% internal rate of return on the then outstanding principal
amount The Company accounts for such potential liability of 20% internal rate of
return on the then outstanding principal amount in accordance with SFAS No. 5
“Accounting for
Contingencies”.
(M) Revenue
Recognition
For
advertising services, the Company recognizes revenue in the period when
advertisements are either aired or published. Revenues from advertising barter
transactions are recognized in the period during which the advertisements are
either aired or published. Expenses from barter transactions are recognized in
the period as incurred. Barter transactions are accounted in accordance with
EITF Issue No. 99-17, “Accounting for Advertising Barter
Transactions”, which are recorded at the fair value of the advertising
provided based on the Company’s own historical practice of receiving cash for
similar advertising from buyers unrelated to the counterparty in the barter
transactions. The amounts included in advertising services revenue and general
and administrative for barter transactions were approximately $41,000 and $nil
for the three and nine months ended September 30, 2008 and 2007
respectively.
For hotel
management services, the Company recognizes revenue in the period when the
services are rendered and collection is reasonably assured.
For tour
services, the Company recognizes services-based revenue when the services have
been performed. Guangdong Tianma International Travel Service Co., Ltd.
(“Tianma”) offers independent leisure travelers bundled packaged-tour products
which include both air-ticketing and hotel reservations. Tianma’s packaged-tour
products cover a variety of domestic and international
destinations.
Tianma
organizes inbound and outbound tour and travel packages which can incorporate,
among other things, air and land transportation, hotels, restaurants and tickets
to tourist destinations and other excursions. Tianma books all elements of such
packages with third-party service providers such as airlines, car rental
companies and hotels, or through other tour package providers and then resells
such packages to its clients. A typical sale of tour services is as
follows:
|
1.
|
Tianma,
in consultation with sub-agents, organizes a tour or travel package,
including making reservations for blocks of tickets, rooms, etc. with
third-party service providers. Tianma may be required to make deposits,
pay all or part of the ultimate fees charged by such service providers or
make legally binding commitments to pay such fees. For air-tickets, Tianma
normally books a block of air tickets with airlines in advance and pays
the full amount of the tickets to reserve seats before any tours are
formed. The air tickets are usually valid for a certain period of time. If
the pre-packaged tours do not materialize and are eventually not formed,
Tianma will resell the air tickets to other travel agents or customers.
For hotels, meals and transportation, Tianma usually pays an upfront
deposit of 50-60% of the total cost. The remaining balance is then settled
after completion of the tours.
|
|
2.
|
Tianma,
through its sub-agents, advertises tour and travel packages at prices set
by Tianma and sub-agents.
|
|
3.
|
Customers
approach Tianma or its appointed sub-agents to book an advertised packaged
tour.
|
|
4.
|
The
customers pay a deposit to Tianma directly or through its appointed
sub-agents.
|
|
5.
|
When
the minimum required number of customers (which number is different for
each tour based on the elements and costs of the tour) for a particular
tour is reached, Tianma will contact the customers for tour confirmation
and request full payment. All payments received by the appointed
sub-agents are paid to Tianma prior to the commencement of the
tours.
|
|
6.
|
Tianma
will then make or finalize corresponding bookings with outside service
providers such as airlines, bus operators, hotels, restaurants, etc. and
pay any unpaid fees or deposits to such
providers.
|
Tianma is
the principal in such transactions and the primary obligor to the third-party
providers regardless of whether it has received full payment from its customers.
In addition, Tianma is also liable to the customers for any claims relating to
the tours such as accidents or tour services. Tianma has adequate insurance
coverage for accidental loss arising during the tours. The Company utilizes a
network of sub-agents who operate strictly in Tianma’s name and can only
advertise and promote the business of Tianma with the prior approval of
Tianma.
(N) Stock-based
Compensation
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R “Share-Based
Payment”, a revision to SFAS No. 123 “Accounting for Stock-Based
Compensation”, and superseding APB Opinion No. 25 “Accounting for Stock Issued to
Employees” and its related implementation guidance. Effective January 1,
2006, the Company adopted SFAS No. 123R, using a modified prospective
application transition method, which establishes accounting for stock-based
awards in exchange for employee services. Under this application, the Company is
required to record stock-based compensation expense for all awards granted after
the date of adoption and unvested awards that were outstanding as of the date of
adoption. SFAS No. 123R requires that stock-based compensation cost is measured
at grant date, based on the fair value of the award, and recognized in expense
over the requisite services period.
Common
stock, stock options and warrants issued to other than employees or directors in
exchange for services are recorded on the basis of their fair value, as required
by SFAS No. 123R, which is measured as of the date required by EITF
Issue 96-18 “Accounting
for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services”. In accordance with
EITF 96-18, the non-employee stock options or warrants are measured at
their fair value by using the Black-Scholes option pricing model as of the
earlier of the date at which a commitment for performance to earn the equity
instruments is reached (“performance commitment date”) or the date at which
performance is complete (“performance completion date”). The stock-based
compensation expenses are recognized on a straight-line basis over the shorter
of the period over which services are to be received or the vesting period.
Accounting for non-employee stock options or warrants which involve only
performance conditions when no performance commitment date or performance
completion date has occurred as of reporting date requires measurement at the
equity instruments then-current fair value. Any subsequent changes in the market
value of the underlying common stock are reflected in the expense recorded in
the subsequent period in which that change occurs.
(O) Income
Taxes
The
Company accounts for income taxes under SFAS No. 109 “Accounting for Income
Taxes”. Under SFAS No. 109, deferred tax assets and liabilities are
provided for the future tax effects attributable to temporary differences
between the financial statement carrying amounts of assets and liabilities and
their respective tax bases, and for the expected future tax benefits from items
including tax loss carry forwards.
Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or reversed. Under SFAS No. 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.
(P) Comprehensive Income
(Loss)
The
Company follows SFAS No. 130 “Reporting Comprehensive
Income” for the reporting and display of its comprehensive income (loss)
and related components in the financial statements and thereby reports a measure
of all changes in equity of an enterprise that results from transactions and
economic events other than transactions with the shareholders. Items of
comprehensive income (loss) are reported in both the consolidated statement of
operations and comprehensive loss and the consolidated statement of
stockholders’ equity.
(Q) Earnings (Loss) Per Common
Share
Basic
earnings (loss) per common share are computed in accordance with SFAS
No. 128 “Earnings Per
Share” by dividing the net income (loss) attributable to holders of
common stock by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings (loss) per share is computed by
dividing net income (loss) by the weighted average number of common shares
including the dilutive effect of common share equivalents then
outstanding.
The
diluted net loss per share is the same as the basic net loss per share for the
three and nine months ended September 30, 2008 and 2007 as all potential
ordinary shares including stock options and warrants are anti-dilutive and are
therefore excluded from the computation of diluted net loss per
share.
(R) Operating
Leases
Leases
where substantially all the rewards and risks of ownership of assets remain with
the leasing company are accounted for as operating leases. Payments made under
operating leases are charged to the consolidated statements of operations on a
straight-line basis over the lease period.
(S) Foreign Currency
Translation
The
assets and liabilities of the Company’s subsidiaries denominated in currencies
other than United States (“U.S.”) dollars are translated into U.S. dollars using
the applicable exchange rates at the balance sheet date. For statement of
operations’ items, amounts denominated in currencies other than U.S. dollars
were translated into U.S. dollars using the average exchange rate during the
period. Equity accounts were translated at their historical exchange rates. Net
gains and losses resulting from translation of foreign currency financial
statements are included in the statements of stockholders’ equity as accumulated
other comprehensive income (loss). Foreign currency transaction gains and losses
are reflected in the consolidated statements of operations.
(T) Fair Value of
Financial
Instruments
The
carrying value of the Company’s financial instruments, which consist of cash,
accounts receivables, prepaid expenses and other current assets, accounts
payable, accrued expenses and other payables, approximates fair value due to the
short-term maturities.
The
carrying value of the Company’s financial instruments related to warrants
associated with convertible promissory notes issued in 2007 is stated at a value
being equal to the allocated proceeds of convertible promissory notes based on
the relative fair value of notes and warrants. In the measurement of the fair
value of these instruments, the Black-Scholes option pricing model is utilized,
which is consistent with the Company’s historical valuation techniques. These
derived fair value estimates are significantly affected by the assumptions used.
The allocated value of the financial instruments related to warrants associated
with convertible promissory notes is recorded as an equity, which does not
require to mark-to-market as of each subsequent reporting period.
(U) Concentration of Credit
Risk
The
Company places its cash with various financial institutions. The Company
believes that no significant credit risk exists as these cash investments are
made with high-credit-qualify financial institutions.
All the
revenue of the Company and a significant portion of the Company’s assets are
generated and located in China. The Company’s business activities and accounts
receivables are mainly from tour services and advertising services. Deposits are
usually collected from customers in advance and the Company performs ongoing
credit evaluation of its customers. The Company believes that no significant
credit risk exists as credit loss.
(V) Segmental
Reporting
SFAS No.
131 “Disclosures about
Segments of an Enterprise and Related Information” establishes standards
for reporting information about operating segments on a basis consistent with
the Company’s internal organization structure as well as information about
geographical areas, business segments and major customers in financial
statements. The Company’s operating segments are organized internally primarily
by the type of services rendered. It is the management’s view that the services
rendered by the Company are of three operating segments: Media Network, Travel
Network and Investment Holding. During the three months ended September 30,
2008, the Company disposed of one of the operating segments, Travel Network
which was included in discontinued operation accordingly.
(W) Recent Accounting
Pronouncements
In
September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”.
SFAS No. 157 defined fair value, establishes a framework for measuring fair
value and expands disclosure requirements about fair value measurements. In
February 2008, the FASB released FASB Staff Position No. FAS 157-2 “Effective Date of FASB Statement No.
157”, which delayed the effective date of SFAS No. 157 for all
nonfinancial assets and liabilities, expect those that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). The
provisions of SFAS No. 157 are effective for fair value measurements made in
fiscal years beginning after November 15, 2007. The adoption of this statement
did not have a material effect on the Company's future reported financial
position or results of operations.
In
February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
159 “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB
Statement No. 115”. This statement permits entities to choose to measure
many financial instruments and certain other items at fair value. Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option. However, the amendment to SFAS No. 115 “Accounting for Certain Investments
in Debt and Equity Securities” applies to all entities with
available-for-sale and trading securities. SFAS No. 159 is effective as of the
beginning of an entity’s first fiscal year that begins after November 15, 2007.
Early adoption is permitted as of the beginning of a fiscal year that begins on
or before November 15, 2007, provided the entity also elects to apply the
provision of SFAS No. 157 “Fair Value Measurements”. The
adoption of this statement did not have a material effect on the Company's
financial statements.
In
December 2007, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141 (Revised), “Business Combinations”
(“SFAS No. 141 (R)”), replacing SFAS No. 141, “Business Combinations” (“SFAS No. 141”),
and SFAS No. 160 “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51”.
SFAS No. 141(R) retains the fundamental requirements of
SFAS No. 141, broadens its scope by applying the acquisition method to
all transactions and other events in which one entity obtains control over one
or more other businesses, and requires, among other things, that assets
acquired and liabilities assumed be measured at fair value as of the
acquisition date, that liabilities related to contingent consideration
be recognized at the acquisition date and re-measured at fair
value in each subsequent reporting period, that acquisition-related costs
be expensed as incurred, and that income be recognized if the fair
value of the net assets acquired exceeds the fair value of the
consideration transferred. SFAS No. 160 improves the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements by establishing
accounting and reporting standards that require; the ownership interests in
subsidiaries held by parties other than the parent and the amount of
consolidated net income attributable to the parent and to the noncontrolling
interest be clearly identified and presented on the face of the consolidated
statement of income, changes in a parent’s ownership interest while the parent
retains its controlling financial interest in its subsidiary be accounted for
consistently, when a subsidiary is deconsolidated, any retained noncontrolling
equity investment in the former subsidiary be initially measured at fair value,
entities provide sufficient disclosures that clearly identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners. SFAS No. 160 affects those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate a
subsidiary. SFAS No. 141(R) and SFAS No. 160 are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008. The Company is currently assessing the impact of adopting
SFAS No. 141 (R) and SFAS No. 160 on its financial
statements and related disclosures.
In March
2008, the FASB issued SFAS No. 161 “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133” (SFAS No. 161). This statement is intended to improve
transparency in financial reporting by requiring enhanced disclosures of an
entity’s derivative instruments and hedging activities and their effects on the
entity’s financial position, financial performance, and cash flows. SFAS No. 161
applies to all derivative instruments within the scope of SFAS 133 “Accounting for Derivative
Instruments and Hedging Activities” (SFAS No.133) as well as related
hedged items, bifurcated derivatives, and nonderivative instruments that are
designated and qualify as hedging instruments. Entities with instruments subject
to SFAS No. 161 must provide more robust qualitative disclosures and expanded
quantitative disclosures. SFAS No. 161 is effective prospectively for financial
statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application permitted. The Company
is currently assessing the impact of adopting SFAS No. 161 on its
financial statements and related disclosures.
In
May 2008, the FASB issued SFAS No. 162 “The Hierarchy of Generally Accepted
Accounting Principles.” SFAS No. 162 identifies the sources of accounting
principles and the framework for selecting the accounting principles to be used.
Any effect of applying the provisions of this statement will be reported as a
change in accounting principle in accordance with SFAS No. 154 “Accounting Changes and Error
Corrections”. SFAS No. 162 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008. The
Company is currently evaluating the impact the adoption of this statement could
have on its financial condition, results of operations and cash
flows.
In May
2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee
Insurance Contracts, an interpretation of FASB Statement No. 60.” The
scope of this Statement is limited to financial guarantee insurance (and
reinsurance) contracts, as described in this Statement, issued by enterprises
included within the scope of Statement 60. Accordingly, this Statement does not
apply to financial guarantee contracts issued by enterprises excluded from the
scope of Statement 60 or to some insurance contracts that seem similar to
financial guarantee insurance contracts issued by insurance enterprises (such as
mortgage guaranty insurance or credit insurance on trade receivables). This
Statement also does not apply to financial guarantee insurance contracts that
are derivative instruments included within the scope of FASB Statement No. 133,
“Accounting for Derivative
Instruments and Hedging Activities”. This Statement will not have any
impact on the Company’s consolidated financial statements.
In May
2008, the FASB issued Staff Position No. APB 14-1 “Accounting for Convertible Debt
Instruments that May be Settled in Cash Upon Conversion”. APB 14-1
requires that the liability and equity components of convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement) be separately accounted for in a manner that reflects an issuer’s
nonconvertible debt borrowing rate. The resulting debt discount is amortized
over the period the convertible debt is expected to be outstanding as additional
non-cash interest expense. APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. Retrospective application to all periods presented is
required except for instruments that were not outstanding during any of the
periods that will be presented in the annual financial statements for the period
of adoption but were outstanding during an earlier period. The Company is
currently evaluating the impact of the adoption of this position could have on
its financial condition, results of operations and cash flows.
In June
2008, the FASB issued Emerging Issues Task Force Issue No. 07-5 “Determining whether an Instrument
(or Embedded Feature) is indexed to an Entity’s Own Stock” (“EITF No.
07-5”). This Issue is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years. Early application is not permitted. Paragraph 11(a) of Statement of
Financial Accounting Standard No 133 “Accounting for Derivatives and
Hedging Activities” (“SFAS No.133”) specifies that a contract that would
otherwise meet the definition of a derivative but is both (a) indexed to
the Company’s own stock and (b) classified in stockholders’ equity in the
statement of financial position would not be considered a derivative financial
instrument. EITF No.07-5 provides a new two-step model to be applied in
determining whether a financial instrument or an embedded feature is indexed to
an issuer’s own stock and thus able to qualify for the SFAS No.133 paragraph
11(a) scope exception. The Company is currently evaluating the impact of
adoption of EITF No. 07-5 on its financial statements and related
disclosures.
In June
2008, FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming
Changes to Issue No. 98-5 (“EITF No. 08-4”)”. The objective of EITF
No.08-4 is to provide transition guidance for conforming changes made to EITF
No. 98-5, “Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios”, that result from EITF No. 00-27 “Application of Issue No. 98-5 to
Certain Convertible Instruments”, and SFAS No. 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity”. This
Issue is effective for financial statements issued for fiscal years ending after
December 15, 2008. Early application is permitted. The Company is currently
evaluating the impact of adoption of EITF No. 08-4 on the accounting for the
convertible notes and related warrants transactions.
NOTE
4. RESTATEMENT AND RECLASSIFICATION
|
(a)
|
Restatement
of Financial Results
|
On
October 10, 2008, we filed a Current Report on Form 8-K to announce
that our Board of Directors, based upon the consideration of issues addressed in
the SEC review and the recommendation of the Audit Committee, determined that we
should restate our previously issued condensed consolidated financial statements
for quarterly periods ended March 31, 2008 and June 30, 2008 and consolidated
financial statements for the year ended December 31, 2007.
The
restatement adjustments corrected the accounting errors arising from our
misapplication of accounting policies to the discount associated with the
beneficial conversion feature attributed to the issuance of the 3% convertible
promissory notes in 2007 and 2008. The Company initially amortized the discount
according to EITF Issue No. 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio”, which stated that discount resulting from allocation
of proceeds to the beneficial conversion feature should be recognized as
interest expense over the minimum period from the date of issuance to the date
of earliest conversion. As the notes are convertible at the date of issuance,
the Company fully amortized such discount through interest expense at the date
of issuance accordingly. However, according to Issue 6 of EITF Issue No.
00-27, “Application of Issue
No. 98-5 to Certain Convertible Instruments”, EITF Issues No. 98-5 should
be modified to require the discount related to the beneficial conversion feature
to be accreted from the date of issuance to the stated redemption date
regardless of when the earliest conversion date occurs using the effective
interest method. The restatement adjustments were to reflect the retrospective
application of the Issue 6 of EITF Issue No. 00-27.
The
aggregate net effect of the restatement was to (1) increase stockholders’ equity
by approximately $14.3 million, $15.1 million and $4.7 million as of June 30,
2008, March 31, 2008 and December 31, 2007 respectively; (2) increase both
non-cash interest expense and net loss for the three months ended June 30, 2008
by approximately $0.8 million and decrease both non-cash interest expense and
net loss for the three months ended March 31, 2008 and for the year ended
December 31, 2008 by approximately $10.4 million and $4.7 million respectively.
Accordingly, the net loss per common share (basic and diluted) for the three
months ended June 30, 2008 and March 31, 2008 increased from $0.11 to $0.12 and
decreased from $0.26 to $0.12 respectively while for the year ended December 31,
2008 decreased from $0.28 to $0.21.
|
(b)
|
Reclassification
|
To better
present the results of the Company, the “by function of expense” method for the
presentation of the statements of operations and comprehensive loss has been
adopted. Comparative amounts for prior periods have been reclassified in order
to achieve a consistent presentation.
In
addition, the Company completed the disposal of travel network during the three
months ended September 30, 2008. As a result of the disposal, the condensed
consolidated financial statements of the Company reflect travel network
operation as discontinued operations for all presented periods. Accordingly,
revenues and costs and expenses of travel network have been excluded from the
respective accounts in the condensed consolidated statements of operations. The
net operating results of the discontinued operations have been reported, net of
applicable income taxes and minority interests, as “Income (Loss) from
Discontinued Operations, Net of Income Taxes and Minority Interests”. For
details, please refer to Note 14 – Discontinued Operations.
The above
reclassification does not have an effect on net loss and net loss per
share.
