f10q_052112.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____ to _____
 
Commission File Number:  000-52672

ChinaNet Online Holdings, Inc.
(Exact name of registrant as specified in its charter)
 
 Nevada
 20-4672080
(State or other jurisdiction of incorporation or organization)
 (I.R.S. Employer Identification No.)   

No.3 Min Zhuang Road, Building 6,
Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC 100195
 (Address of principal executive offices) (Zip Code)

+86-10-5160-0828
(Registrant’s telephone number, including area code)

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

Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:   Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer o Non-accelerated filer (Do not check if a smaller reporting company) o Smaller reporting company x

 
 

 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

As of May 21, 2012 the registrant had 22,186,540 shares of common stock outstanding.
 
 
 

 
TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
PAGE
     
 
     
 
     
 
     
 
     
 
     
   
   
     
PART II. OTHER INFORMATION
 
     
     
   
     
   
     
     
     
 
 
 

 
PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
March 31,
2012
   
December 31,
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 8,964     $ 10,695  
Accounts receivable, net
    7,623       4,444  
Other receivables, net
    5,844       3,631  
Prepayment and deposit to suppliers
    13,718       15,360  
Due from related parties
    278       324  
Contingent consideration receivables
    160       159  
Other current assets
    153       129  
Deferred tax assets-current
    222       -  
Total current assets
    36,962       34,742  
                 
Investment in and advance to equity investment affiliates
    1,212       1,396  
Property and equipment, net
    1,775       1,902  
Intangible assets, net
    7,941       8,151  
Goodwill
    11,068       10,999  
Deferred tax assets-non current
    196       92  
Total Assets
  $ 59,154     $ 57,282  
                 
Liabilities and Equity
               
Current liabilities:
               
Accounts payable *
  $ 214     $ 268  
Advances from customers *
    1,890       724  
Accrued payroll and other accruals *
    485       616  
Due to equity investment affiliate *
    538       220  
Due to related parties *
    84       161  
Payable for acquisition *
    553       550  
Taxes payable *
    5,701       5,040  
Other payables *
    158       114  
Dividend payable
    -       5  
Total current liabilities
    9,623       7,698  
 
 
F-1

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands, except for number of shares and per share data)
 
   
March 31,
2012
   
December 31,
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Long-term liabilities:
           
Deferred tax liability-non current *
    1,850       1,893  
Long-term borrowing from director
    138       137  
Total Liabilities
    11,611       9,728  
                 
Commitments and contingencies
               
                 
Equity:
               
Common stock (US$0.001 par value; authorized 50,000,000 shares; issued and outstanding 22,186,540 shares and 22,146,540 shares at March 31, 2012 and December 31, 2011, respectively)
     22        22  
Additional paid-in capital
    20,764       20,747  
Statutory reserves
    2,117       2,117  
Retained earnings
    16,322       16,688  
Accumulated other comprehensive income
    2,358       2,132  
Total ChinaNet Online Holdings, Inc.’s stockholders’ equity
    41,583       41,706  
                 
Noncontrolling interests
    5,960       5,848  
Total equity
    47,543       47,554  
                 
Total Liabilities and Equity
  $ 59,154     $ 57,282  
 
*All of the VIEs' assets can be used to settle obligations of its primary beneficiary. Liabilities recognized as a result of consolidating these VIEs do not represent additional claims on the Company’s general assets (Note 2).
 
See notes to consolidated financial statements
 
 
F-2

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS)/INCOME
(In thousands)
 
       
   
Three Months Ended March 31,
 
 
2012
   
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
Sales
           
  From unrelated parties
  $ 14,920     $ 6,834  
  From related parties
    15       190  
      14,935       7,024  
Cost of sales
    12,538       2,030  
Gross margin
    2,397       4,994  
                 
Operating expenses
               
  Selling expenses
    689       713  
  General and administrative expenses
    1,243       890  
  Research and development expenses
    331       353  
      2,263       1,956  
                 
Income from operations
    134       3,038  
                 
Other income (expenses)
               
  Interest income
    5       1  
  Gain on deconsolidation of subsidiaries
    -       229  
  Other (expenses)/income
    (1 )     6  
      4       236  
                 
Income before income tax expense, equity method investments and noncontrolling interests
    138       3,274  
  Income tax expense
    236       431  
(Loss)/income before equity method investments and noncontrolling interests
    (98 )     2,843  
  Share of losses in equity investment affiliates
    (193 )     (47 )
Net (loss)/income
    (291 )     2,796  
  Net (income)/loss attributable to noncontrolling interests
    (75 )     16  
Net (loss)/income attributable to ChinaNet Online Holdings, Inc.
    (366 )     2,812  
 
 
F-3

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS)/INCOME (CONTINUED)
(In thousands, except for number of shares and per share data)
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
             
Net (loss)/income attributable to ChinaNet Online Holdings, Inc.
  $ (366 )   $ 2,812  
Dividend of Series A convertible preferred stock
    -       (169 )
                 
Net (loss)/income attributable to common stockholders of ChinaNet Online Holdings, Inc.
  $ (366 )   $  2,643  
                 