NOTE
5. SUBSIDIARIES AND VARIABLE
INTEREST ENTITIES
Details
of the Company’s principal consolidated subsidiaries and variable interest
entities as of September 30, 2008 were as follows:
|
Name
|
Place
of
incorporation
|
Ownership
interest
attributable to
the Company
|
Principal activities
|
|
NCN
Group Limited
|
British
Virgin Islands
|
100%
|
Investment
holding
|
|
NCN
Media Services Limited
|
British
Virgin Islands
|
100%
|
Investment
holding
|
|
Crown
Winner International
Limited
|
Hong
Kong
|
100%
|
Investment
holding
|
|
Cityhorizon
Limited
|
Hong
Kong
|
100%
|
Investment
holding
|
|
NCN
Group Management
Limited
|
Hong
Kong
|
100%
|
Provision
of administrative and
management
services
|
|
NCN
Huamin Management
Consultancy
(Beijing)
Company
Limited
|
The
PRC
|
100%
|
Provision
of administrative and
management
services
|
|
Shanghai
Quo Advertising
Company
Limited
|
The
PRC
|
100%
|
Provision
of advertising services
|
|
Xuancaiyi
(Beijing) Advertising
Company
Limited
|
The
PRC
|
51%
|
Provision
of advertising services
|
|
Teda
(Beijing) Hotels
Management
Limited
|
The
PRC
|
100%
|
Dormant;
undergoing liquidation
process
|
|
NCN
Asset Management
Services
Limited
|
British
Virgin Islands
|
100%
|
Dormant
|
|
NCN
Travel Services Limited
|
British
Virgin Islands
|
100%
|
Dormant
|
|
NCN
Financial Services Limited
|
British
Virgin Islands
|
100%
|
Dormant
|
|
Linkrich
Enterprise Advertising
and
Investment Limited
|
Hong
Kong
|
100%
|
Dormant
|
|
Cityhorizon
Limited (Note 6)
|
British
Virgin Islands
|
100%
|
Investment
holding
|
|
Huizhong
Lianhe Media
Technology
Co., Ltd (Note 6)
|
The
PRC
|
100%
|
Provision
of high-tech services
|
|
Beijing
Huizhong Bona Media
Advertising
Co., Ltd. (Note 6)
|
The
PRC
|
100%
|
Provision
of advertising services
|
|
Huizhi
Botong Media
Advertising
Beijing Co., Ltd (Note 6)
|
The
PRC
|
100%
|
Provision
of advertising services
|
|
Crown
Eagle Investment Limited
|
Hong
Kong
|
100%
|
Dormant
|
|
Profit
Wave Investment Limited
|
Hong
Kong
|
100%
|
Dormant
|
|
Qingdao
Zhongan Boyang
Advertising
Co., Ltd.
|
The
PRC
|
60%
|
Provision
of advertising services
|
Remarks
:
|
1)
|
The
Company established its wholly-owned subsidiaries, namely, Crown
Eagle Investment Limited and Profit Wave Investment Limited in January
2008.
|
|
2)
|
The
Company established its subsidiary Qingdao Zhongan Boyang Advertising
Co., Ltd. in March 2008.
|
|
3)
|
The
Company disposed of all its travel network related subsidiaries and
variable interest entity, namely, NCN Management Services Limited, NCN
Hotels Investment Limited, NCN Pacific Hotels Limited, Tianma, NCN
Landmark International Hotel Group Limited and Beijing NCN Landmark Hotel
Management Limited in September 2008. See Note 14 – Discontinued
Operations for details.
|
NOTE
6. BUSINESS
COMBINATIONS
(a) Acquisition
of Cityhorizon BVI
On
January 1, 2008, the Company and its wholly owned subsidiary Cityhorizon Limited
(“Cityhorizon Hong Kong”), a Hong Kong company, entered into a Share Purchase
Agreement with Cityhorizon BVI, Huizhong Lianhe Media Technology Co., Ltd.
(“Lianhe”), a wholly owned subsidiary of Cityhorizon BVI, Beijing Huizhong Bona
Media Advertising Co., Ltd. (“Bona”), a wholly owned subsidiary of Cityhorizon
BVI, and Liu Man Ling, an individual and sole shareholder of Cityhorizon BVI
pursuant to which the Company, through its subsidiary Cityhorizon Hong Kong,
acquired 100% of the issued and outstanding shares of Cityhorizon BVI from Liu
Man Ling. Pursuant to the Share Purchase Agreement, the Company in January 2008
paid the Liu Man Ling US$5,000,000 in cash and issued Liu Man Ling 1,500,000
shares of restricted common stock of par value of $0.001 each, totaling
$3,738,000. The total purchase consideration was $8,738,000. The purpose of the
acquisition was to strengthen the Company’s Media Network in China.
The
acquisition has been accounted for using the purchase method of accounting and
the results of operations of Cityhorizon BVI, Lianhe and Bona have been included
in the Company's consolidated statement of operations since the completion of
the acquisition on January 1, 2008.
The
allocation of the purchase price is as follows:
|
Cash
|
$ | 2,427,598 | ||
|
Prepayments
for advertising operating rights
|
2,450,794 | |||
|
Prepayments
and other current assets
|
170,347 | |||
|
Equipment,
net
|
1,995,702 | |||
|
Intangible
assets, net
|
1,973,865 | |||
|
Liabilities
assumed
|
(280,306 | ) | ||
|
Total
purchase price
|
$ | 8,738,000 |
Intangible
assets represent the acquired application systems developed internally by Lianhe
for controlling LED activities. Based on a valuation performed by an independent
valuer, the fair value of the acquired application systems as of the date of
acquisition amounted to RMB31,000,000 (equivalent to US$4,252,564). This fair
value, after deducting negative goodwill of $2,278,699 arising from business
combination with Cityhorizon BVI, Lianhe and Bona, equaled to $1,973,865. Such
net amount was amortized over the useful lives of the application
systems.
(b) Consolidation
of variable interest entity - Botong
On
January 1, 2008, the Company caused its subsidiary, Lianhe, to enter into a
series of commercial agreements with Huizhi Botong Media Advertising Beijing
Co., Ltd (“Botong”), a company organized under the laws of the PRC, and their
respective registered shareholders, pursuant to which Lianhe provides exclusive
technology and management consulting services to Botong in exchange for service
fees amounting to substantially all of the net income of Botong. Each of the
registered PRC shareholders of Botong also entered into equity pledge agreements
and option agreements with Lianhe which cannot be amended or terminated except
by written consent of all parties. Pursuant to these equity pledge agreements
and option agreements, each shareholder pledged such shareholder’s interest in
Botong for the performance of such Botong’s payment obligations under its
respective exclusive technology and management consulting services agreements.
In addition, Lianhe has been assigned all voting rights by the shareholders of
Botong and has the option to acquire the equity interests of Botong at a
mutually agreed purchase price which shall first be used to repay any loans
payable to Lianhe or any affiliate of Lianhe by the registered PRC
shareholders.
In
addition, as of January 1, 2008, Lianhe committed to extend loan totaling
US$137,179 to the registered shareholders of Botong for the purpose of financing
such shareholders’ investment in Botong. Through the above contractual
arrangements, Lianhe becomes the primary beneficiary of Botong which is a
variable interest entity as defined under FIN 46 (Revised) “Consolidation of Variable Interest
Entities”. The results of operations of Botong have been included in the
Company's consolidated statement of operations since January 1,
2008.
On
January 1, 2008, the net assets of Botong were as follows:
|
Cash
|
$ | 653 | ||
|
Prepaid
expenses and other current assets
|
102,154 | |||
|
Equipment,
net
|
599,348 | |||
|
Intangible
asset
|
551,031 | |||
|
Liabilities
assumed
|
(1,116,007 | ) | ||
|
Net
assets
|
$ | 137,179 |
Identifiable
intangible asset with a fair value of $551,031 as of the effective date of
Lianhe and Botong entering into the above contractual arrangements is amortized
over the remaining contract period of Botong’s advertising right.
NOTE
7. PREPAYMENTS FOR ADVERTISING OPERATING
RIGHTS
Prepayments
for advertising operating rights as of September 30, 2008 and December 31,
2007 were as follows:
|
As
of
September
30, 2008
(Unaudited)
|
As
of
December
31, 2007
(Audited)
|
|||||||
|
Gross
carrying amount
|
$ | 25,139,969 | 14,676,513 | |||||
|
Less:
accumulated amortization
|
(14,496,933 | ) | (1,040,335 | ) | ||||
|
Less:
provision for impairment
|
(5,671,782 | ) | -- | |||||
|
Prepayments
for advertising operating rights, net
|
$ | 4,971,254 | 13,636,178 | |||||
Total
amortization expense of prepayments for advertising operating rights of the
Company for the three months ended September 30, 2008 and 2007 were $4,992,495
and $nil respectively while for the nine months ended September 30, 2008 and
2007 amounted to $12,977,200 and $nil respectively.
Provision
for impairment
As the
Company recorded a continuous net loss, the Company performed an impairment
review of its prepayments for advertising operating rights during the quarter
ended September 30, 2008. The Company compared the carrying amount of the
prepayments for advertising operating rights of each project to the sum of the
undiscounted cash flows expected to be generated. For those projects with
carrying values exceeding undiscounted cash flows, the Company determined
their fair values using a discounted cash flow analysis. Accordingly, the
Company recorded an impairment loss of $5,671,782 for the three and nine
months ended September 30, 2008 in relation to the prepayments for certain
advertising operating rights projects. The impairment loss was included
as non-cash impairment charges in the unaudited condensed consolidated
statements of operations for the three and nine months ended September 30,
2008.
NOTE
8. INTANGIBLE ASSETS,
NET
Intangible
assets as of September 30, 2008 and December 31, 2007 were as
follows:
|
|
As
of
September
30, 2008
(Unaudited)
|
As
of
December
31, 2007
(Audited)
|
||||||
|
Amortized
intangible rights
|
||||||||
|
Gross
carrying amount
|
$ | 7,137,097 | 7,825,267 | |||||
|
Less:
accumulated amortization
|
(1,102,470 | ) | (999,106 | ) | ||||
|
Less:
provision for impairment loss
|
- | (711,611 | ) | |||||
|
Amortized
intangible rights, net
|
6,034,627 | 6,114,550 | ||||||
|
Unamortized
intangible rights
|
||||||||
|
Gross
carrying amount
|
- | 815,902 | ||||||
|
Less:
provision for impairment
|
- | (815,902 | ) | |||||
|
Unamortized
intangible rights, net
|
- | - | ||||||
|
Amortized
acquired application systems
|
||||||||
|
Gross
carrying amount
|
$ | 1,973,865 | - | |||||
|
Less:
accumulated amortization
|
(148,041 | ) | - | |||||
|
Amortized
acquired application systems, net
|
1,825,824 | - | ||||||
|
Intangible
assets, net
|
$ | 7,860,451 | 6,114,550 | |||||
During
the three months ended June 30, 2008, the Company wrote-off all the intangible
rights to which provision for impairment were fully provided in fiscal 2007.
Total amortization expense of intangible assets of the Company for the three
months ended September 30, 2008 and 2007 were $259,665 and $118,336 respectively
while for the nine months ended September 30, 2008 and 2007 amounted to $778,995
and $279,514 respectively.
NOTE
9. CONVERTIBLE PROMISSORY NOTES
AND
WARRANTS
(a) 12%
Convertible Promissory Note and Warrants
On
November 12, 2007, the Company entered into a 12% Note and Warrant Purchase
Agreement with Wei An Developments Limited (“Wei An”) with respect to the
purchase by Wei An a convertible promissory note in the principal account of
$5,000,000 at interest rate of 12% per annum (the “12% Convertible Promissory
Note”). The 12% Convertible Promissory Note is convertible into the
Company’s common stock at the conversion price of $2.40 per share. Pursuant
to the agreement, the Company is subject to a commitment fee of 2% of the
principal amount of the 12% Convertible Promissory Note. The term of the 12%
Convertible Promissory Note is six months and the Company has the option to
extend the 12% Convertible Promissory Note by an additional six-month period at
an interest rate of 14% per annum and be subject to an additional commitment fee
of 2% of the principal amount of the note. However, the Company has the right to
prepay all or any portion of the amounts due under the note at any time without
penalty or premium. In addition, pursuant to the Warrant Purchase Agreement, the
Company issued warrants to purchase up to 250,000 shares of the Company’s common
stock at the exercise price of $2.30 per share, which are exercisable for a
period of two years.
On
February 13, 2008, the Company fully redeemed 12% Convertible Promissory Note
due May 2008 at a redemption price equal to 100% of the principal amount of
$5,000,000 plus accrued and unpaid interest. No penalty or premium was charged
for such early redemption. The Company recognized the unamortized portion of the
associated deferred charges and debt discount as expenses included in
amortization of deferred charges and debt discount on the consolidated
statements of operation during the period of extinguishment.
(b) 3%
Convertible Promissory Notes and warrants
On
November 19, 2007, the Company, Quo Advertising and certain Designated Holders,
entered into a 3% Note and Warrant Purchase Agreement (the “Purchase Agreement”)
with affiliated investment funds of Och-Ziff Capital Management Group (the
“Investors”). Pursuant to the Purchase Agreement, the Company agreed to issue 3%
Senior Secured Convertible Notes due June 30, 2011 in the aggregate principal
amount of up to $50,000,000 (the “3% Convertible Promissory Notes”) and warrants
to acquire an aggregate amount of 34,285,715 shares of common stock of the
Company (the “Warrants”).
The 3%
Convertible Promissory Notes and Warrants are issued in three
tranches:
1) On
November 19, 2007, Convertible Notes in the aggregate principal amount of
$6,000,000, Warrants exercisable for 2,400,000 shares at $2.50 per share and
Warrants exercisable for 1,714,285 shares at $3.50 per share were
issued;
2) On
November 28, 2007, Convertible Notes in the aggregate principal amount of
$9,000,000, Warrants exercisable for 3,600,000 shares at $2.50 per share and
Warrants exercisable for 2,571,430 shares at $3.50 per share were issued;
and
3) On
January 31, 2008, Convertible Notes in the aggregate principal amount of
$35,000,000, Warrants exercisable for 14,000,000 shares at $2.50 per share and
Warrants exercisable for 10,000,000 shares at $3.50 per share were
issued.
The 3%
Convertible Promissory Notes, maturing on June 30, 2011, bear interest at 3% per
annum payable semi-annually in arrears. The 3% Convertible Promissory Notes are
convertible into shares of common stock at an initial conversion price of $1.65
per share, subject to customary anti-dilution adjustments. In addition, the
conversion price will be adjusted downward on an annual basis if the Company
should fail to meet certain annual earnings per share (“EPS”) targets described
in the Purchase Agreement. The EPS targets for fiscal 2008, 2009 and 2010 are
$0.081, $0.453, and $0.699 respectively. In the event of a default, or if the
Company’s actual EPS as defined in the Purchase Agreement for any fiscal year is
less than 80% of the respective EPS target, certain Investors may require the
Company to redeem the 3% Convertible Promissory Notes at 100% of the principal
amount, plus any accrued and unpaid interest, plus an amount representing a 20%
internal rate of return on the then outstanding principal amount.. The Warrants
grant the holders the right to acquire shares of common stock at $2.50 and $3.50
per share, subject to customary anti-dilution adjustments. The exercise price of
the Warrants will also be adjusted downward whenever the conversion price of the
3% Convertible Promissory Notes is adjusted downward in accordance with the
provisions of the Purchase Agreement. The warrants shall expire on June 30,
2011, pursuant to the Purchase Agreement.
On
January 31, 2008, the Company issued $35,000,000 in 3% Convertible Promissory
Notes and amended and restated $15,000,000 in 3% Convertible Promissory Notes
issued in late 2007. Concurrent with the Third Closing, the Company loaned
substantially all the proceeds from 3% Convertible Promissory Notes to its
directly wholly owned subsidiary, NCN Group Limited (“NCN Group”), and such loan
was evidenced by an intercompany note issued by NCN Group in favor of the
Company (the “NCN Group Note”). The Company entered into a Security Agreement,
dated January 31, 2008, pursuant to which the Company granted to the collateral
agent for the benefit of the Investors a first-priority security interest in
certain of its assets, including the NCN Group Note and 66% of the shares of NCN
Group. In addition, NCN Group and certain of the Company’s indirectly wholly
owned subsidiaries each granted the Company a security interest in certain of
the assets of such subsidiaries to, among other things, secure the NCN Group
Note and certain related obligations.
As of
September 30, 2008, none of the conversion options and warrants associated with
the above convertible promissory notes was exercised.
The
following table details the accounting treatment of the convertible promissory
notes:
|
12%
Convertible
Promissory
Note
|
3%
Convertible
Promissory
Notes
(first and second
tranches)
|
3%
Convertible
Promissory
Notes
(third
tranche)
|
Total
|
|||||||||||||
|
Proceeds
of convertible promissory notes
|
$ | 5,000,000 | $ | 15,000,000 | $ | 35,000,000 | $ | 55,000,000 | ||||||||
|
Allocation
of proceeds:
|
||||||||||||||||
|
Allocated
relative fair value of warrants
|
(333,670 | ) | (2,490,000 | ) | (5,810,000 | ) | (8,633,670 | ) | ||||||||
|
Allocated
intrinsic value of beneficial conversion feature
|
- | (4,727,272 | ) | (11,030,303 | ) | (15,757,575 | ) | |||||||||
|
Total
net proceeds of the convertible promissory notes
|
4,666,330 | 7,782,728 | 18,159,697 | 30,608,755 | ||||||||||||
|
Repayment
of convertible promissory note
|
(5,000,000 | ) | - | - | (5,000,000 | ) | ||||||||||
|
Amortization
of debt discount
|
333,670 | 1,196,551 | 2,324,769 | 3,854,990 | ||||||||||||
|
Net
carrying value of convertible promissory notes as of September 30,
2008
|
$ | - | $ | 8,979,279 | $ | 20,484,466 | $ | 29,463,745 | ||||||||
Warrants
and Beneficial Conversion Features
The fair
values of the financial instruments associated with warrants of both 12%
convertible promissory note and 3% convertible promissory notes were determined
utilizing Black-Scholes option pricing model, which is consistent with the
Company’s historical valuation methods. The following assumptions and estimates
were used in the Black-Scholes option pricing model: (1) 12% convertible
promissory note: volatility of 182%; an average risk-free interest rate of
3.52%; dividend yield of 0%; and an expected life of 2 years, (2) 3% convertible
promissory notes: volatility of 47%; an average risk-free interest rate of
3.30%; dividend yield of 0%; and an expected life of 3.5 years.
Both the
warrants and embedded conversion features issued in connection with 12%
convertible promissory note and 3% convertible promissory notes meet the
criteria of EITF 00-19,
“Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock” for equity classification and also met the other
criteria in paragraph 11(a) of SFAS 133 “Accounting for Derivative
Instruments and Hedging Activities” . Accordingly, the conversion
features do not require derivative accounting. The intrinsic value of beneficial
conversion feature is calculated according to EITF Issue No. 98-5 “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio” and EITF Issue No. 00-27 “Application of Issue No. 98-5 to
Certain Convertible Instruments” . For 3% convertible promissory note, as
the effective conversion price after allocating a portion of the proceeds to the
warrants was less than the Company’s market price of common stock at commitment
date, it was considered to have a beneficial conversion feature while for the
12% convertible promissory note, no beneficial conversion feature existed. The
value of beneficial conversion feature is recorded as a reduction in the
carrying value of the convertible promissory notes against additional paid-in
capital. As the 3% convertible promissory notes has stated redemption date, the
respective debt discount being equal to the value of beneficial conversion
feature of $15,757,575 is amortized over the term of the notes from the
respective date of issuance using the effective yield method.
Amortization of Deferred Charges and
Debt Discount
The
amortization of deferred charges and debt discount for the three months ended
September 30, 2008 was as follows:
|
Warrants
|
Conversion
Features
|
Deferred
Charges
|
Total
|
|||||||||||||
|
12%
convertible promissory note
|
$ | - | $ | - | $ | - | $ | - | ||||||||
|
3%
convertible promissory notes
|
443,478 | 841,944 | 106,694 | 1,392,116 | ||||||||||||
|
Total
|
$ | 443,478 | $ | 841,944 | $ | 106,694 | $ | 1,392,116 | ||||||||
The
amortization of deferred charges and debt discount for the nine months ended
September 30, 2008 was as follows:
|
Warrants
|
Conversion
Features
|
Deferred
Charges
|
Total
|
|||||||||||||
|
12%
convertible promissory note
|
$ | 259,204 | $ | - | $ | 80,700 | $ | 339,904 | ||||||||
|
3%
convertible promissory notes
|
1,179,420 | 2,239,132 | 332,648 | 3,751,200 | ||||||||||||
|
Total
|
$ | 1,438,624 | $ | 2,239,132 | $ | 413,348 | $ | 4,091,104 | ||||||||
NOTE
10. COMMITMENTS AND
CONTINGENCIES
(a) Commitments
1.
Rental Lease Commitment
The
Company’s existing rental leases do not contain significant restrictive
provisions. The following is a schedule by year of future minimum lease
obligations under non-cancelable rental operating leases as of September 30,
2008:
|
Three
months
ending December
31,2008
|
$ | 256,530 | ||
|
Fiscal
years
ending
December 31,
|
||||
|
2008
|
$ | 256,530 | ||
|
2009
|
971,561 | |||
|
2010
|
843,241 | |||
|
2011
|
197,474 | |||
|
Total
|
$ | 2,268,806 |
2.
Annual Advertising Operating Rights Fee Commitment
Since
November 2006, the Company, through its subsidiaries NCN Media Services Limited,
Quo Advertising , Xuancaiyi, Bona and Botong has acquired advertising rights
from third parties to operate different types of advertising panels for periods
ranging from 1 year to 20 years.
The
following table sets forth the estimated future annual commitment of the Company
with respect to the advertising operating rights of 1,864 roadside advertising
panels, 11,000 in-building LCD and 11 mega-size advertising panels that the
Company held as of September 30, 2008:
|
(In millions)
|
||||
|
Three
months
ending December
31,2008
|
$ | 13.06 | ||
|
Fiscal
years
ending
December 31,
|
||||
|
2008
|
$ | 13.06 | ||
|
2009
|
14.61 | |||
|
2010
|
4.04 | |||
|
2011
|
4.06 | |||
|
2012
|
3.97 | |||
|
Thereafter
|
25.42 | |||
|
Total
|
$ | 65.16 | ||
3.
Capital commitments
As
of September 30, 2008, the Company had commitments for capital expenditures
in connection with construction of roadside advertising panels and mega-size
advertising panels of approximately $97,000.
(b) Contingencies
The
Company accounts for loss contingencies in accordance with SFAS No. 5, “Accounting for Loss Contingencies” and other
related guidelines. Set forth below is a description of certain loss
contingencies as of September 30, 2008 and management’s opinion as to the
likelihood of loss in respect of loss contingency.
1.
Tianma litigation
Guangdong
Tianma International Travel Service Co., Ltd, (“Tianma) of which the Company
owned 55% interest through trust was involved in a legal litigation associated
with a car accident in 2005. The Company was indemnified for any future
liability by the previous owners when it acquired Tianma in June 2006. As of
September 1, 2008, the Company entered into a stock purchase agreement to
dispose of its 55% interest in Tianma. For details, please refer to Note 14 –
Discontinued Operations. There were no provisions in the stock purchase
agreement requiring the Company to indemnify the buyer for any future liability
arising from transactions incurred prior to September 1, 2008. Accordingly, the
Company considers that it has no loss contingencies in relation to Tianma as of
September 30, 2008.
2.
Early Redemption of 3% Convertible Promissory Notes
In the
event of a default, or if the Company’s actual EPS as defined in the Purchase
Agreement for any fiscal year is less than 80% of the respective EPS target,
certain investors may require the Company to redeem the 3% Convertible
Promissory Notes at 100% of the principal amount, plus any accrued and unpaid
interest, plus an amount representing a 20% internal rate of return on the then
outstanding principal amount. As the Company recorded a continuous net loss as
of September 30, 2008, management anticipates that the Company is unlikely to
achieve the EPS target or 80% of the EPS target in fiscal year 2008. The Company
is in the process of re-negotiating with the investors in the hope of revising
certain terms of the Purchase Agreement.
In the
event of early redemption of 3 % convertible promissory notes, the Company has
to redeem its outstanding principal amount of $50 million as of September 30,
2008, plus accrued and unpaid interest of $1,084,083 as of September 30, 2008
and penalties of approximately $7 million which represented 20% internal rate of
return on the outstanding principal balance of $50 million.
The
Company considers that the likelihood of the investors calling for early
redemption is between remote and reasonably possible. Accordingly, the Company
is only disclosing the loss contingencies and made no accrual for any penalties
arising from early redemption.
NOTE
11. STOCKHOLDERS’
EQUITY
(a) Stock,
Options and Warrants Issued for Services
1. In
February 2006, the Company issued an option to purchase up to 225,000 shares of
common stock to its legal counsel at an exercise price of $0.10 per share. So
long as the counsel’s relationship with the Company continues, one-twelfth of
the shares underlying the option vested and became exercisable each month from
the date of issuance. The option was exercisable for 120 days after termination
of the relationship. The fair market value of the option was estimated on the
grant date using the Black-Scholes option pricing model as required by SFAS 123R
with the following assumptions and estimates: expected dividend 0%, volatility
147%, a risk-free rate of 4.5% and an expected life of one (1) year. The value
of an option recognized for the three months ended September 30, 2008 and 2007
were $nil while during the nine months ended September 30, 2008 and 2007 were
$nil and $1,317 respectively. The option was exercised in April
2007.
2. In
August 2006, the Company issued a warrant to purchase up to 100,000 shares of
restricted common stock to a consultant at an exercise price $0.70 per share.
One-fourth of the shares underlying the warrant became exercisable every 45 days
beginning from the date of issuance. The warrant remains exercisable until
August 25, 2016. The fair market value of the warrant was estimated on the grant
date using the Black-Scholes option pricing model as required by SFAS 123R with
the following assumptions and estimates: expected dividend 0%, volatility 192%,
a risk-free rate of 4.5% and an expected life of one (1) year. The value
recognized for the three months ended September 30, 2008 and 2007 were
approximately $nil and $6,201 respectively while during the nine months ended
September 30, 2008 and 2007 were $nil and $26,604 respectively.
3. In
April 2007, the Company issued 45,000 S-8 shares of common stock of par value of
$0.001 each, totaling $18,000 to its legal counsel for services
rendered.
4. In
April 2007, the Company issued 377,260 S-8 shares of common stock of par value
of $0.001 each, totaling $85,353 to its directors and officers for services
rendered.
5. In
July 2007, NCN Group Management Limited entered into Executive Employment
Agreements (the “Agreements”) with Godfrey Hui, Chief Executive Officer, Daniel
So, Managing Director, Daley Mok, Chief Financial Officer, Benedict Fung, the
President, and Stanley Chu, General Manager. Pursuant to the Agreements, each
executive was granted shares of the Company’s common stock subject to annual
vesting over five years in the following amounts: Mr. Hui, 2,000,000
shares; Mr. So, 2,000,000 shares; Dr. Mok 1,500,000 shares; Mr. Fung 1,200,000
shares and Mr. Chu, 1,000,000 shares. In connection with these stock grants and
in accordance with SFAS 123R, the Company recognized non-cash stock-based
compensation of $699,300 and $854,700 included in general and administrative
expenses on the consolidated statement of operations for the three months ended
September 30, 2008 and 2007 respectively while during the nine months ended
September 30, 2008 and 2007 were $2,097,900 and $854,700 respectively. Out of
the total shares granted under the Agreements, on January 2, 2008, an aggregate
of 660,000 S-8 shares with par value of $0.001 each were vested and issued to
the concerned executives.
6. In
August 2007, the Company issued 173,630 shares of restricted common stock of par
value of $0.001 each, totaling $424,004 to a consultant for services rendered.
The value of stock grant is fully amortized and recognized during the six months
ended December 31, 2007.
7. In
August 2007, the Company issued 230,000 S-8 shares of common stock of par value
of $0.001 each, totaling $69,500 to its directors and officers for services
rendered.
8. In
September, 2007, the Company entered into a service agreement with independent
directors, Peter Mak, Gerd Jakob, Edward Lu, Ronglie Xu and Joachim Burger.
Pursuant to the service agreements, each independent director was granted shares
of the Company’s common stock subject to a vesting period of ten months in the
following amounts: Peter Mak:15,000 shares; Ronglie Xu:15,000 shares; Joachim
Burger:15,000 shares, Gerd Jakob:10,000 shares and Edward Lu:10,000 shares. In
connection with these stock grants and in accordance with SFAS 123R, the Company
recognized $nil and $14,495 of non-cash stock-based compensation included in
Payroll on the consolidated statement of operation for the three months ended
September 30, 2008 and 2007 respectively while during the nine months ended
September 30, 2008 and 2007 were $86,970 and $14,495 respectively. On July 21,
2008, an aggregate of 65,000 S-8 shares of common stock of par value of $0.001
each were vested and issued to the independent directors.
9. In
November 2007, the Company was obligated to issue a warrant to purchase up to
300,000 shares of restricted common stock to a placement agent for provision of
agency services in connection with the issuance of 3% convertible promissory
notes as mentioned in Note 9 – Convertible Promissory Notes and Warrants at an
exercise price $3.0 per share which are exercisable for a period of two years.
The fair value of the warrant was estimated on the grant date using the
Black-Scholes option pricing model as required by SFAS 123R with the following
weighted average assumptions: expected dividend 0%, volatility 182 %, a
risk-free rate of 4.05 % and an expected life of two (2) year. The value of the
warrant recognized for the three months ended September 30, 2008 and 2007 were
$31,959 and $nil respectively while during the nine months ended September 30,
2008 and 2007 were $95,875 and $nil respectively.
10. In
December 2007, the Company committed to grant 235,000 S-8 shares of common stock
to certain employees of the Company for their services rendered during the year
ended December 31, 2007. In connection with these stock grants and in accordance
with SFAS 123R, the Company recognized non-cash stock-based compensation of
$611,000 in Payroll on the consolidated statement of operation for the year
ended December 31, 2007. Such 235,000 S-8 shares of par value of $0.001 each
were issued on January 2, 2008. In addition, the Company committed to grant
certain shares of common stock to an employee pursuant to his employment
contract for service rendered. Accordingly, the Company recognized the non-cash
stock-based compensation of $6,375 and $nil for the three months ended September
30, 2008 and 2007 while $76,500 and $nil for the nine months ended September 30,
2008 and 2007. In October 2008, an aggregate of 30,000 S-8 shares of common
stock of par value of $0.001 each were vested and issued to an
employee.
11. In
June 2008, the Board of Directors resolved to grant 110,000 shares of common
stock to the board of directors, Peter Mak, Gerd Jakob, Edward Lu, Ronglie Xu,
Joachim Burger, Godfrey Hui, Daniel So, Daley Mok and Stanley Chu, as part of
their directors’ fee. Each director was granted shares of the Company’s common
stock subject to a vesting period of twelve months in the following amounts:
Peter Mak:15,000 shares; Ronglie Xu:15,000 shares; Joachim Burger:15,000 shares;
Gerd Jakob:10,000 shares; Edward Lu:10,000 shares; Godfrey Hui: 15,000 shares;
Daniel So: 10,000 shares; Daley Mok: 10,000 shares and Stanley Chu:10,000
shares. In connection with these stock grants and in accordance with SFAS 123R,
the Company recognized $54,999 and $nil of non-cash stock-based compensation
included in general and administrative expenses on the consolidated statement of
operations for the three months and nine months ended September 30, 2008 and
2007 respectively.
12. In
July 2008, the Company committed to grant 170,000 S-8 shares of common stock to
certain employees of the Company for their services rendered. Accordingly, the
Company recognized the non-cash stock-based compensation of $43,283 and $nil for
the three months ended September 30, 2008 and 2007 while $43,283 and $nil for
the nine months ended September 30, 2008 and 2007.
13. In
August 2008, the Company committed to grant 100,000 S-8 shares of common stock
to a consultant for services rendered. The value of stock grant recognized for
the three months and nine months ended September 30, 2008 and 2007 were $20,941
and $nil respectively.
(b) Stock
Issued for Acquisition
1. In
January 2007, in connection with the acquisition of Quo Advertising, the Company
issued 300,000 shares of restricted common stock of par value of $0.001 each,
totaling $843,600.
2. In
January 2008, in connection with the acquisition of Cityhorizon BVI, the Company
issued 1,500,000 shares of restricted common stock of par value of $0.001 each,
totaling $3,738,000 as part of consideration.
(c)
Stock
Issued for Private Placement
In April
2007, the Company issued and sold 500,000 shares of restricted common stock of
par value of $0.001 each, totaling $1,500,000 in a private placement. No
investment banking fees were incurred as a result of this
transaction.
(d) Conversion
Option and Stock Warrants Issued in Notes Activities
On
November 12, 2007, pursuant to the 12% Note and Warrant Purchase Agreement of
$5,000,000, the Company issued warrants to purchase up to 250,000 shares of the
Company’s common stock at the exercise price of $2.30 per share, which are
exercisable for a period of two years to Wei An. The allocated proceeds to the
warrants of $333,670 based on the relative fair value of 12% Convertible
Promissory Notes and warrants were recorded as reduction in the carrying value
of the note against additional-paid in capital. As the effective conversion
price is higher than the Company’s market price of common stock at commitment
date, no beneficial conversion existed. Please refer to Note 9 – Convertible
Promissory Note and Warrant for details.
On
November 19, 2007, pursuant to the 3% Note and Warrant purchase Agreement, the
Company issued warrants to purchase up to 2,400,000 shares of the Company’s
common stock at the exercise price of $2.5 per share and 1,714,285 shares of the
Company’s common stock at the exercise price of $3.5 per share associated with
the convertible notes of $6,000,000 in the first closing. On November 28, 2007,
the Company also issued warrants to purchase up to 3,600,000 shares of the
Company’s common stock at the exercise price of $2.5 per share and 2,571,430
shares of the Company’s common stock at the exercise price of $3.5 per share.
The allocated proceeds to these warrants were $2,490,000 in aggregate which were
recorded as reduction in the carrying value of the notes against additional
paid-in capital. As the effective conversion price after allocating a portion of
the proceeds to the warrants was less than the Company’s market price of common
stock at commitment date, it was considered to have a beneficial conversion
feature with value of $4,727,272 recorded as a reduction in the carrying value
of the notes against additional paid-in capital. Please refer to Note 9 –
Convertible Promissory Note and Warrant for details.
On
January 31, 2008, the Company issued $35,000,000 in 3% Convertible Promissory
Notes and amended and restated $15,000,000 in 3% Convertible Promissory Notes
issued in late 2007. In addition, the Company issued additional warrants to
purchase 14,000,000 shares of the Company’s common stock at $2.50 per share and
warrants to purchase 10,000,000 shares of the Company’s common stock at $3.50
per share. Concurrently with the Third Closing, the Company loaned substantially
all the proceeds from 3% Convertible Promissory Notes to its direct wholly owned
subsidiary, NCN Group Limited (“NCN Group”), and such loan was evidenced by an
intercompany note issued by NCN Group in favor of the Company (the “NCN Group
Note”). The Company entered into a Security Agreement, dated as of January 31,
2008 pursuant to which the Company granted to the collateral agent for the
benefit of the Investors a first-priority security interest in certain of its
assets, including the NCN Group Note and 66% of the shares of NCN Group. In
addition, NCN Group and certain of the Company’s indirect wholly owned
subsidiaries each granted the Company a security interest in certain of the
assets of such subsidiaries to, among other things, secure the NCN Group Note
and certain related obligations. The allocated proceeds to these warrants were
$5,810,000 in aggregate which were recorded as reduction in the carrying value
of the notes against additional paid-in capital. As the effective conversion
price after allocating a portion of the proceeds to the warrants was less than
the Company’s market price of common stock at commitment date, it was considered
to have a beneficial conversion feature with value of $11,030,303 recorded as a
reduction in the carrying value of the notes against additional paid-in capital.
Please refer to Note 9 – Convertible Promissory Note and Warrant for
details.
NOTE
12. RELATED PARTY
TRANSACTIONS
During
the nine months ended September 30, 2008 and 2007, the Company did not
enter into any material transactions or series of transactions that would be
considered material in which any officer, director or beneficial owner of 5% or
more of any class of the Company’s capital stock, or any immediate family member
of any of the preceding persons, had a direct or indirect material
interest.
NOTE
13. NET INCOME (LOSS) PER COMMON
SHARE
Net loss
per share information for the three and nine months ended September 30, 2008 and
2007 was as follows:
|
For
the three
months
ended
September
30,
2008
|
For
the three
months
ended
September
30,
2007
|
For
the nine
months
ended
September
30,
2008
|
For
the nine
months
ended
September
30,
2007
|
|||||||||||||
|
Numerator:
|
||||||||||||||||
|
Net
loss from continuing operations
|
(15,546,407 | ) | (3,207,019 | ) | (32,776,641 | ) | (8,459,050 | ) | ||||||||
|
Net
income (loss) from discontinued operations
|
72,041 | 3,025 | 42,640 | (121,869 | ) | |||||||||||
|
Net
loss attributable to stockholders
|
$ | (15,474,366 | ) | $ | (3,203,994 | ) | $ | (32,734,001 | ) | $ | (8,580,919 | ) | ||||
|
Denominator:
|
||||||||||||||||
|
Weighted average number of shares outstanding, basic
|
71,597,478 | 68,947,906 | 71,563,688 | 68,355,391 | ||||||||||||
|
Effect
of dilutive securities
|
||||||||||||||||
|
Options
and warrants
|
- | - | - | - | ||||||||||||
|
Weighted average number of shares outstanding, diluted
|
71,597,478 | 68,947,906 | 71,563,688 | 68,355,391 | ||||||||||||
|
Net
income (loss) per common share – basic and diluted
|
||||||||||||||||
|
Continuing
operations
|
(0.22 | ) | (0.05 | ) | (0.46 | ) | (0.12 | ) | ||||||||
|
Discontinued
operations
|
0.00 | 0.00 | 0.00 | (0.00 | ) | |||||||||||
|
Net
loss per common share – basic and diluted
|
$ | (0.22 | ) | $ | (0.05 | ) | $ | (0.46 | ) | $ | (0.13 | ) | ||||
The
diluted net loss per common share is the same as the basic net loss per common
share for the three and nine months ended September 30, 2008 and 2007 as all
potential ordinary shares including stock options and warrants are anti-dilutive
and are therefore excluded from the computation of diluted net loss per common
share. The securities that could potentially dilute basic net income (loss) per
common share in the future that were not included in the computation of diluted
net income (loss) per common share because of anti-dilutive effect as of
September 30, 2008 and 2007 were summarized as follows:
|
For
the three
months
ended September 30,
2008
|
For
the three
months
ended September 30,
2007
|
For
the nine
months
ended September 30,
2008
|
For
the nine
months
ended September 30,
2007
|
|||||||||||||
|
Potential
common equivalent shares:
|
||||||||||||||||
|
Stock
options for services
|
- | - | - | - | ||||||||||||
|
Stock
warrants for services (1)
|
61,430 | 141,308 | 61,430 | 141,308 | ||||||||||||
|
Conversion
feature associated with convertible promissory notes to common
stock
|
30,303,030 | - | 30,303,030 | - | ||||||||||||
|
Common
stock to be granted to directors executives and employees for services
(including non-vested shares)
|
7,070,000 | - | 7,135,000 | - | ||||||||||||
|
Total
|
37,434,460 | 141,308 | 37,499,460 | 141,308 | ||||||||||||
Remarks:
|
(1)
|
As
of September 30, 2008, the number of potential common equivalent shares
associated with warrants issued for services was 61,430 which was related
to a warrant to purchase 100,000 common stock issued by the Company to a
consultant in 2006 for service rendered at an exercise price of $0.70,
which expired in August 2016.
|
NOTE
14. DISCONTINUED
OPERATIONS
During
the three months ended September 30, 2008, the Company disposed of its entire
travel network which was classified as one of the Company’s business segments in
order to focus on its media business. Accordingly, the Company entered into
stock purchase agreements to dispose of its entire travel network.
On
September 1, 2008, the Company completed the sale of all its interests in NCN
Management Services Limited (“NCN Management Services”) to Zhanpeng Wang
(“Zhanpeng”), an individual for a consideration of HK$1,350,000, or
approximately US$173,000, in cash. Zhanpeng acquired NCN
Management Services along with its subsidiaries, which include 100% interest in
NCN Hotels Investment Limited, 100% interest in NCN Pacific Hotels Limited and
55% interest (through trust) in Tianma. The Company reported a gain on the sale,
net of income taxes and minority interests of $61,570. The carrying amount of
the assets and liabilities included in the relevant disposal group as of the
disposal date of September 1, 2008 were as follows:
|
Cash
|
$ | 662,515 | ||
|
Accounts
receivable
|
1,041,781 | |||
|
Prepaid
expenses and other current assets
|
860,036 | |||
|
Equipment,
net
|
17,464 | |||
|
Minority
interest
|
(99,423 | ) | ||
|
Liabilities
assumed
|
(2,370,866 | ) | ||
|
Net
assets
|
$ | 111,507 |
On
September 30, 2008, the Company completed the sale of its 99.9% interests in NCN
Landmark International Hotel Group Limited (“NCN Landmark”) to Ngar Yee Tsang
(“Ngar”), an individual for a cash consideration of $20,000. Ngar acquired NCN
Landmark along with its subsidiary, Beijing NCN Landmark Hotel Management
Limited, a PRC corporation. The Company reported a gain on the sale, net of
income taxes and minority interests of $4,515. The carrying amount of the assets
and liabilities included in the relevant disposal group as of the disposal date
of September 30, 2008 were as follows:
|
Cash
|
$ | 3,389 | ||
|
Prepaid
expenses and other current assets
|
9,566 | |||
|
Equipment,
net
|
10,053 | |||
|
Liabilities
assumed
|
(7,523 | ) | ||
|
Net
assets
|
$ | 15,485 |
The
Company treated the sale of NCN Management Services along with its subsidiaries
and variable interest entity and NCN Landmark along with its subsidiary as
discontinued operations. Accordingly, revenues, costs and expenses of the
discontinued operations have been excluded from the respective captions in the
condensed consolidated statements of operations. The net operating results of
the discontinued operations have been reported, net of applicable income taxes
and minority interests, as “Income (Loss) from Discontinued Operations, Net of
Income Taxes and Minority Interests”.
Summary
operating results for the discontinued operations for travel network were as
follows:
|
For
the Three Months ended
|
For
the Nine Months Ended
|
|||||||||||||||
|
September
30,
2008
|
September
30,
2007
|
September
30,
2008
|
September
30,
2007
|
|||||||||||||
|
Revenues
|
6,342,479 | 8,018,734 | 24,528,096 | 15,432,761 | ||||||||||||
|
Cost
of revenues
|
(6,242,465 | ) | (7,926,043 | ) | (24,172,537 | ) | (15,221,181 | ) | ||||||||
|
Gross
profit
|
100,014 | 92,691 | 355,599 | 211,580 | ||||||||||||
|
Operating
expenses
|
(156,864 | ) | (91,597 | ) | (477,481 | ) | (345,600 | ) | ||||||||
|
Other
income
|
58,027 | 5,322 | 98,838 | 9,209 | ||||||||||||
|
Interest
income
|
72 | 871 | 2,040 | 2,075 | ||||||||||||
|
Minority
interest
|
4,707 | (4,262 | ) | (2,401 | ) | 867 | ||||||||||
|
Income
(loss) from discontinued operations, net of income taxes and minority
interests
|
5,956 | 3,025 | (23,445 | ) | (121,869 | ) | ||||||||||
NOTE
15. BUSINESS
SEGMENTS FROM
CONTINUING OPERATIONS
The
Company has changed their operating segments in 2007 as a result of change of
internal organization structure by management. As the Company disposed of its
entire Travel Network in September 2008, the Company’s continuing operations are
classified into two primary business segments accordingly, which operate
exclusively: 1) Media Network segment provides marketing communications
consultancy services to customers in China and 2) Investment Holding segment
represents the companies which provide administrative and management services to
its subsidiaries or fellow subsidiaries. The accounting policies of the segments
are the same as described in the summary of significant accounting policies.
There were no inter-segment sales.
|
For
the Three Months Ended
September
30, 2008
|
Media
Network
|
Investment
Holding
|
Total
|
|||||||||
|
Revenues
|
$ | 2,520,474 | $ | - | $ | 2,520,474 | ||||||
|
Net
loss from continuing operations
|
11,956,600 | 3,589,807 | 15,546,407 | |||||||||
|
Depreciation
and amortization
|
||||||||||||
|
-
Equipment and intangible assets
|
448,865 | 92,666 | 541,531 | |||||||||
|
- Deferred charges and debt discount
|
- | 1,392,116 | 1,392,116 | |||||||||
|
Interest
expense
|
- | 383,334 | 383,334 | |||||||||
|
Allownace
for doubtful debt for other receivables (1)
|
1,411,287 | - | 1,411,287 | |||||||||
|
Non-cash
impairment charges
|
5,671,782 | - | 5,671,782 | |||||||||
|
Assets
|
36,278,980 | 8,245,851 | 44,524,831 | |||||||||
|
Capital
Expenditures
|
205,712 | - | 205,712 | |||||||||
|
For
the Three Months Ended
September
30, 2007
|
Media
Network
|
Investment
Holding
|
Total
|
|||||||||
|
Revenues
|
$ | 466,071 | $ | - | $ | 466,071 | ||||||
|
Net
loss from continuing operations
|
118,248 | 3,088,771 | 3,207,019 | |||||||||
|
Depreciation
and amortization
-
Equipment and intangible assets
|
55,309 | 74,897 | 130,206 | |||||||||
|
Assets
|
3,211,071 | 8,526,429 | 11,737,500 | |||||||||
|
Capital
Expenditures
|
- | 41,532 | 41,532 | |||||||||
|
For
the Nine Months Ended
September
30, 2008
|
Media
Network
|
Investment
Holding
|
Total
|
|||||||||
|
Revenues
|
$ | 4,158,529 | $ | - | $ | 4,158,529 | ||||||
|
Net
loss from continuing operations
|
21,937,422 | 10,839,219 | 32,776,641 | |||||||||
|
Depreciation
and amortization
|
||||||||||||
|
-
Equipment and intangible assets
|
1,297,961 | 121,839 | 1,419,800 | |||||||||
|
-
Deferred charges and debt discount
|
- | 4,091,104 | 4,091,104 | |||||||||
|
Allowance
for doubtful debt for other receivables (1)
|
1,411,287 | - | 1,411,287 | |||||||||
|
Non-cash
impairment charges
|
5,918,467 | - | 5,918,467 | |||||||||
|
Interest
expense
|
- | 1,109,125 | 1,109,125 | |||||||||
|
Assets
|
36,278,980 | 8,245,851 | 44,524,831 | |||||||||
|
Capital
Expenditures
|
3,338,300 | 119,051 | 3,457,351 | |||||||||
|
For
the Nine Months Ended
September
30, 2007
|
Media
Network
|
Investment
Holding
|
Total
|
|||||||||
|
Revenues
|
$ | 965,995 | $ | - | $ | 965,995 | ||||||
|
Net
loss from continuing operations
|
144,714 | 8,314,336 | 8,459,050 | |||||||||
|
Depreciation
and amortization
-Equipment
and intangible assets
|
64,834 | 250,919 | 315,753 | |||||||||
|
Assets
|
3,211,071 | 8,566,429 | 11,777,500 | |||||||||
|
Capital
Expenditures
|
3,330 | 54,119 | 57,449 | |||||||||
Remarks
:
(1) The
Company recorded a one-time doubtful debt provision of $1,411,287 for
other receivables during the three months ended September 30, 2008. Such
provision was included in general and administrative expenses on the
consolidated statements of operations for the three and nine months
ended September 30, 2008.
Item 2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
CAUTIONARY
STATEMENTS
The
following management’s discussion and analysis of financial condition and
results of operations is based upon and should be read in conjunction with the
Company’s condensed consolidated financial statements and the notes thereto
included in “Part I — Financial Information, Item 1.
Financial
Statement”. All amounts are
expressed in U.S. dollars.
OVERVIEW
Network
CN Inc. (“we” or “the Company”), originally incorporated on September 10, 1993,
is a Delaware company with headquarters in the Hong Kong Special Administrative
Region, the People’s Republic of China (“the PRC” or “China”). It was operated
by different management teams in the past, under different operating names,
pursuing a variety of business ventures. The most recent former name was Teda
Travel Group, Inc. On August 1, 2006, the Company changed its name to “Network
CN Inc.” in order to better reflect the Company’s vision under its new and
expanded management team.
Our
business plan in early 2006 was to build a nationwide information and
entertainment network in the PRC. To achieve this goal, we established two
business divisions: the Media Business division and the Non-Media Business
division. During the latter half of 2006, we adjusted our primary focus away
from the Non-Media Business to our Media Business and began building a media
network with the goal of becoming a nationwide leader in out-of-home, digital
display advertising, roadside LED digital video panels and mega-size video
billboards.
With the
completion of $50 million financing in three tranches from November 2007 to
January 2008, the Company’s original plan was to secure advertising rights and
install a nationwide digital network up to 20 mega-size panels and 2,000
roadside panels. With the support of the investors in the financing, however,
substantial amount of funds in the aggregate amount of approximately US$15
million were re-allocated to two major projects, namely, Terminal 3 Beijing
Airport Project (the “T3 Project”) and the Co-operation Project with Beijing All
Media Culture Group (the “BAMC Project”) from which the Company expected to
generate substantial revenues with the 2008 Beijing Olympics. The T3 Project
covers an exclusive right to operate 98 freestanding multimedia advertisement
light boxes in designated locations within the newly-built Terminal 3 of the
Beijing International Airport, while the BAMC Project covers an exclusive right
to operate 11,000 in-building LCD screens in governmental and office buildings,
banks, hotels, hospitals, Olympic venues and other locations in
Beijing.
Disposal
of Non-Media Business
The Board
of Directors of the Company resolved in June 2008 that it was in the best
interests of the Company to focus on developing its media business and to
explore ways of divesting its travel business. During the quarter, the Company
successfully sold its entire travel network.
The
Company believed that it was in the best interests of the Company to dispose of
its non-core business in order to focus on developing its media
business.
Market
Conditions
The
Company’s results of operations during the nine months ended September 30, 2008
were negatively affected by a variety of factors including:
|
|
·
|
The
rising costs to acquire advertising rights due to competition among
bidders for those rights;
|
|
|
·
|
Delays
in obtaining government approvals for panel installation due to the
government’s focus on fighting snow storms in different provinces in the
early months of the year;
|
|
|
·
|
Slower
than expected consumer acceptance of the digital form of advertising
media;
|
|
|
·
|
Strong
competition from other media
companies;
|
|
|
·
|
The
provision of free advertising time to air earthquake information,
government recovery efforts and donation-related information for the 8.0
magnitude earthquake in the Sichuan
Province;
|
|
|
·
|
Various
administrative delays and restrictions of the Beijing Olympic Committee
limiting advertisements during the Olympic period in Olympic-related
panels to official Olympic sponsors only. Non-Olympic sponsors with which
the Company had negotiated were forced to pull out;
and
|
|
|
·
|
Slowing
demand due to the worldwide financial crisis and deteriorating economic
conditions in China, leading many customers to cut their advertising
budget. The impact of the reduction in the pace of advertising spending is
expected to be more significant on our new digital form of media than
traditional advertising platforms.
|
In
addition to the above market factors, one of our key projects, the T3 Project,
also encounters the following issues:
T3
Project
In
November 2007, the Company obtained an exclusive right to operate 98
freestanding multimedia advertisement light boxes to be situated in designated
locations within Beijing International Airport in China for a 3-year period.
Terminal 3 is the new international terminal which was scheduled to open in
January 2008 but the opening date was delayed to late March 2008. The
commencement date to operate our advertisement light boxes, originally planned
to operate in January 2008, was therefore delayed to late March
2008.
During
the 2008 Olympics, as required by the Olympic Organizing Committee, all the
advertising contracts had to be signed among three parties, namely, the Beijing
International Airport Authority, the authority party with advertising rights
directly granted by the Beijing International Airport Authority (the “Authority
Party”), and the customer. The authority party had the right to receive the
relevant payment from customers on behalf of the Company. In July 2008, in view
of the market situation, the Company started re-negotiating certain terms of the
concession right contract with the Authority Party. Subsequently in August 2008,
the Company received a unilateral termination letter regarding the exclusive
right from the authority party. During September 2008, the Authority Party
received a total of $1,411,287 from customers on behalf of the Company without
paying back to the Company. Currently, the Company is evaluating its ability to
take legal action against the authority party for the withheld payment and all
other associated losses. No assurance can be given that the Company will be able
to recover the fees due to it and has conservatively treated the withheld
payment as uncollectible in the financial statements. Accordingly, allowance for
doubtful debt of $1,411,287 was provided for such receivable during the three
months ended September 30, 2008.
For
more information relating to the Company’s business, please see the section
entitled “Description of Business” in the Annual Report on Form 10-KSB as filed
by Network CN Inc. with the United States Securities and Exchange Commission on
March 24, 2008.
RESTATEMENTS
OF CONSOLIDATED FINANCIAL STATEMENTS
On
October 10, 2008, we filed a Current Report on Form 8-K to announce
that our Board of Directors, based upon the consideration of issues addressed in
the SEC review and the recommendation of the Audit Committee, determined that we
should restate our previously issued condensed consolidated financial statements
for quarterly periods ended March 31, 2008 and June 30, 2008 and consolidated
financial statements for the year ended December 31, 2007.
The
restatement adjustments corrected the accounting errors arising from our
misapplication of accounting policies to the discount associated with the
beneficial conversion feature attributed to the issuance of the 3% convertible
promissory notes in 2007 and 2008. The Company initially amortized the discount
according to EITF Issue No. 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio”, which stated that discount resulting from allocation
of proceeds to the beneficial conversion feature should be recognized as
interest expense over the minimum period from the date of issuance to the date
of earliest conversion. As the notes are convertible at the date of issuance,
the Company fully amortized such discount through interest expense at the date
of issuance accordingly. However, according to Issue 6 of EITF Issue No.
00-27, “Application of Issue
No. 98-5 to Certain Convertible Instruments”, EITF Issues No. 98-5 should
be modified to require the discount related to the beneficial conversion feature
to be accreted from the date of issuance to the stated redemption date
regardless of when the earliest conversion date occurs using the effective
interest method. The restatement adjustments were to reflect the retrospective
application of the Issue 6 of EITF Issue No. 00-27.
The
aggregate net effect of the restatement was to (1) increase stockholders’ equity
by approximately $14.3 million, $15.1 million and $4.7 million as of June 30,
2008, March 31, 2008 and December 31, 2007 respectively; (2) increase both
non-cash interest expense and net loss for the three months ended June 30, 2008
by approximately $0.8 million and decrease both non-cash interest expense and
net loss for the three months ended March 31, 2008 and for the year ended
December 31, 2008 by approximately $10.4 million and $4.7 million respectively.
Accordingly, the net loss per common share (basic and diluted) for the three
months ended June 30, 2008 and March 31, 2008 increased from $0.11 to $0.12 and
decreased from $0.26 to $0.12 respectively while for the year ended December 31,
2008 decreased from $0.28 to $0.21.
CRITICIAL
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 adjust to our judgments and estimates where facts and
circumstances dictate. Actual results could differ from our
estimates.
We
believe the following critical accounting policies are important to the
portrayal of our financial condition and results and require our management's
most difficult, subjective or complex judgments, often because of the need to
make estimates about the effect of matters that are inherently
uncertain.
(1) Principles of
Consolidation
The
condensed consolidated financial statements include the financial statements of
Network CN Inc., its subsidiaries and variable interest entities. Variable
interest entities are those entities in which the Company, through contractual
arrangements, bears the risks of, and enjoys the rewards normally associated
with ownership of the entities, and therefore the Company is the primary
beneficiary of these entities. In accordance with Interpretation No. 46R,
Consolidation of Variable Interest Entities ("FIN 46R"), the primary
beneficiary is required to consolidate the variable interest entities for
financial reporting purposes. All significant intercompany transactions and
balances have been eliminated upon consolidation.
(2) Prepayments for advertising
operating
rights
Prepayments
for advertising operating rights are measured at cost less accumulated
amortization and impairment losses. Cost includes prepaid expenses directly
attributable to the acquisition of advertising operating rights. Such prepaid
expenses are in general charged to the consolidated statements of
operations on a straight-line basis over the operating period. All the costs
expected to be amortized after 12 months of the balance sheet date are
classified as non-current assets.
An
impairment loss is recognized when the carrying amount of the prepayments for
advertising operating rights exceeds the sum of the undiscounted cash flows
expected to be generated from the advertising operating right’s use and eventual
disposition. An impairment loss is measured as the amount by which the carrying
amount exceeds the fair value of the asset calculated using a discounted cash
flow analysis.
(3) Equipment, Net
Equipment
is stated at cost less accumulated depreciation. Depreciation is provided using
the straight-line method over the estimated useful life as follows:
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Media
display equipment
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|
5 -
7 years
|
|
Office
equipment
|
|
3 - 5
years
|
|
Furniture
and fixtures
|
|
3-
5 years
|
|
Leasehold
improvements
|
|
Over
the unexpired lease terms
|
Construction
in progress is carried at cost less impairment losses, if any. It relates to
construction of media display equipment. No provision for depreciation is made
on construction in progress until such time the relevant assets are completed
and put into use.
When
equipment is retired or otherwise disposed of, the related cost and accumulated
depreciation are removed from the respective accounts, and any gain or loss is
reflected in the statement of operations. Repairs and maintenance costs on
equipment are expensed as incurred.
(4) Intangible Assets, Net
Intangible
assets are stated at cost less accumulated amortization and provision for
impairment loss. Intangible assets that have indefinite useful lives are not
amortized. Other intangible assets with finite useful lives are amortized on a
straight-line basis over their estimated useful lives of 16 months to 20 years.
The amortization methods and estimated useful lives of intangible assets are
reviewed regularly.
(5) Impairment of Long-Lived
Assets
Long-lived
assets, including intangible assets with definite lives, are reviewed for
impairment whenever events or changes in circumstance indicate that the carrying
amount of the assets may not be recoverable. An intangible asset that is not
subject to amortization is reviewed for impairment annually or more frequently
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. An impairment loss is recognized when the
carrying amount of a long-lived asset and intangible asset exceeds the sum of
the undiscounted cash flows expected to be generated from the asset’s use and
eventual disposition. An impairment loss is measured as the amount by which the
carrying amount exceeds the fair value of the asset calculated using a
discounted cash flow analysis.
(6) Convertible Promissory
Notes and Warrants
In 2007,
the Company issued 12% convertible promissory note and warrants and 3%
convertible promissory notes and warrants. In 2008, the Company issued
additional 3% convertible promissory notes and warrants. As of June 30, 2008 and
December 31, 2007, the warrants and embedded conversion feature were classified
as equity under Emerging Issues Task Force (“EITF”) Issue No. 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock” and met the other criteria in paragraph 11(a) of Statement of
Financial Accounting Standards (“SFAS”) No.133 “Accounting for Derivative
Instruments and Hedging Activities”. Such classification will be
reassessed at each balance sheet date. The Company allocated the proceeds of the
convertible promissory notes between convertible promissory notes and the
financial instruments related to warrants associated with convertible promissory
notes based on their relative fair values at the commitment date. The fair value
of the financial instruments related to warrants associated with convertible
promissory notes was determined utilizing the Black-Scholes option pricing model
and the respective allocated proceeds to the warrants is recorded in additional
paid-in capital. The embedded beneficial conversion feature associated with
convertible promissory notes was recognized and measured by allocating a portion
of the proceeds equal to the intrinsic value of that feature to additional
paid-in capital in accordance with EITF Issue No. 98-5 “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio” and EITF Issue No. 00-27 “Application of Issue No. 98-5 to
Certain Convertible Instruments”.
The
portion of debt discount resulting from the allocation of proceeds to the
financial instruments related to warrants associated with convertible promissory
notes is being amortized to interest expense over the life of the convertible
promissory notes, using the effective yield method. For the portion of debt
discount resulting from the allocation of proceeds to the beneficial conversion
feature, it is amortized to interest expense over the term of the notes from the
respective dates of issuance, using the effective yield method.
(7) Early Redemption of
Convertible Promissory Notes
Should
early redemption of convertible promissory notes occur, the unamortized portion
of the associated deferred charges and debt discount would be fully written off
and any early redemption premium will be recognized as expense upon its
occurrence. All related charges, if material, would be aggregated and included
in a separate line “charges on early redemption of convertible promissory
notes”. Such an expense would be included in ordinary activities on the
consolidated statement of operations as required by SFAS No.145 “Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections”.
Pursuant
to the provisions of agreements in connection with the 3% convertible promissory
notes, in the event of a default, or if the Company’s actual EPS in any fiscal
year is less than 80% of the respective EPS target, certain investors may
require the Company to redeem the 3% Convertible Promissory Notes at 100% of the
principal amount, plus any accrued and unpaid interest, plus an amount
representing a 20% internal rate of return on the then outstanding principal
amount The Company accounts for such potential liability of 20% internal rate of
return on the then outstanding principal amount in accordance with SFAS No. 5
“Accounting for
Contingencies”.
(8) Revenue
Recognition
For
advertising services, the Company recognizes revenue in the period when
advertisements are either aired or published. Revenues from advertising barter
transactions are recognized in the period during which the advertisements are
either aired or published. Expenses from barter transactions are recognized in
the period as incurred. Barter transactions are accounted in accordance with
EITF Issue No. 99-17, “Accounting for Advertising Barter
Transactions”, which are recorded at the fair value of the advertising
provided based on the Company’s own historical practice of receiving cash for
similar advertising from buyers unrelated to the counterparty in the barter
transactions. The amounts included in advertising services revenue and general
and administrative for barter transactions were approximately $41,000 and $nil
for the three and nine months ended September 30, 2008 and 2007
respectively.
For hotel
management services, the Company recognizes revenue in the period when the
services are rendered and collection is reasonably assured.
For tour
services, the Company recognizes services-based revenue when the services have
been performed. Guangdong Tianma International Travel Service Co., Ltd
(“Tianma”) offers independent leisure travelers bundled packaged-tour products
which include both air-ticketing and hotel reservations. Tianma’s packaged-tour
products cover a variety of domestic and international
destinations.
Tianma
organizes inbound and outbound tour and travel packages which can incorporate,
among other things, air and land transportation, hotels, restaurants and tickets
to tourist destinations and other excursions. Tianma books all elements of such
packages with third-party service providers such as airlines, car rental
companies and hotels, or through other tour package providers and then resells
such packages to its clients. A typical sale of tour services is as
follows:
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1.
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Tianma,
in consultation with sub-agents, organizes a tour or travel package,
including making reservations for blocks of tickets, rooms, etc. with
third-party service providers. Tianma may be required to make deposits,
pay all or part of the ultimate fees charged by such service providers or
make legally binding commitments to pay such fees. For air-tickets, Tianma
normally books a block of air tickets with airlines in advance and pays
the full amount of the tickets to reserve seats before any tours are
formed. The air tickets are usually valid for a certain period of time. If
the pre-packaged tours do not materialize and are eventually not formed,
Tianma will resell the air tickets to other travel agents or customers.
For hotels, meals and transportation, Tianma usually pays an upfront
deposit of 50-60% of the total cost. The remaining balance is then settled
after completion of the tours.
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2.
|
Tianma,
through its sub-agents, advertises tour and travel packages at prices set
by Tianma and sub-agents.
|
|
3.
|
Customers
approach Tianma or its appointed sub-agents to book an advertised packaged
tour.
|
|
4.
|
The
customers pay a deposit to Tianma directly or through its appointed
sub-agents.
|
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5.
|
When
the minimum required number of customers (which number is different for
each tour based on the elements and costs of the tour) for a particular
tour is reached, Tianma will contact the customers for tour confirmation
and request full payment. All payments received by the appointed
sub-agents are paid to Tianma prior to the commencement of the
tours.
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6.
|
Tianma
will then make or finalize corresponding bookings with outside service
providers such as airlines, bus operators, hotels, restaurants, etc. and
pay any unpaid fees or deposits to such
providers.
|
Tianma is
the principal in such transactions and the primary obligor to the third-party
providers regardless of whether it has received full payment from its customers.
In addition, Tianma is also liable to the customers for any claims relating to
the tours such as accidents or tour services. Tianma has adequate insurance
coverage for accidental loss arising during the tours. The Company utilizes a
network of sub-agents who operate strictly in Tianma’s name and can only
advertise and promote the business of Tianma with the prior approval of
Tianma.
(9) Stock-based
Compensation
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R “Share-Based
Payment”, a revision to SFAS No. 123 “Accounting for Stock-Based
Compensation”, and superseding APB Opinion No. 25 “Accounting for Stock Issued to
Employees” and its related implementation guidance. Effective January 1,
2006, the Company adopted SFAS No. 123R, using a modified prospective
application transition method, which establishes accounting for stock-based
awards in exchange for employee services. Under this application, the Company is
required to record stock-based compensation expense for all awards granted after
the date of adoption and unvested awards that were outstanding as of the date of
adoption. SFAS No. 123R requires that stock-based compensation cost is measured
at grant date, based on the fair value of the award, and recognized in expense
over the requisite services period.
Common
stock, stock options and warrants issued to other than employees or directors in
exchange for services are recorded on the basis of their fair value, as required
by SFAS No. 123R, which is measured as of the date required by EITF
Issue 96-18 “Accounting
for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services”. In accordance with
EITF 96-18, the non-employee stock options or warrants are measured at
their fair value by using the Black-Scholes option pricing model as of the
earlier of the date at which a commitment for performance to earn the equity
instruments is reached (“performance commitment date”) or the date at which
performance is complete (“performance completion date”). The stock-based
compensation expenses are recognized on a straight-line basis over the shorter
of the period over which services are to be received or the vesting period.
Accounting for non-employee stock options or warrants which involve only
performance conditions when no performance commitment date or performance
completion date has occurred as of reporting date requires measurement at the
equity instruments then-current fair value. Any subsequent changes in the market
value of the underlying common stock are reflected in the expense recorded
in the subsequent period in which that change occurs.
(10) Income
Taxes
The
Company accounts for income taxes under SFAS No. 109 “Accounting for Income
Taxes”. Under SFAS No. 109, deferred tax assets and liabilities are
provided for the future tax effects attributable to temporary differences
between the financial statement carrying amounts of assets and liabilities and
their respective tax bases, and for the expected future tax benefits from items
including tax loss carry forwards.
Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or reversed. Under SFAS No. 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.
(11) Foreign Currency
Translation
The
assets and liabilities of the Company’s subsidiaries denominated in currencies
other than United States (“U.S.”) dollars are translated into U.S. dollars using
the applicable exchange rates at the balance sheet date. For statement of
operations’ items, amounts denominated in currencies other than U.S. dollars
were translated into U.S. dollars using the average exchange rate during the
period. Equity accounts were translated at their historical exchange rates. Net
gains and losses resulting from translation of foreign currency financial
statements are included in the statements of stockholders’ equity as accumulated
other comprehensive income (loss). Foreign currency transaction gains and losses
are reflected in the consolidated statements of operations.
(12) Recent Accounting
Pronouncements
In
September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”.
SFAS No. 157 defined fair value, establishes a framework for measuring fair
value and expands disclosure requirements about fair value measurements. In
February 2008, the FASB released FASB Staff Position No. FAS 157-2 “Effective Date of FASB Statement No.
157”, which delayed the effective date of SFAS No. 157 for all
nonfinancial assets and liabilities, expect those that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). The
provisions of SFAS No. 157 are effective for fair value measurements made in
fiscal years beginning after November 15, 2007. The adoption of this statement
did not have a material effect on the Company's future reported financial
position or results of operations.
In
February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
159 “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB
Statement No. 115”. This statement permits entities to choose to measure
many financial instruments and certain other items at fair value. Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option. However, the amendment to SFAS No. 115 “Accounting for Certain Investments
in Debt and Equity Securities” applies to all entities with
available-for-sale and trading securities. SFAS No. 159 is effective as of the
beginning of an entity’s first fiscal year that begins after November 15, 2007.
Early adoption is permitted as of the beginning of a fiscal year that begins on
or before November 15, 2007, provided the entity also elects to apply the
provision of SFAS No. 157 “Fair Value Measurements”. The
adoption of this statement did not have a material effect on the Company's
financial statements.
In
December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
141 (Revised), “Business Combinations” (“SFAS No. 141 (R)”), replacing SFAS No.
141, “Business Combinations” (“SFAS No. 141”), and SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements – an amendment of ARB No. 51”.
SFAS No. 141(R) retains the fundamental requirements of SFAS No. 141, broadens
its scope by applying the acquisition method to all transactions and other
events in which one entity obtains control over one or more other businesses,
and requires, among other things, that assets acquired and liabilities assumed
be measured at fair value as of the acquisition date, that liabilities related
to contingent consideration be recognized at the acquisition date and
re-measured at fair value in each subsequent reporting period, that
acquisition-related costs be expensed as incurred, and that income be recognized
if the fair value of the net assets acquired exceeds the fair value of the
consideration transferred. SFAS No. 160 improves the relevance, comparability,
and transparency of the financial information that a reporting entity provides
in its consolidated financial statements by establishing accounting and
reporting standards that require; the ownership interests in subsidiaries held
by parties other than the parent and the amount of consolidated net income
attributable to the parent and to the noncontrolling interest be clearly
identified and presented on the face of the consolidated statement of income,
changes in a parent’s ownership interest while the parent retains its
controlling financial interest in its subsidiary be accounted for consistently,
when a subsidiary is deconsolidated, any retained noncontrolling equity
investment in the former subsidiary be initially measured at fair value,
entities provide sufficient disclosures that clearly identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners. SFAS No. 160 affects those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate a
subsidiary. SFAS No. 141(R) and SFAS No. 160 are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008. The Company is currently assessing the impact of adopting SFAS No. 141 (R)
and SFAS No. 160 on its financial statements and related
disclosures.
In
March 2008, the FASB issued SFAS No. 161 “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
(SFAS 161). This statement is intended to improve transparency in financial
reporting by requiring enhanced disclosures of an entity’s derivative
instruments and hedging activities and their effects on the entity’s financial
position, financial performance, and cash flows. SFAS 161 applies to all
derivative instruments within the scope of SFAS No.133 “Accounting for
Derivative Instruments and Hedging Activities” (SFAS No. 133) as well as related
hedged items, bifurcated derivatives, and nonderivative instruments that are
designated and qualify as hedging instruments. Entities with instruments subject
to SFAS No.161 must provide more robust qualitative disclosures and expanded
quantitative disclosures. SFAS No. 161 is effective prospectively for financial
statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application permitted. The Company
is currently assessing the impact of adopting SFAS No. 161 on its
financial statements and related disclosures.
In
May 2008, the FASB issued SFAS No. 162 “The Hierarchy of Generally Accepted
Accounting Principles”. SFAS No. 162 identifies the sources of accounting
principles and the framework for selecting the accounting principles to be used.
Any effect of applying the provisions of this statement will be reported as a
change in accounting principle in accordance with SFAS No. 154 “Accounting Changes and Error
Corrections”. SFAS No. 162 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008. The
Company is currently evaluating the impact the adoption of this statement could
have on its financial condition, results of operations and cash
flows.
In May
2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee
Insurance Contracts, an interpretation of FASB Statement No. 60”. The
scope of this Statement is limited to financial guarantee insurance (and
reinsurance) contracts, as described in this Statement, issued by enterprises
included within the scope of Statement 60. Accordingly, this Statement does not
apply to financial guarantee contracts issued by enterprises excluded from the
scope of Statement 60 or to some insurance contracts that seem similar to
financial guarantee insurance contracts issued by insurance enterprises (such as
mortgage guaranty insurance or credit insurance on trade receivables). This
Statement also does not apply to financial guarantee insurance contracts that
are derivative instruments included within the scope of FASB Statement No. 133,
“Accounting for Derivative
Instruments and Hedging Activities”. This Statement will not have any
impact on the Company’s consolidated financial statements.
In May
2008, the FASB issued Staff Position No. APB 14-1 “Accounting for Convertible Debt
Instruments that May be Settled in Cash Upon Conversion”. APB 14-1
requires that the liability and equity components of convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement) be separately accounted for in a manner that reflects an issuer’s
nonconvertible debt borrowing rate. The resulting debt discount is amortized
over the period the convertible debt is expected to be outstanding as additional
non-cash interest expense. APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. Retrospective application to all periods presented is
required except for instruments that were not outstanding during any of the
periods that will be presented in the annual financial statements for the period
of adoption but were outstanding during an earlier period. The Company is
currently evaluating the impact of the adoption of this position could have on
its financial condition, results of operations and cash flows.
In June
2008, the FASB issued Emerging Issues Task Force Issue No. 07-5 “Determining whether an Instrument
(or Embedded Feature) is indexed to an Entity’s Own Stock” (“EITF No.
07-5”). This Issue is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years. Early application is not permitted. Paragraph 11(a) of SFAS No. 133
“Accounting for Derivatives
and Hedging Activities” (“SFAS 133”) specifies that a contract that would
otherwise meet the definition of a derivative but is both (a) indexed to
the Company’s own stock and (b) classified in stockholders’ equity in the
statement of financial position would not be considered a derivative financial
instrument. EITF No.07-5 provides a new two-step model to be applied in
determining whether a financial instrument or an embedded feature is indexed to
an issuer’s own stock and thus able to qualify for the SFAS No. 133 paragraph
11(a) scope exception. The Company is currently evaluating the impact of
adoption of EITF No. 07-5 on its financial statements and related
disclosures.
In June
2008, FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming
Changes to Issue No. 98-5 (“EITF No. 08-4”)”. The objective of EITF
No.08-4 is to provide transition guidance for conforming changes made to EITF
No. 98-5, “Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios”, that result from EITF No. 00-27 “Application of Issue No. 98-5 to
Certain Convertible Instruments”, and SFAS No. 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity”. This
Issue is effective for financial statements issued for fiscal years ending after
December 15, 2008. Early application is permitted. The Company is currently
evaluating the impact of adoption of EITF No. 08-4 on the accounting for the
convertible notes and related warrants transactions.
RESULTS
OF OPERATIONS
For
the three months ended September 30, 2008 and 2007
Revenues
In the
three months ended September 30, 2008 our revenues were derived from sale of
advertising services. Revenues from advertising services for the three
months ended September 30, 2008 were $2,520,474 as compared to
$466,071 for the corresponding prior year period, an increase of 441%, the
significant increase was due to the Company started to generate LED advertising
revenue in late 2007.
Cost
of Advertising Services
Cost of
advertising services for the three months ended September 30, 2008 was
$5,651,467, an increase of 1513% compared to $350,325 for the corresponding
prior year period. The significant increase was attributable to
the consolidation of Botong and Bona in 2008. In addition, there is an
increase in amortization of advertising rights which were acquired in the later
half of 2007 and early 2008 and depreciation of media display
equipments which were placed into operation in early 2008.
Selling
and Marketing Expenses
Selling
and marketing expenses for the three months ended September 30,
2008 increased by 520% to $656,114 compared to $105,847 for the
corresponding prior year period, primarily due to increase in advertising
services provided by the Company.
General
and Administrative Expenses
General
and administrative expenses for the three months ended September 30,
2008 increased by 37% to $4,408,534 compared to $3,215,893 for the
corresponding prior year period. The increase was mainly due to the occurrence
of a one-time allowance for doubtful debt of $1,411,287 for other
receivables during the three months ended September 30, 2008. Such other
receivables represented the balance of payment from our customers being
withheld by the Authority Party of T3 Project. In addition, the increase
was also driven by the increase in staff costs, office rental expense and other
miscellaneous administrative expense as a result of the Company’s expansion in
2008, while offset by the decrease in the stock-based compensation expense. The
decrease in the stock-based compensation was mainly due to less stock having
been granted for services rendered in 2008.
Non-cash
impairment charges
The
Company recorded non-cash impairment charges of $5,671,782 for the three months
ended September 30, 2008 compared to $nil for the corresponding prior year
period. As the Company recorded a continuous net loss, it performed an
impairment review of its prepayments for advertising operating rights during the
quarter ended September 30, 2008. Accordingly, an impairment loss of $3,473,468,
$1,737,991 and $460,323 was recorded for prepayments for advertising operating
rights associated with T3 Project, BAMC Project and certain roadside
advertising panels’ projects, respectively.
Interest
Expenses
Interest
expense for the three months ended September 30, 2008 was $1,775,450, compared
to $nil for the corresponding prior year period. The increase was primarily
due to the issuance of convertible promissory notes in late 2007 and early
2008.
Net
loss from Continuing Operations
The
Company incurred a net loss from continuing operations of $15,546,407 for the
three months ended September 30, 2008, an increase of 385% compared to a net
loss of $3,207,019 for the corresponding prior year period. The increase in net
loss was driven by several factors: (1) increase in cost of advertising services
related to our media business as mention above, (2) increase in impairment loss
of $5,671,782 recorded for prepayments for advertising operating rights
associated with T3 project, BAMC project and certain roadside advertising
panels’ projects, (3) increase in amortization of deferred charges and a debt
discount associated with the issuance of convertible promissory notes in late
2007 and early 2008, (4) the increase in amortization charges of intangible
assets of $259,665 as a result of the addition of identifiable intangible assets
arising from the consolidation of Botong and Lianhe in January 2008, (5)
occurrence of a one-time allowance for doubtful debt of $1,411,287 for other
receivables as mentioned above and (6) an increase in professional fees, payroll
and other administrative expenses as a result of our rapid
expansion.
For
the nine months ended September 30, 2008 and 2007
Revenues
In the
nine months ended September 30, 2008 our revenues were derived from the sale of
advertising services. Revenues from advertising services for the nine months
ended September 30, 2008 were $4,158,529, as compared to $965,995 for the
corresponding prior year period, an increase of 330%. The significant increase
was attributable to the Company beginning to generate LED advertising
revenue in late 2007.
Cost
of Advertising Services
Cost of
advertising services for the nine months ended September 30, 2008 was
$14,258,071, an increase of 1917% compared to $706,698 for the corresponding
prior year period. The significant increase was attributable to the
consolidation of Botong and Bona in 2008. In addition, there is an increase in
amortization of advertising rights which acquired in the latter half of 2007 and
in the early of 2008 and depreciation of media display equipment which were
placed into operation in the early of 2008.
Selling
and Marketing Expenses
Selling
and marketing expenses for the nine months ended September 30,
2008 increased by 842% to $2,120,397 compared to $225,092 for the
corresponding prior year period, primarily due to an increase in
advertising services provided by the Company.
General
and Administrative Expenses
General
and administrative expenses for the nine months ended September 30,
2008 increased by 17% to $9,929,559 compared to $8,500,827 for the
corresponding prior year period. The increase was mainly due to
the occurrence of a one-time allownace for doubtful debt of $1,411,287 for
other receivables during the three months ended September 30, 2008. Such other
receivables represented the balance of payment from our customers being withheld
by the Authority Party of T3 Project. Besides, the increase was also driven by
the increase in staff costs, office rental expense and other miscellaneous
administrative expense as a result of the Company’s expansion in 2008, while
offset by the decrease in the stock-based compensation expense. The decrease in
the stock-based compensation was mainly due to less stock having been granted
for services rendered during the nine months ended September 30,
2008.
Non-cash
impairment charges
The
Company recorded non-cash impairment charges of $5,671,782 for the nine months
ended September 30, 2008 compared to $nil for the corresponding prior year
period. As the Company recorded a continuous net loss, it performed an
impairment review of its prepayments for advertising operating rights during the
quarter ended September 30, 2008. Accordingly, an impairment loss of $3,473,468,
$1,737,991 and $460,323 was recorded for prepayments for advertising operating
rights associated with T3 Project, BAMC Project and certain roadside
advertising panels’ projects, respectively.
Interest
expenses
Interest
expense for the nine months ended September 30, 2008 were $5,200,229 compared to
$421 for the corresponding prior year period. The significant increase was
primarily due to the issuance of convertible promissory notes in 2007 and
2008.
Net
loss from Continuing Operations
The
Company incurred a net loss from continuing operations of $32,776,641 for the
nine months ended September 30, 2008, an increase of 287% compared to a net loss
of $8,459,050 for the corresponding prior year period. The increase in net loss
was driven by several factors: (1) increase in cost of advertising services
related to our media business as mention above, (2) increase in impairment loss
of $5,671,782 recorded for prepayments for advertising operating rights
associated with T3 project, BAMC project and certain roadside
advertising panels projects,, (3) the increase in amortization of deferred
charges and a debt discount associated with the issuance of convertible
promissory notes in late 2007 and early 2008, (4) the increase in amortization
charges of intangible assets of $778,995 as a result of the addition of
identifiable intangible assets arising from the consolidation of Botong and
Lianhe in January 2008 (5) occurrence of a one-time allowance for doubtful debt
of $1,411,287 for other receivables as mentioned above and (6) an increase in
professional fees, payroll and other administrative expenses as a result of our
rapid expansion.
Discontinued
Operations
As
previously discussed, the Company sold its entire travel network during the
three months ended September 30, 2008. The Company entered into stock purchase
agreements to dispose of its entire travel network.
On
September 1, 2008, the Company completed the sale of all its interests in NCN
Management Services Limited (“NCN Management Services”) to Zhanpeng Wang
(“Zhanpeng”), an individual for a consideration of HK$1,350,000, or
approximately US$173,000, in cash. Zhanpeng acquired NCN
Management Services along with its subsidiaries, which include 100% interest in
NCN Hotels Investment Limited, 100% interest in NCN Pacific Hotels Limited and a
55% interest (through trust) in Tianma. The Company reported a gain on the sale,
net of income taxes and minority interests of $61,570.
On
September 30, 2008, the Company completed the sale of its 99.9% interest in NCN
Landmark International Hotel Group Limited (“NCN Landmark”) to Ngar Yee Tsang
(“Ngar”), an individual for a cash consideration of $20,000. Ngar acquired NCN
Landmark along with its subsidiary, 100% interest in Beijing NCN Landmark Hotel
Management Limited, a PRC corporation. The Company reported a gain on the sale,
net of income taxes and minority interests of $4,515.
The
Company treated the sales of NCN Management Services along with its subsidiaries
and variable interest entity and NCN Landmark along with its subsidiary as
discontinued operations. Accordingly, revenues, costs and expenses of the
discontinued operations have been excluded from the respective captions in the
condensed consolidated statements of operations. Summary operating results for
the discontinued operations for travel network as follows:
|
For
the Three Months ended
|
For
the Nine Months Ended
|
|||||||||||||||
|
September
30,
2008
|
September
30,
2007
|
September
30,
2008
|
September
30,
2007
|
|||||||||||||
|
Revenues
|
6,342,479 | 8,018,734 | 24,528,096 | 15,432,761 | ||||||||||||
|
Cost
of revenues
|
(6,242,465 | ) | (7,926,043 | ) | (24,172,537 | ) | (15,221,181 | ) | ||||||||
|
Gross
Profit
|
100,014 | 92,691 | 355,599 | 211,580 | ||||||||||||
|
Operating
expenses
|
(156,864 | ) | (91,597 | ) | (477,481 | ) | (345,600 | ) | ||||||||
|
Other
income
|
58,027 | - | 98,838 | 9,209 | ||||||||||||
|
Interest
income
|
72 | - | 2,040 | 2,075 | ||||||||||||
|
Minority
interest
|
4,707 | (4,262 | ) | (2,401 | ) | 867 | ||||||||||
|
Income
(loss) from discontinued operations, net of income taxes and minority
interests
|
5,956 | (3,168 | ) | (23,405 | ) | (121,869 | ) | |||||||||
LIQUIDITY
AND CAPITAL RESOURCES
As of
September 30, 2008, the Company had cash of $10,041,572 compared to $2,233,528
as of December 31, 2007, representing an increase of $7,808,044. The
increase was attributable to the issuance of convertible promissory notes in
late 2007 and early 2008.
Net cash
utilized by operating activities for the nine months ended September 30, 2008
was $16,012,039, as compared with $2,004,231 for the corresponding prior year
period. The increase in net cash used in operating activities was attributable
to an increase in the payments for acquiring advertising operating
right.
Net cash
used in investing activities for the nine months ended September 30, 2008
was $6,648,969, compared with net cash used in investing activities of $376,647
for the corresponding prior year period. For the nine months ended September 30,
2008, the investing activities consisted primarily of the purchase
of equipment related to our media business and costs associated with the
acquisition of Cityhorizon BVI. Net cash used in investing activities in the
nine months ended September 30, 2008 was also increased by the sale of the
entire travel network in the quarter ended September 30, 2008, resulting a cash
outflow of $472,827 which represents the proceeds of disposals, net of cash
disposed of.
Net cash
provided by financing activities was $28,900,000 for the nine months ended
September 30, 2008, compared with net cash provided by financing activities
of $1,519,380 for the corresponding prior year period. The increase was
primarily attributable to the issuance of $35,000,000 in 3% Convertible
Promissory Notes, offset by $5,000,000 paid to redeem outstanding 12%
convertible promissory note due May 2008. For the nine months ended September
30, 2007, the financing activities were attributable to a private placement that
raised proceeds of $1,500,000.
Capital
Expenditures
We
continue to seek opportunities to enter new markets, increase market share or
broaden service offerings through acquisitions. During the nine months ended
September 30, 2008, we acquired assets of $3,761,165 which were financed through
proceeds
from the issuance of convertible promissory notes.
Commitments
a) Rental
Lease Commitment
The
Company’s existing rental leases do not contain significant restrictive
provisions. The following is a schedule by year of future minimum lease
obligations under non-cancelable rental operating leases as of September 30,
2008:
|
Three months
ending December
31,2008
|
$ | 256,530 | ||
|
Fiscal years ending
December 31,
|
||||
|
2008
|
$ | 256,530 | ||
|
2009
|
971,561 | |||
|
2010
|
843,241 | |||
|
2011
|
197,474 | |||
|
Total
|
$ | 2,268,806 |
b) Annual
Advertising Operating Rights Fee Commitment
Since
November 2006, the Company, through its subsidiaries, NCN Media Services
Limited, Quo Advertising, Xuancaiyi, Bona and Botong, have acquired rights from
third parties to operate 1,864 roadside advertising panels, 11,000 in-building
LCD and 11 mega-size advertising panels for periods ranging from 1 to 20
years.
A summary
of the estimated future annual advertising operating rights fee commitments
based on the 1,864 roadside advertising panels, 11,000 in-building LCD and 11
mega-size advertising panels as of September 30, 2008 was as
follows:
|
(In
millions)
|
||||
|
Three
months
ending December
31,2008
|
$ | 13.06 | ||
|
Fiscal years ending
December 31,
|
||||
|
2008
|
$ | 13.06 | ||
|
2009
|
14.61 | |||
|
2010
|
4.04 | |||
|
2011
|
4.06 | |||
|
2012
|
3.97 | |||
|
Thereafter
|
25.42 | |||
|
Total
|
$ | 65.16 | ||
Remarks
:
|
1)
|
The
above 1,864 roadside advertising panels include 98 freestanding
multimedia advertisement light boxes under T3 Project which the Company
received a unilateral termination letter regarding the exclusive right
from the Authority Party in August 2008. Currently, the Company is
evaluating its ability to take legal action against the Authority
Party.
|
|
2)
|
The
contract period for T3 Project was 3 years. As the termination of
exclusive right from Authority Party was unilateral, the Company
conservatively included the future annual advertising operating right fees
in the above commitment table. Such future annual advertising operating
rights fees of T3 Project were reflected in 2009 and 2010 with balance of
$8.9 million and $9.9 million
respectively.
|
c) Capital
commitments
As
of September 30, 2008, the Company had commitments for capital expenditures
in connection with construction of roadside advertising panels and mega-size
advertising panels of approximately $97,000.
Financing
Activities
Due to
the unexpected unfavorable market conditions described above, cash inflows from
advertising revenues were less than we expected. The Company will have to raise
additional funds in order to further expand its media network, though it should
be able to satisfy its requirements during the next 12 months if it scales down
its operations. Because we presently have only limited revenue from operations,
we intend to continue to rely primarily on financing through the sale of our
equity and debt securities to satisfy future capital requirements such that we
will be able to finance ongoing operations. There can be no assurance that we
will be able to enter into such agreements. Current global financial conditions
and unfavorable conditions in our existing notes described below make securing a
financing difficult to achieve. Failure to raise additional funds would have a
material adverse effect on our financial condition. Furthermore, the issuance of
equity or debt securities which are or may become convertible into equity
securities in connection with such financing could result in substantial
additional dilution to the stockholders.
To
address our cash constraints, the Board of Directors has directed management to
undergo drastic cost-cutting exercises including reduction of the Company’s
workforce, rentals, as well as selling and marketing expenses and other general
and administrative expenses. Commencing in October, salary increases to the four
executive directors during 2008 would be accrued but payments will be withheld.
In addition, contractual share grants for 2008 to the top executives will be
withheld until further notice. Management is re-assessing the commercial
viability of each of the Company’s concession rights, actively negotiating with
the authority parties of concession rights to reduce rights fees and exploring
ways to terminate commercially non-viable concession rights contracts.
Impairment losses have been provided for T3 Project, BAMC Project and certain
roadside advertising panels’ projects during the three months ended September
30, 2008. Please refer to Note 7 - Prepayments for Advertising Operating Rights
for details.
3%
Convertible Promissory Notes and Warrants
The
Company’s convertible promissory notes and warrants contain various provisions
that protect the interests of the holders of these securities in a manner that
may be adverse to our common stock holders. The 3% Convertible Promissory Notes
bear interest at 3% per annum payable semi-annually in arrears and mature on
June 30, 2011. The Warrants grant the holders the right to acquire shares of
common stock at $2.50 and $3.50 per share.
The 3%
Convertible Promissory Notes are convertible into shares of common stock at an
initial conversion price of $1.65 per share, subject to customary anti-dilution
adjustments. In addition, the conversion price will be adjusted downward on
an annual basis if the Company should fail to meet certain annual earnings per
share (“EPS”) targets. The Company anticipates that it is unlikely to meet the
2008 EPS target and thus it is likely that the conversion price would be
adjusted downward. The amount of the adjustment could potentially reduce the
conversion price dramatically and result in substantial dilution to our
stockholders.
The
exercise price of the Warrants will also be adjusted downward whenever the
conversion price of the 3% Convertible Promissory Notes is adjusted downward and
thus it is likely that the exercise price would be adjusted downward as
discussed above. The amount of the adjustment could potentially reduce the
exercise price dramatically and result in substantial dilution to our
stockholders.
In the
event of a default, or if the Company’s actual EPS for any fiscal year is less
than 80% of the respective EPS target, the investors may require the Company to
redeem the 3% Convertible Promissory Notes at 100% of the principal amount, plus
any accrued and unpaid interest, plus an amount representing a 20% internal rate
of return on the then outstanding principal amount. If the Company were to
receive EPS for 2008 at less than 80% of the target for 2008, the investors
could require the Company to redeem the notes as discussed above. The Company
currently does not have funds sufficient to pay the redemption amounts that
would be owed if the investors elect to redeem the notes. There can be no
assurance that the Company would be able to raise such funds in the event the
investors choose to exercise their option to redeem the notes. Failure to pay
the redemption amount would have a material adverse effect on our financial
condition.
It is
likely that the Company will not achieve 80% of its EPS target for 2008, thus
giving the investors the right to call the notes for redemption as discussed
above. The Company has been discussing its situation with the investors, and
believed that the likelihood of the investors calling for early redemption is
between remote and reasonably possible.
Discontinued
Operations
As
previously discussed, the Company disposed of its entire travel network during
the three months ended September 30, 2008 in order to focus on its media
business. The Company believed that the impact of the absence of cash flows
related to the discontinued operation of our travel network was immaterial to
the Company’s future liquidity and capital resources.
Off-Balance
Sheet Arrangements
We do not
have any off-balance sheet financing arrangements.
Item 3. Quantitative and Qualitative Disclosure About Market
Risk
The
follow discussion about our market risk disclosures involves forward-looking
statements. Actual results could differ from those projected in the
forward-looking statements. We are exposed to market risk related to changes in
interest rates and foreign currency exchange rates. We do not use derivative
financial instruments for speculative or trading purposes.
Interest rate sensitivity –
The Company has no significant interest-bearing assets, the Company’s
income and operating cash flows are substantially independent of changes in
market rates. The Company’s fair value interest-rate risk arises from
convertible notes issued which issued at fixed rates.
Foreign currency exchange risk
– We face exposure to
adverse movements in foreign currency exchange rates. Because our financial
results are denominated in U.S. dollars, our foreign currency exchange exposure
is related to the fact that our operating business are currently conducted in
China and substantially all of our revenues and expenses are denominated in
Renminbi (“RMB”) and our funding are denominated in United States Dollars
(“USD”), fluctuations in exchange rates between USD and RMB will affect our
balance sheet and financial results. Our assets and liabilities related to RMB
were related to accounts receivable and payables. Since July 2005, RMB has
been no longer solely pegged with USD but is pegged against a basket of
currencies as a whole in order to keep a more stable exchange rate for
international trading. With the very strong economic growth in China in the last
few years, RMB is facing a very high pressure to appreciate against USD. Such
pressure would result in more fluctuations in exchange rates and in turn our
business would suffer from higher foreign currency exchange rate
risk. There are very limited hedging tools available in China to
hedge our exposure in exchange rate fluctuations. They are also ineffective in
the sense that these hedges cannot be performed in the PRC financial market, and
more important, the frequent changes in PRC exchange control regulations would
limit our hedging ability for RMB. As of September 30, 2008, we do not expect an
increase or decrease in the foreign exchange rate for RMB will have a material
impact on our financial position. We have not hedged against foreign currency
fluctuations.
Item 4. Controls and Procedures
|
(a)
|
Evaluation of Disclosure
Controls and Procedures.
|
Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an evaluation of the
effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended, as of the end of the period covered by this
Quarterly Report on Form 10-Q (the “Evaluation Date”). The purpose of this
evaluation was to determine if, as of the Evaluation Date, our disclosure
controls and procedures were operating effectively such that the information,
required to be disclosed in our Securities and Exchange Commission (“SEC”)
reports (i) was recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms, and (ii) was accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
Based on
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the Evaluation Date, our disclosure controls and
procedures were operating effectively.
|
(b)
|
Changes in Internal Control
over Financial
Reporting.
|
There
have been no significant changes in our internal controls over financial
reporting that occurred during the third quarter of fiscal year 2008 that have
materially affected, or are reasonably likely to materially affect our internal
controls over financial reporting.
Limitations
on the Effectiveness of Disclosure Controls and Procedures
Disclosure
controls and procedures and other procedures that are designed to ensure that
information required to be disclosed in our reports filed or submitted under the
Exchange Act are recorded, processed, summarized and reported, within the time
period specified in the SEC'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
As of
September 30, 2008, we are not aware of any material, active or pending legal
proceedings against the Company or its subsidiaries or variable interest
entities, nor are we involved as a plaintiff in any material proceeding or
pending litigation. There are no proceedings adverse to the Company in which any
of our directors, officers or affiliates of the Company, any owner of record or
beneficiary of more than 5% of any class of voting securities of the Company, or
security holder is a party or has a material interest.
Item 1A. Risk Factors
1. Risks Related to Operating
Our Business in China
All of
our assets and revenues are derived from our operations located in China.
Accordingly, our business, financial condition, results of operations and
prospects are subject, to a significant extent, to economic, political and legal
developments in China.
The
PRC’s economic, political and social conditions, as well as governmental
policies, could affect the financial markets in China, our liquidity and our
ability to access to capital and to operate our business.
The PRC
economy differs from the economies of most developed countries in many respects,
including the extent of government involvement, level of development, growth
rate, and control of foreign exchange and allocation of resources. While the PRC
economy has experienced significant growth over the past several years, growth
has been irregular, both geographically and among various sectors of the
economy. The PRC government has implemented various measures to encourage
economic growth and guide the allocation of resources. Some of these measures
benefit the overall PRC economy, but may also have a negative effect on the
Company. The PRC economy has been transitioning from a planned economy to a more
market-oriented economy. Although the PRC government has implemented measures
since the late 1970’s emphasizing the utilization of market forces for economic
reform, the reduction of state ownership of productive assets and the
establishment of improved corporate governance in business enterprises, a
substantial portion of productive assets in China are still owned by the PRC
government. In addition, the PRC government continues to play a significant role
in regulating industry development by imposing industrial policies. The PRC
government also exercises significant control over China’s economic growth
through allocating resources, controlling payment of foreign
currency-denominated obligations, establishing monetary policy and providing
preferential treatment to particular industries or companies. Since late 2003,
the PRC government has implemented a number of measures, such as raising bank
reserves against deposit rates to place additional limitations on the ability of
commercial banks to make loans and raise interest rates, in order to slow down
specific segments of China’s economy, which is believed to be overheating. These
actions, as well as future actions and policies of the PRC government, could
materially affect our liquidity and our ability to access to capital and to
operate our business.
China's
central bank announced on 16 January 2008 that it will raise the required
reserve ratio for commercial banks by half a percentage point as of 25 January
2008. As such, the ratio would be raised to 15 %, the highest since
1984. The intention of this action, together with other stringent monetary
policies, is to reduce their lending power in an effort to cool down the
economic overheating. Together with this action, the central bank raised the
reserve ratio a total of 11 times and benchmark interest rates six times from
last year. Since from last few years, excess liquidity is a major challenge
for the China government as it results in bubbles and economic overheating.
China's stock market benchmark Shanghai Composite Index almost doubled last year
and the economy expanded 11.5 % in the first three quarters of
2007.
Such move
is due to the fact that the PRC government has prime concern about Renminbi
appreciation and accelerating inflation pressure. In January 2008, it is
reported that China's macro data showed a slightly decrease in both the trade
surplus and money supply from November. China’s December trade surplus is
US$22.7 billion and it shows a jump of 48 % from a year earlier. Due to the
export surplus, M2, the broadest measure of money supply, rises 16.7 % to
US$5.55 trillion from a year earlier. Along with the trade surplus growth, it
helps push up foreign reserves to a total US$1.53 trillion by the end of 2007.
At the same time, economic growth is likely to continue accelerating. Inflation
in China surges to 6.9 % in November 2007, the fastest since 1996.
It is
expected that the PRC government will continue to institute further tightening
measures to cool down the risk of the liquidity-fueled A-share bubble and hot
property market. The interest rate and the reserve requirement ratio would
likely go higher in this year. These actions, together with other actions and
policies of the government, could materially affect our liquidity and operation
in business.
Our
operations in China may be adversely affected by changes in the policies of the
PRC government.
The
political environment in the PRC may adversely affect the Company’s business
operations. PRC has been operating as a socialist state since 1949 and is
controlled by the Communist Party of China. In recent years, however, the
government has introduced reforms aimed at creating a “socialist market economy”
and policies have been implemented to allow business enterprises greater
autonomy in their operations. Changes in the political leadership of the PRC may
have a significant effect on laws and policies related to the current economic
reforms program, other policies affecting business and the general political,
economic and social environment in the PRC, including the introduction of
measures to control inflation, changes in the rate or method of taxation, the
imposition of additional restrictions on currency conversion and remittances
abroad, foreign investment and so on. Since most of our operating assets and
revenues are derived from our operations located in China, our business and
financial condition, results of operations and prospects are closely subject to
economic, political and legal developments in China. Moreover, economic reforms
and growth in the PRC have been more successful in certain provinces than in
others, and the continuation or increases of such disparities could affect the
political or social stability of the PRC.
Our
business development in China may be affected by the introduction of Enterprise
Income Tax Law (the EIT Law) effective from January 1, 2008.
The EIT
Law was promulgated by the National People’s Congress on March 16, 2007 to
introduce a new uniform taxation regime in the PRC. Both resident and
non-resident enterprises deriving income from the PRC will be subject to this
EIT Law from January 1, 2008. It replaces the previous two different tax rates
applied to foreign-invested enterprises and domestic enterprises by only one
single income tax rate applied for all enterprises in the PRC. Under this EIT
Law, except for some hi-tech enterprises which are subject to EIT rates of 15%,
the general applicable EIT rate in the PRC is 25%. We may not enjoy tax
incentives for our further established companies in the PRC and therefore our
tax advantages over domestic enterprises may be diminished. As a result, our
business development in China may be adversely affected.
The
PRC government exerts substantial influence over the manner in which the Company
must conduct its business activities.
Only
recently has the PRC government permitted greater provincial and local economic
autonomy and private economic activities. The PRC government has exercised and
continues to exercise substantial control over virtually every sector of the
Chinese economy through regulation and state ownership. Accordingly, any
decision not to continue to support recent economic reforms and to return to a
more centrally planned economy, regional or local variations in the
implementation of economic policies could have a significant effect on economic
conditions in the PRC or particular regions. The Company may be requested to
divest the interests it then holds in Chinese properties or joint ventures. Any
such developments could have a material affect on the business, operations,
financial condition and prospects of the Company.
Future
inflation in China may inhibit economic activity and therefore affect our
operations.
Recently,
the Chinese economy has experienced periods of rapid expansion. During this
period, there have been high rates of inflation. As a result, the PRC government
adopted various corrective and cool-down measures designed to restrict the
availability of credit or regulate growth and contain inflation. While inflation
has moderated since 1995, high inflation would cause the PRC government to
impose controls on credit and/or prices, which could inhibit economic activity
in China, and thereby affecting the Company’s business operations and prospects
in the PRC.
We
may be restricted from exchanging RMB to other currencies in a timely
manner.
At the
present time, Renminbi (“RMB”) is not an exchangeable currency. The Company
receives nearly all of its revenue in RMB, which may need to be exchanged to
other currencies, primarily U.S. dollars, and remitted outside of the PRC.
Effective from July 1, 1996, foreign currency “current account” transactions by
foreign investment enterprises, including Sino-foreign joint ventures, are no
longer subject to the approval of State Administration of Foreign Exchange
(“SAFE”, formerly, “State Administration of Exchange Control”), but need only a
ministerial review, according to the Administration of the Settlement, Sale and
Payment of Foreign Exchange Provisions promulgated in 1996 (the “FX
regulations”). “Current account” items include international commercial
transactions, which occur on a regular basis, such as those relating to trade
and provision of services. Distributions to joint venture parties also are
considered a “current account transaction”. Other non-current account items,
known as “capital account” items, remain subject to SAFE approval. Under current
regulations, the Company can obtain foreign currency in exchange for RMB from
swap centers authorized by the government. The Company does not anticipate
problems in obtaining foreign currency to satisfy its requirements; however,
there is no assurance that foreign currency shortages or changes in currency
exchange laws and regulations by the PRC government will not restrict the
Company from exchanging RMB in a timely manner. If such shortages or changes in
laws and regulations occur, the Company may accept RMB, which can be held or
reinvested in other projects.
We
may suffer from exchange rate risks that could result in foreign currency
exchange loss.
Because
our business transactions are denominated in RMB and our funding will be
denominated in USD, fluctuations in exchange rates between USD and RMB will
affect our balance sheet and financial results. Since July 2005, RMB has
been no longer solely pegged with USD but is pegged against a basket of
currencies as a whole in order to keep a more stable exchange rate for
international trading. With the very strong economic growth in China in the last
few years, RMB is facing a very high pressure to appreciate against USD. Such
pressure would result in more fluctuations in exchange rates and in turn our
business would suffer from higher foreign currency exchange rate
risk.
There are
very limited hedging tools available in China to hedge our exposure in exchange
rate fluctuations. They are also ineffective in the sense that these hedges
cannot be performed in the PRC financial market, and more important, the
frequent changes in PRC exchange control regulations would limit our hedging
ability for RMB.
Due
to our assets are located in PRC, stockholders may not receive distributions
that they would otherwise be entitled to if we were declared bankruptcy or
insolvency.
Due to
the Company’s assets are located in PRC, the assets of the Company may be
outside of the jurisdiction of U.S. courts to administer if the Company was the
subject of an insolvency or bankruptcy proceeding. As a result, if the Company
was declared bankrupt or insolvent, the Company’s stockholders may not be able
to receive the distributions on liquidation that they are otherwise entitled to
under U.S. bankruptcy law.
If
any of our PRC companies becomes the subject of a bankruptcy or liquidation
proceeding, we may lose the ability to use and enjoy those assets, which could
materially affect our business, ability to generate revenue and the market price
of our common stock.
To comply
with PRC laws and regulations relating to foreign ownership restrictions in the
advertising businesses, we currently conduct our operations in China through
contractual arrangements with with shareholders of Quo Advertising, Lianhe, Bona
and Botong. As part of these arrangements, these persons hold some of the
assets that are important to the operation of our business. If any of these
entities files for bankruptcy and all or part of their assets become subject to
liens or rights of third-party creditors, we may be unable to continue some or
all of our business activities, which could affect our business, financial
condition and results of operations.
Our
acquisitions of Quo Advertising, Xuancaiyi, Lianhe and Bona were structured to
attempt to fully comply with PRC rules and regulations. However, such
arrangements may be adjudicated by relevant PRC government agencies as not being
in compliance with PRC governmental regulations on foreign investment in
advertising industries and such structures may limit our control with respect to
such entities.
Since
2005, the PRC government has allowed foreign investors to directly own 100% of
an advertising business if the foreign investor has at least three years of
direct operations in the advertising business outside of China or to own less
than 100% if the foreign investor has at least two years of direct operations in
the advertising industry outside of China. As we do not currently directly
operate an advertising business outside of China, we are not entitled to own
directly 100% of an advertising business in China.
Our
advertising business was run through our contractual arrangements with our PRC
operating subsidiary Quo Advertising. Quo Advertising was owned by two PRC
citizens designated by us and directly operated our advertising network
projects. In January 2008, we restructured our advertising business after
further acquiring the media subsidiaries namely Lianhe and Bona. We, through our
newly acquired company, Lianhe, entered into an exclusive management consulting
services agreement and an exclusive technology consulting services agreement
with each of Quo Advertising, Bona and Botong. In addition, Lianhe also entered
into an equity pledge agreement and an option purchase agreement with each of
the shareholders of Quo Advertising, Bona and Botong pursuant to which these
shareholders had pledged 100% of their shares to Lianhe and granted Lianhe the
option to acquire their shares at a mutually agreed purchase price which shall
first be used to repay any loans payable to Lianhe or any affiliate of Lianhe by
the registered PRC shareholders. These commercial arrangements enable us to
exert effective control on these entities, and transfer their economic benefits
to us for financial results consolidation.
Since we
believe that there is risk in our structural arrangement with advertising
entities, we try to minimize this risk by consulting a local legal counsel in
China. The local legal counsel critically analyzes and reviews the documents and
agreements. Based on the advice given by the local legal counsel, we make
amendments in our legal documents and, if necessary, and prepare additional
legal document in order to improve our position for the case of any legal
proceeding. Although the risk cannot be avoided totally, we believe that we
performed our reasonable effort to reduce the risk arising from our contractual
arrangement.
We have
been and will continue to be dependent on these PRC operating companies to
operate our advertising business in the near future. If our existing PRC
operating subsidiaries are found to be in violation of any PRC laws or
regulations and fail to obtain any of the required permits or approvals under
any relevant PRC regulations, we could be penalized. It would have an effect on
our ability to conduct business in these aspects.
The
PRC government regulates the advertising industry. If we fail to obtain or
maintain all pertinent permits and approvals or if the PRC government imposes
more restrictions on this industry, our business may be affected.
The PRC
government regulates the advertising industry. We are required to obtain
applicable permits or approvals from different regulatory authorities to conduct
our business, including separate licenses for advertising activities. If we fail
to obtain or maintain any of the required permits or approvals, we may be
subject to various penalties, such as fines or suspension of operations in these
regulated businesses, which could severely disrupt our business operations. As a
result, our financial condition and results of operations may be
affected.
We
have attempted to comply with the PRC government regulations regarding licensing
requirements by entering into a series of agreements with our affiliated Chinese
entities. If the PRC laws and regulations change, our business in China may be
affected.
To comply
with the PRC government regulations regarding licensing requirements, we have
entered into a series of agreements with our affiliated Chinese entities to
exert operational control and secure consulting fees and other payments from
them. We have been advised by our PRC legal counsel that our arrangements with
our affiliated Chinese entities are valid under current PRC laws and
regulations. However, we cannot assure that we will not be required to
restructure our organization structure and operations in China to comply with
changing and new PRC laws and regulations. Restructuring of our operations may
result in disruption of our business, diversion of management attention and the
incurrence of substantial costs.
The
PRC legal system embodies uncertainties, which could limit law enforcement
availability.
The PRC
legal system is a civil law system based on written statutes. Unlike common law
systems, it is a system in which decided legal cases have little precedence. In
1979, the PRC government began to promulgate a comprehensive system of laws and
regulations governing economic matters in general. The overall effect of
legislation over the past 28 years has significantly enhanced the
protections afforded to various forms of foreign investment in China. Each of
our PRC operating subsidiaries and affiliates is subject to PRC laws and
regulations. However, these laws and regulations change frequently and the
interpretation and enforcement involve uncertainties. For instance, we may have
to resort to administrative and court proceedings to enforce the legal
protection that we are entitled to by law or contract. However, since PRC
administrative and court authorities have significant discretion in interpreting
statutory and contractual terms, it may be difficult to evaluate the outcome of
administrative court proceedings and the level of law enforcement that we would
receive in more developed legal systems. Such uncertainties, including the
inability to enforce our contracts, could affect our business and operation. In
addition, intellectual property rights and confidentiality protections in China
may not be as effective as in the United States or other countries. Accordingly,
we cannot predict the effect of future developments in the PRC legal system,
particularly with regard to the industries in which we operate, including the
promulgation of new laws. This may include changes to existing laws or the
interpretation or enforcement thereof, or the preemption of local regulations by
national laws. These uncertainties could limit the availability of law
enforcement, including our ability to enforce our agreements with Lianhe, Bona,
Botong, and Quo Advertising with other foreign investors.
Recent
PRC regulations relating to offshore investment activities by PRC residents may
increase our administrative burden and restrict our overseas and cross-border
investment activities. If our shareholders who are PRC residents fail to make
any required applications and filings under such regulations, we may be unable
to distribute profits and may become subject to liability under PRC
laws.
The PRC
National Development and Reform Commission, NDRC, and SAFE recently promulgated
regulations that require PRC residents and PRC corporate entities to register
with and obtain approvals from relevant PRC government authorities in connection
with their direct or indirect offshore investment activities. These regulations
apply to our shareholders who are PRC residents and may apply to any offshore
acquisitions that we make in the future.
Under the
SAFE regulations, PRC residents who make, or have previously made, direct or
indirect investments in offshore companies will be required to register those
investments. In addition, any PRC resident who is a direct or indirect
shareholder of an offshore company is required to file with the local branch of
SAFE any material change involving capital variation. This would include an
increase or decrease in capital, transfer or swap of shares, merger, division,
long-term equity or debt investment or creation of any security interest over
the assets located in China. If any PRC shareholder fails to make the required
SAFE registration, the PRC subsidiaries of that offshore parent company may be
prohibited from distributing their profits and the proceeds from any reduction
in capital, share transfer or liquidation, to their offshore parent company. The
offshore parent company may be prohibited from injecting additional capital into
their PRC subsidiaries. Moreover, failure to comply with the various SAFE
registration requirements described above could result in liability under PRC
laws for evasion of applicable foreign exchange restrictions.
We cannot
guarantee that all of our shareholders who are PRC residents will comply with
our request to obtain any registrations or approvals required under these
regulations or other related legislation. Furthermore, as the regulations are
relatively new, the PRC government has yet to publish implementing rules, and
much uncertainty remains concerning the reconciliation of the new regulations
with other approval requirements. It is unclear how the regulations concerning
offshore or cross-border transactions will be implemented by the relevant
government authorities. The failure or inability of our PRC resident
shareholders to comply with these regulations may subject us to fines and legal
sanctions, restrict our overseas or cross-border investment activities, limit
our ability to inject additional capital into our PRC subsidiaries, and the
ability of our PRC subsidiaries to make distributions or pay dividends, or
affect our ownership structure. If any of the foregoing events occur, our
acquisition strategy, business operations and ability to distribute profits to
our investors could be affected.
The
PRC tax authorities may require us to pay additional taxes in connection with
our acquisitions of offshore entities that conduct their PRC operations through
their affiliates in China.
Our
operations and transactions are subject to review by the PRC tax authorities
pursuant to relevant PRC laws and regulations. However, these laws, regulations
and legal requirements change frequently, and their interpretation and
enforcement involve uncertainties. For instance, in the case of some of our
acquisitions of offshore entities that conducted their PRC operations through
their affiliates in China, we cannot assure our investors that the PRC tax
authorities will not require us to pay additional taxes in relation to such
acquisitions, in particular where the PRC tax authorities take the view that the
previous taxable income of the PRC affiliates of the acquired offshore entities
needs to be adjusted and additional taxes be paid. In the event that the sellers
failed to pay any taxes required under PRC laws in connection with these
transactions, the PRC tax authorities might require us to pay the tax together
with late-payment interest and penalties.
We
rely on our affiliated Chinese personnel to conduct travel and advertising
businesses. If our contractual arrangements and commercial agreement
arrangements with our affiliated Chinese personnel are violated, our related
businesses will be damaged.
As
mentioned earlier, we depend on commercial agreements and contractual
arrangements to run our advertising and traveling businesses respectively in
China. These agreements and contracts are governed by PRC laws and provide for
the resolution of disputes through arbitration or litigation in the PRC. Upon
arbitration or litigation, these contracts would be interpreted in accordance
with PRC laws and any disputes would be resolved in accordance with PRC legal
procedures. The uncertainties in the PRC legal system could disable us to
enforce these commercial agreements and contractual arrangements. Should such a
situation occur, we may be unable to enforce these agreements and contracts, and
unable to enforce our control over our operating subsidiaries to conduct our
businesses.
We
have limited business insurance coverage in China.
The
insurance industry in China is still at an early stage of development. Insurance
companies in China offer limited business insurance products. As a result, we
have limited business liability or disruption insurance coverage for our
operations in China. Any business disruption, litigation or natural disaster
might result in substantial costs and diversion of resources and have an effect
on our business and operating results.
Our
subsidiaries and affiliated Chinese entities in China are subject to
restrictions on paying dividends or making other payments to us, which may
restrict our ability to satisfy our liquidity requirements.
We rely
on dividends from our subsidiaries in China and consulting and other fees paid
to us by our affiliated Chinese entities. Current PRC regulations permit our
subsidiaries to pay dividends to us only out of their accumulated profits, if
any, determined in accordance with Chinese accounting standards and regulations.
In addition, our subsidiaries in China are required to set aside at least 10% of
their respective accumulated profits each year, if any, to fund certain reserve
funds. These reserves are not distributable as cash dividends. Further, if our
subsidiaries and affiliated Chinese entities in China incur debt on their own
behalf, the instruments governing the debt may restrict their ability to pay
dividends or make other payments to us, which may restrict our ability to
satisfy our liquidity requirements.
2. Risks Related to Our Media
Business
In early
2007, we have entered into a contract to acquire Quo Advertising to expand our
business operations in the media business. Since the acquisition, we have
successfully entered into several material business agreements in Beijing,
Shanghai, Nanjing, Wuhan and so on to manage and operate LED outdoor advertising
video panels and mega-size digital video billboards. In January 2008, we
restructured our advertising business after further acquiring the media
companies namely Lianhe and Bona. We anticipate that we would enter into
agreements in other major cities to strengthen our position in the out-of-home
media business in China. In addition to the risks described above in “Risks Related to Operating a
Business in China”, we are subject to additional risks related to our
media business.
The
media and advertising industries are sensitive to changes in economic conditions
and advertising trends.
The
advertisers’ spending to advertise is highly depends on the changes in general
economic conditions and advertising trends. A deterioration of economic
conditions would lead to a decrease in demand for advertising, the advertisers
would reduce the advertising expenditures and significantly affect our
revenue.
The
media and advertising industries are highly competitive and we will compete with
companies that are larger and better capitalized.
We have
to compete with other advertising companies in the out-of-home advertising
market. We compete for advertising clients primarily in terms of network size
and coverage, locations of our LED panels and billboards, pricing, and range of
services that we can offer. We also face competition from advertisers in other
forms of media such as out-of-home television advertising network in commercial
buildings, hotels, restaurants, supermarkets and convenience chain stores. We
expect that the competition will be more severe in the near future. The
relatively low fixed costs and the practice of non-exclusive arrangement with
advertising clients would provide a very low barrier for new entrants in this
market segment. Moreover, international advertising media companies have been
allowed to operate in China since 2005, exposing us to even greater competition.
Moreover,
it becomes more difficult to increase the number of desirable locations in major
cities because most of the locations have already been occupied by our
competitors and limitation by municipal zoning and planning policies. In other
cities, although we could increase the locations, they would only generate less
economic return to the Company. Anyway, we anticipate the economic return would
increase with the pace of economic development of these cities. If we are unable
to increase the placement of our out-of-home advertising market, we may be
unable to expand our client base to sell advertising time slots on our network
or increase the rates we charge for time slots. As a consequence of this, our
operating margins and profitability may be reduced, and may result in a loss of
market share. Since we are a new entrant to this market segment, we have less
competitive advantages than the existing competitors in terms of experience,
expertise, and marketing force. The Company is tackling these problems by
further acquisition of well-established advertising company like Quo
Advertising, Lianhe and Bona. We cannot guarantee that we will be able to
compete against new or existing competitors to generate profit.
Moreover,
due to the less desirable locations currently the Company has, we can only
charge the advertisers for at a lower rates. If the Company is unable to
continuously secure more desirable locations for deployment of our advertising
poster frames, we may be unable or need to lower our rates to attract
advertisers to purchase time slots from us to generate satisfactory
profit.
If
we cannot enter into further agreements for roadside LED video panels and
mega-size digital video billboards in other major cities in China, we may be
unable to grow our revenue base and hence unable to generate higher levels of
revenue.
The
Company continues geographic expansion in media network by entering into
business cooperation agreements with local advertising companies to operate and
manage our roadside LED video panels and mega-size digital video billboards in
China. We have concluded several major agreements and are currently searching
for more opportunities. Nevertheless, many of the most desirable locations in
the major cities have been occupied by our competitors. If we are unable to or
need to pay extra considerations in order to enter into any new agreements, it
may highly increase our costs of sales and may be unable to convince our
advertisers to purchase more advertising time and generate our satisfactory
profits.
If
we are unable to attract advertisers to advertise on our networks, we will be
unable to grow our revenue base to generate revenues.
We charge
our advertisers based on the time that is used on our roadside LED video panels
and mega-size digital video billboards. The desire of advertisers to advertise
on our out-of-home media networks depends on the size and coverage of the
networks, the desirability of the locations of the LED panels and billboards,
our brand name and charging rate. If we fail to increase the number of
locations, displays and billboards in our networks to provide the advertising
services to suit the needs of our advertisers, we may be unable to attract them
to purchase our advertising time to generate revenues.
If
the public does not accept our out-of-home advertising media, we will be unable
to generate revenue.
The
out-of-home advertising network that we are developing is a rather new concept
in China. It is too early to conclude whether the public accept this advertising
means or not. In case the public finds any element like audio or video features
in our media network to be disruptive or intrusive, advertisers may withdraw
their requests for purchasing time slots from us and to advertise on other
networks. On the contrary, if the viewing public is receptive toward our
advertising network, our advertisers will continue to purchase the time from us.
As such, together with other uncertainties like locations coverage, acceptance
by public etc, we may be unable to generate satisfactory revenue in our media
network business.
We
may be subject to government regulations in installing our out-of-home roadside
LED video panels and mega-size digital video billboards advertising
network.
The
placement and installation of LED panels and billboards are subject to municipal
zoning requirements and governmental approvals. It is necessary to obtain
approvals for construction permits from the relevant supervisory departments of
the PRC government for each installation of roadside LED video panel and
mega-size digital video billboard. However, we cannot provide any guarantee that
we can obtain all the relevant government approvals for all of our installations
in China. If such approvals are not granted, we will be unable to install LED
panels or billboards on schedule, or may incur more installation
costs.
If
we are unable to adapt to changing advertising trends and the technology needs
of advertisers and consumers, we will not be able to compete effectively and we
will be unable to increase or maintain our revenues, which may affect our
business prospects and revenues.
The
market for out-of-home advertising requires us to research new advertising
trends and the technology needs of advertisers and consumers, which may require
us to develop new features and enhancements for our advertising network. The
majority of our displays use medium-size roadside LED video panels. We also use
mega-size LED digital video billboards. We are currently researching ways that
we may be able to utilize other technology such as cable or broadband
networking, advanced audio technologies and high-definition panel technology.
Development and acquisition costs may have to be incurred in order to keep pace
with new technology needs but we may not have the financial resources necessary
to fund and implement future technological innovations or to replace obsolete
technology. Furthermore, we may fail to respond to these changing technology
needs. For instance, if the use of wireless or broadband networking capabilities
on our advertising network becomes a commercially viable alternative and meets
all applicable PRC legal and regulatory requirements, and we fail to implement
such changes on our out-of-home network and in-store network or fail to do so in
a timely manner, our competitors or future entrants into the market who do take
advantage of such initiatives could gain a competitive advantage over us. If we
cannot succeed in developing and introducing new features on a timely and
cost-effective basis, advertiser demand for our advertising networks may
decrease and we may not be able to compete effectively or attract advertising
clients, which would have an effect on our business prospects and
revenues.
3. Risks Related To Regulation
of Our Business and 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 advertising industry, we could be subject to severe
penalties.
Our media
operations are conducted by Lianhe, Botong, Bona and Quo Advertising through
commercial agreements arrangement.
PRC
regulations require any foreign entities that invest in the advertising services
industry to have at least two years of direct operations in the advertising
industry outside of China. Beginning December 10, 2005, foreign investors
have been allowed to own directly 100% of PRC companies operating an advertising
business if the foreign entity has at least three years of direct operations in
the advertising business outside of China or less than 100% if the foreign
investor has at least two years of direct operations in the advertising
industry. We do not directly operate an advertising business outside of China
and cannot qualify under PRC regulations any earlier than two or three years
after we commence any such operations outside of China or until we acquire a
company that has directly operated an advertising business outside of China for
the required period. Accordingly, our PRC operating subsidiaries are currently
unable to apply for the required licenses for providing advertising services in
China. Before 2008, all of our advertising business is run through Quo
Advertising, which is owned by two PRC citizens designated by us. Quo
Advertising holds the requisite licenses to provide advertising services in
China. We have entered into contractual agreements with the shareholders of Quo
Advertising, which provide us with the substantial ability to control Quo
Advertising and its subsidiaries.
In
January 2008, we restructured our advertising business after further acquiring
the media companies namely Lianhe and Bona. We, through our newly acquired
company, Lianhe, entered into an exclusive management consulting services
agreement and an exclusive technology consulting services agreement with each of
Quo Advertising, Bona and Botong. In addition, we entered into an equity pledge
agreement and an option agreement with each of the shareholders of Quo
Advertising, Bona and Botong and pursuant to which these shareholders had
pledged 100% of their shares to Lianhe and granted Lianhe the option to acquire
their shares at a mutually agreed purchase price which shall first be used to
repay any loans payable to Lianhe or any affiliate of Lianhe by the registered
PRC shareholders These commercial arrangements enable us to exert effective
control on these entities, and transfer their economic benefits to us for
financial results consolidation.
If we,
our existing or future PRC operating subsidiaries and affiliates are found to be
in violation of any PRC laws or regulations or fail to obtain or maintain any of
the required permits or approvals, the relevant PRC regulatory authorities,
including the State Administration for Industry and Commerce (SAIC), would have
broad discretion in dealing with such violations, including:
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revoking
the business and operating licenses of our PRC subsidiaries and
affiliates;
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discontinuing
or restricting our PRC subsidiaries’ and affiliates’
operations;
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imposing
conditions or requirements with which we or our PRC subsidiaries and
affiliates may not be able to
comply;
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requiring
us or our PRC subsidiaries and affiliates to restructure the relevant
ownership structure or operations;
or
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restricting
or prohibiting our use of the proceeds of this offering to finance our
business and operations in China.
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The
imposition of any of these penalties would result in a material and adverse
effect on our ability to conduct our business.
We
rely on contractual arrangements and commercial agreement arrangement with our
PRC operating companies and their shareholders for our China operations, which
may not be as effective in providing operational control as direct
ownership.
In the
past, the Company has relied on contractual arrangements with the shareholders
of Quo Advertising to operate our advertising business. In January 2008, we
restructure our advertising business after further acquiring the media companies
namely Lianhe and Bona. We, through our newly acquired company, Lianhe, entered
into a series of commercial agreements with each of Quo Advertising, Bona and
Botong and their respective registered shareholders. It enables us to exert
effective control on these entities, and transfer their economic benefits to us
for financial results consolidation. These contractual arrangements and
commercial agreement arrangements may not be as effective in providing us with
control over media subsidiaries as direct ownership. If our PRC operating
subsidiaries or any of their subsidiaries and shareholders fails to perform
their respective obligations under these contractual arrangements and commercial
agreement arrangements, we may have to incur substantial costs and resources to
enforce such arrangements, and rely on legal remedies under PRC law. This would
also include seeking specific performance or injunctive relief, and claiming
damages, which we cannot guarantee to be effective.
Many of
these contractual arrangements and commercial agreement arrangements are
governed by PRC laws and provide for the resolution of disputes through either
arbitration or litigation in the PRC. Accordingly, these contracts would be
interpreted in accordance with PRC laws and any disputes would be resolved in
accordance with PRC legal procedures. The legal environment in the PRC is not
developed as in other jurisdictions, such as the United States. As a result,
uncertainties in the PRC legal system could limit our ability to enforce these
contractual arrangements. In the event we are unable to enforce these
contractual arrangements and commercial agreements, we may not be able to exert
effective control over our operating entities, and our ability to conduct our
business may be negatively affected.
Contractual
arrangements and commercial agreement arrangements we have entered into among
our subsidiaries and affiliated entities may be subject to scrutiny by the PRC
tax authorities and a finding that we owe additional taxes or are ineligible for
our tax exemption, or both, could substantially increase our taxes owed, and
reduce our net income and the value of your investment.
Under PRC
laws, arrangements and transactions among related parties may be subject to
audit or challenge by the PRC tax authorities. If any of the transactions we
have entered into among our subsidiaries and affiliates are found not to be on
an arm’s length basis or result in a reduction in tax under PRC laws, the PRC
tax authorities will disallow our tax savings, adjust the profits and losses of
our respective PRC entities and assess late payment interest and penalties
accordingly.
Our
business operations may be affected by legislative or regulatory
changes.
There are
no formal PRC laws or regulations that define or regulate out-of-home
advertising. It has been reported that the relevant PRC government authorities
are currently considering adopting new regulations governing out-of-home
advertising. We cannot predict the timing of establishing such regulations and
their impacts on our Company. Changes in laws and regulations or the enactment
of new laws and regulations governing placement or content of out-of-home
advertising, may affect our business prospects and results of operations. For
instance, the PRC government has promulgated regulations allowing foreign
companies to hold a 100% equity interest in PRC advertising companies starting
from December 10, 2005. We are not certain how the PRC government will
implement this regulation or how it could affect our business and our
organization structure.
PRC
regulation of loans and direct investment by offshore holding companies to PRC
entities may delay or prevent us from raising finance to make loans or
additional capital contributions to our PRC operating subsidiaries and
affiliates.
As an
offshore holding company of our PRC operating subsidiaries and affiliates, we
may make loans to our PRC subsidiaries and consolidated PRC affiliated entities,
or we may make additional capital contributions to our PRC subsidiaries. Any
loans to our PRC subsidiaries or consolidated PRC affiliated entities are
subject to PRC regulations and approvals.
We may
also decide to finance advertising subsidiaries by means of capital
contributions. These capital contributions to advertising subsidiaries must be
approved by the PRC Ministry of Commerce or its local counterpart. We cannot
guarantee that we can obtain these government registrations or approvals on a
timely basis, if at all, with respect to future loans or capital contributions
by us to our operating subsidiaries. If we fail to receive such registrations or
approvals, these would adversely affect the liquidity of our operating
subsidiaries and our ability to expand the business.
4. Risks Related to Corporate
and Stock Matters
The
loss of key management personnel could harm our business and
prospects.
We depend
on key personnel who may not continue to work for us. Our success substantially
depends on the continued employment of certain executive officers and key
employees, particularly Godfrey Hui who is our founder, Chairman and Chief
Executive Officer, and Daniel So, our Vice Chairman and Managing Director. Not
only do we rely on their expertise and experience in our business, we also need
their business vision, management skills, and good relationships with our
employees and major shareholders to achieve our business targets.
The loss
of services of these or other key officers or employees could harm our business.
If any of these individuals were to leave our company, our business and growth
prospects may be severely disrupted. We would face substantial difficulty in
hiring qualified successors and could experience a loss in productivity while
any such successor obtains the necessary training and experience.
The
market for the Company’s common stock is illiquid.
The
Company’s common stock is traded on the Over-the-Counter Bulletin Board. It is
thinly traded compared to larger and more widely known companies in its
industry. Thinly traded common stock can be more volatile than stock trading in
an active public market. The Company cannot predict the extent of an active
public market for its common stock.
We
have a limited operating history and if we are not successful in continuing to
grow our business, then we may have to scale back or even cease our ongoing
business operations.
The
Company has a limited operating history and is still in the development stage.
Our Company’s operations will be subject to all the risks inherent in the
establishment of a developing enterprise and the uncertainties arising from the
absence of a significant operating history. We may be unable to locate
recoverable reserves or operate on a profitable basis. We are in the development
stage and potential investors should be aware of the difficulties encountered.
If our business plan is not successful, and we are not able to operate
profitably, investors may lose some or all of their investments in our
Company.
Our
acquisitions of Quo Advertising, Xuancaiyi, Lianhe, Bona and any future
acquisitions may expose us to potential risks and have an affect on our ability
to manage our business.
It is our
strategy to expand our business through acquisitions like that of Quo
Advertising, Xuancaiyi, Lianhe and Bona. We would keep on searching for
appropriate opportunities to acquire more businesses or to form joint ventures,
etc. that are complementary to our core business. For each acquisition, our
management encounters whatever difficulties during the integration of new
operations, services and personnel with our existing operations. We may also
expose ourselves to other potential risks like unforeseen or hidden liabilities
of the acquired companies, the allocation of resources from our existing
business to the new operations, uncertainties in generating expected revenue,
employee relationships and governing by new regulations after integration. The
occurrence of any of these unfavorable events in our recent acquisitions or
possible future acquisitions could have an effect on our business, financial
condition and results of operations.
There
may be unknown risks inherent in our acquisitions of Quo Advertising, Xuancaiyi,
Lianhe and Bona.
Although
we had conducted due diligence with respect to the acquisition of Quo
Advertising, Xuancaiyi, Lianhe and Bona, there is no assurance that all risks
associated with the companies have been revealed. To protect us from associated
liabilities, we have received guarantees of indemnification from the original
owners. However, if we were to enforce such guarantees, it could be very costly
and time consuming. The possibility of unknown risks in those acquisitions could
affect our business, financial condition and results of operations.
All
of our directors and officers are outside the United States. It may be difficult
for investors to enforce judgments obtained against officers or directors of the
Company.
All of
our directors and officers are nationals and/or residents of countries other
than the United States, and all their assets are located outside the United
States. As a result, it may be difficult for investors to effect service of
process on our directors or officers, or enforce within the United States or
Canada any judgments obtained against us or our officers or directors, including
judgments predicated upon the civil liability provisions of the securities laws
of the United States or any state thereof. Consequently, you may be prevented
from pursuing remedies under U.S. federal securities laws against them. In
addition, investors may not be able to commence an action in a Canadian court
predicated upon the civil liability provisions of the securities laws of the
United States. The foregoing risks also apply to those experts identified in
this Annual Report that are not residents of the United States.
Our
substantial indebtedness and related interest payments could adversely affect
our operations.
Since
November 2007, we have issued convertible promissory notes with warrants. Our
related interest payments on such convertible promissory notes could impose
financial burdens on us. If further new debt is added to our consolidated debt
level, the related risks that we now face could intensify. Covenants in the
convertible notes and warrants agreements governing our existing convertible
notes, and debt we may incur in the future, may materially restrict our
operations, including our ability to incur debt, pay dividends, make certain
investments and payments, and encumber or dispose of assets. In addition,
financial covenants contained in agreements relating to our existing and future
debt could lead to a default in the event our results of operations do not meet
our plans and we are unable to amend such financial covenants prior to default.
An event of default under any debt instrument, if not cured or waived, could
have a material adverse effect on us, our financial condition and our capital
structure.
We
need additional funds to expand our business through company and project
acquisitions. If we are unable to raise additional funds, we would be restricted
from further business expansion.
Since we
are at the expansion stage of our business, we may require further funding for
capital investment in acquiring target companies and projects. To raise funds,
we may, upon having the consent from our investors, need to issue new equities
or bonds which could result in additional dilution to our shareholders and in
operating and financing covenants that would restrict our operations and
strategy. If we are unable to raise additional funds, our business expansion
would be hampered.
If
we issue additional shares, this may result in dilution to our existing
stockholders.
Our
Certificate of Incorporation authorizes the issuance of 800,000,000 shares of
common stock and 5,000,000 shares of preferred stock. Our Board of Directors has
the authority to issue additional shares up to the authorized capital stated in
the Certificate of Incorporation. Our Board of Directors may choose to issue
shares to acquire one or more businesses or to provide additional financing in
the future. The issuance of shares may result in a reduction of the book value
or market price of the outstanding shares of our common stock. If we issue
additional shares, there may be a reduction in the proportionate ownership and
voting power of all other stockholders. Further, any issuance may result in a
change of control of the Company.
The
authorized preferred stock constitutes what is commonly referred to as “blank
check” preferred stock. This type of preferred stock allows the Board of
Directors to designate the preferred stock into a series, and determine
separately for each series any one or more relative rights and preferences. The
Board of Directors may issue shares of any series without further stockholder
approval. Preferred stock authorized in series allows our Board of Directors to
hinder or discourage an attempt to gain control by a merger, tender offer at a
control premium price, or proxy contest. Consequently, the preferred stock could
entrench our management. In addition, the market price of our common stock could
be affected by the existence of the preferred stock.
If we or our independent registered
public accountants cannot attest to our adequacy of the internal control
measures over our financial reporting, as required by Section 404 of the U.S. Sarbanes-Oxley Act in
future, we may be adversely affected.
As a
public company, we are required to report our internal control structure and
procedures for financial reporting in our Annual Report on Form 10-KSB under
Section 404 of the U.S. Sarbanes-Oxley Act of 2002 by the SEC. The report
must contain an assessment by management about the effectiveness of our internal
controls over financial reporting. Additionally, our independent registered
public accounting firm will be required to issue reports on management’s
assessment of our internal control over financial reporting and their evaluation
of the operating effectiveness of our internal control over financial reporting.
Starting from 2008, the auditor’s report is required for every financial year
end.
The
Company has paid attention to its internal control procedures. In 2007 we
established an internal control working group to investigate and evaluate our
operations and improve procedures wherever necessary. With the participation and
guidance of management, we have evaluated our internal control systems such that
our management can report on, and our independent public accounting firm can
attest to our internal control system pursuant to the requirements under
Section 404 of the Sarbanes-Oxley Act of 2002.
The
Company believes that it has adequate internal control procedures in place.
However, we are still exposed to potential risks from Section 404 of the
Sarbanes-Oxley Act of 2002 that requiring companies to have high standard of
internal control procedures. It may be possible that our management cannot
attest to our effectiveness of internal controls over financial reporting.
Furthermore, even if our management attests to our internal control measures to
be effective, our independent registered public accountants may not be satisfied
with our internal control structure and procedures. If our management cannot
attest to our internal control measures at any time in the future, or if our
independent registered public accounting firm are not satisfied with our
internal control structure, it could result in an adverse impact on us in the
financial marketplace due to the loss of investor confidence in the reliability
of our financial statements, which could negatively impact our stock market
price.
Trading
may be restricted by the SEC, which may limit a stockholder’s ability to buy and
sell our stock.
The SEC
has adopted Rule 15g-9, which generally defines “penny stock” to be any equity
security that has a market price (as defined) less than $5.00 per share or an
exercise price of less than $5.00 per share. Our securities are covered by rules
that impose additional sales practice requirements on broker-dealers who sell to
persons other than established customers and “accredited investors”. The term
“accredited investor” refers generally to institutions with assets in excess of
$5,000,000 or individuals with a net worth in excess of $1,000,000 or annual
income exceeding $200,000 or $300,000 jointly with their spouse. The rules
require a broker-dealer, prior to a transaction in penny stock, to deliver a
standardized risk disclosure document in a form prepared by the SEC. This
provides information about the nature and level of risks in the penny stock
market. The broker-dealer must provide the customer with current bid and offer
quotations for the penny stock, the compensation of the broker-dealer and its
salesperson in the transaction and monthly account statements showing the market
value of each penny stock held in the customer’s account. The bid and offer
quotations, and the broker-dealer and salesperson compensation information, must
be given to the customer orally or in writing prior to effecting the transaction
and must be given to the customer in writing before or with the customer’s
confirmation. In addition, these rules require that prior to a transaction in a
penny stock not otherwise exempt from these rules; the broker-dealer must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser’s written agreement to the transaction.
These disclosure requirements may have the effect of reducing the level of
trading activity in the secondary market for the stock that is subject to these
penny stock rules. Consequently, these penny stock rules may affect the ability
of broker-dealers to trade our securities. We believe that the penny stock rules
discourage investors’ interest in and limit the marketability of our common
stock.
NASD
sales practice requirements may also limit a stockholder’s ability to buy and
sell our stock.
In
addition to the “penny stock” rules described above, the National Association of
Securities Dealers (“NASD”) has adopted rules that require a broker-dealer, when
providing investment recommendations, must have reasonable grounds for believing
that the investment is suitable for that customer. Prior to recommending low
priced securities to their non-institutional customers, broker-dealers must make
reasonable efforts to obtain information about the customer’s financial status,
tax status and investment objectives. Under interpretations of these rules, the
NASD believes that there is a high probability that low priced securities will
not be suitable for at least some customers. The NASD requirements make it more
difficult for broker-dealers to recommend their customers buying our common
stock, which may limit ability of our investors to buy and sell our stock and
hence have an effect on the market for our shares.
Stockholders
should have no expectation of any dividends.
The
holders of our common stock are entitled to receive dividends, when, as and if
declared by the Board of Directors out of funds of the Company legally available
for the payment of dividends. To date, we have not declared nor paid any cash
dividends. The Board of Directors does not intend to declare any dividends in
the near future, but instead intends to retain all earnings, if any, for use in
our business operations.
Certain
terms of the Company’s convertible promissory notes and Common Stock warrants
could result in other security holders suffering potentially significant
dilution.
The
Company’s convertible promissory notes and warrants, as well as the purchase
agreement, contain various provisions that protect the interests of the holders
of these securities in a manner that may be adverse to our Common Stock holders.
The 3% Convertible Promissory Notes bear interest at 3% per annum payable
semi-annually in arrears and mature on June 30, 2011. The 3% Convertible
Promissory Notes are convertible into shares of common stock at an initial
conversion price of $1.65 per share, subject to customary anti-dilution
adjustments. In addition, the conversion price will be adjusted downward on
an annual basis if the Company should fail to meet certain annual earnings per
share (“EPS”) targets described in the notes. In the event of a default, or if
the Company’s actual EPS for any fiscal year is less than 80% of the respective
EPS target, certain Investors may require the Company to redeem the 3%
Convertible Promissory Notes at 100% of the principal amount, plus any accrued
and unpaid interest, plus an amount representing a 20% internal rate of return
on the then outstanding principal amount. The Warrants grant the holders the
right to acquire shares of common stock at $2.50 and $3.50 per share, subject to
customary anti-dilution adjustments. The exercise price of the Warrants will
also be adjusted downward whenever the conversion price of the 3% Convertible
Promissory Notes is adjusted downward in accordance with the provisions of the
notes.
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds
Not
applicable.
Item 3. Defaults Upon Senior Securities
Not
applicable.
Item 4. Submission of Matters to a Vote of Security
Holders
The
following matters were presented for stockholder vote at the annual general
meeting of stockholders held on August 30, 2008: (1) election of 9 members
to our board of directors, each to serve until our annual meeting in 2009, and
until their respective successors are qualified and elected or
earlier resignation or removal; and (2) ratification of the appointment of the
Company’s independent registered public accounting firms for the fiscal year
ended on December 31, 2008; The respective votes of each matter were indicated
as follows:
1.
Election of 9 members to our board of directors:
|
Name
of the directors
|
For
|
Withhold
Authority
|
|
Godfrey
Hui
|
36,266,899
|
-0-
|
|
Daley
Mok
|
36,266,899
|
-0-
|
|
Daniel
So
|
36,266,899
|
-0-
|
|
Stanley Chu
|
36,266,899
|
-0-
|
|
Joachim
Burger
|
36,266,893
|
-6-
|
|
Gerd
Jakob
|
36,266,893
|
-6-
|
|
Edward
Lu
|
36,266,893
|
-6-
|
|
Peter
Mak
|
36,266,893
|
6
|
|
Ronglie
Xu
|
36,266,899
|
-0-
|
2.
Ratification of the appointment of Jimmy C.H. Cheung & Co., independent
registered public accounting firm, to audit the consolidated financial
statements of the Company and its subsidiaries for the fiscal year ending
December 31, 2008;
|
For
|
Against
|
Abstain
|
|
|
Jimmy
C.H. Cheung & Co.
|
36,266,899
|
-0-
|
-0-
|
There
were no broker non-votes for any of the proposals.
Item 5. Other information
Not
applicable.
Item 6. Exhibits
EXHIBIT
INDEX
|
Exhibit
No.
|
Description
of Document
|
|
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
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
32.2
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
NETWORK
CN INC.
|
||
|
Date: November
13, 2008
|
By:
|
/s/
GODFREY HUI
|
|
Godfrey
Hui,
|
||
|
Chief
Executive Officer
|
||
|
Date:
November 13, 2008
|
By:
|
/s/
DALEY MOK
|
|
Daley
Mok,
|
||
|
Chief
Financial Officer
|
||
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