                 
Net (loss)/income
    (291 )     2,796  
Foreign currency translation gain
    263       196  
Comprehensive (Loss)/Income
  $ (28 )   $ 2,992  
Less: Comprehensive (loss)/income attributable to non-controlling interests
    112       (13 )
Comprehensive (loss)/income attributable to ChinaNet Online Holdings, Inc.
  $ (140 )   $ 3,005  
 
               
(Loss)/earnings per share
               
(Loss)/earnings per common share
               
Basic
  $ (0.02 )   $ 0.15  
Diluted
  $ (0.02 )   $ 0.14  
                 
Weighted average number of common shares outstanding:
               
Basic
    22,182,584       17,244,315  
Diluted
    22,182,584       20,819,982  
 
See notes to consolidated financial statements
 
 
F-4

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
             
Cash flows from operating activities
           
Net (loss)/income
  $ (291 )   $ 2,796  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation and amortization
    409       199  
Share-based compensation expenses
    17       107  
Share of losses in equity investment  affiliates
    193       47  
Gain on deconsolidation of subsidiaries
    -       (229 )
Gain on disposal of property and equipment
    -       (3 )
Deferred taxes
    (381 )     (15 )
Changes in operating assets and liabilities
               
Accounts receivable
    (3,154 )     (1,302 )
Other receivables
    261       3,691  
Prepayment and deposit to suppliers
    1,740       (162 )
Due from equity investment affiliates
    -       (8 )
Due from related parties
    48       (190 )
Other current assets
    (22 )     (19 )
Accounts payable
    (56 )     336  
Advances from customers
    1,162       (1,263 )
Accrued payroll and other accruals
    (133 )     (60 )
Due to director
    -       (403 )
Due to related parties
    (78 )     (137 )
Other payables
    18       39  
Taxes payable
    630       397  
Net cash provided by operating activities
    363       3,821  
                 
Cash flows from investing activities
               
Purchases of vehicles and office equipment
    (9 )     (57 )
Purchase of intangible assets
    -       (11 )
Project development deposit to a third party
    (2,452 )     -  
Cash from acquisition of VIEs
    -       24  
Cash effect on deconsolidation of VIEs
    -       (181 )
Long-term investment in and advance to equity investment affiliates
    -       (1,518 )
Net cash used in investing activities
    (2,461 )     (1,743 )
 
F-5

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from financing activities
           
Cash investment contributed by noncontrolling interests
    -       74  
Dividend paid to convertible preferred stockholders
    (5 )     (171 )
Short-term loan borrowed from a equity investment affiliate
    316       -  
Net cash provided by (used in) financing activities
    311       (97 )
                 
Effect of exchange rate fluctuation on cash and cash equivalents
    56       59  
                 
Net (decrease) / increase in cash and cash equivalents
    (1,731 )     2,040  
                 
Cash and cash equivalents at beginning of the period
    10,695       15,590  
Cash and cash equivalents at end of the period
  $ 8,964     $ 17,630  
                 
Supplemental disclosure of cash flow information
               
                 
Income taxes paid
  $ 15     $ 22  
                 
Non-cash transactions:
               
Restricted stock and options granted for future service
  $ 74     $ 193  
 
See notes to consolidated financial statements

 
F-6

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1.  
Organization and nature of operations

ChinaNet Online Holdings, Inc. (formerly known as Emazing Interactive, Inc.), (the “Company”), was incorporated in the State of Texas in April 2006 and re-domiciled to become a Nevada corporation in October 2006. From the date of the Company’s incorporation until June 26, 2009, when the Company consummated the Share Exchange (discussed below), the Company’s activities were primarily concentrated in web server access and company branding in hosting web based e-games.

On June 26, 2009, the Company entered into a Share Exchange Agreement (the “Exchange Agreement”), with (i) China Net Online Media Group Limited, a company organized under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s shareholders, Allglad Limited, a British Virgin Islands company (“Allglad”), Growgain Limited, a British Virgin Islands company ("Growgain"), Rise King Investments Limited, a British Virgin Islands company (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus Elegant Investment Limited, a British Virgin Islands company (“Surplus”), Clear Jolly Holdings Limited, a British Virgin Islands company (“Clear” and together with Allglad, Growgain, Rise King BVI, Star and Surplus, the “China Net BVI Shareholders”), who together owned shares constituting 100% of the issued and outstanding ordinary shares of China Net BVI (the “China Net BVI Shares”) and (iii) G. Edward Hancock, the principal stockholder of the Company at that time. Pursuant to the terms of the Exchange Agreement, the China Net BVI Shareholders transferred to the Company all of the China Net BVI Shares in exchange for the issuance of 13,790,800  shares (the “Exchange Shares”) in the aggregate of the Company’s common stock (the “Share Exchange”). As a result of the Share Exchange, China Net BVI became a wholly owned subsidiary of the Company and the Company is now a holding company, which, through certain contractual arrangements with operating companies in the People’s Republic of China (the “PRC”), is engaged in providing advertising, marketing, communication and brand management and sales channel building services to small and medium companies in China.

The Company’s wholly owned subsidiary, China Net BVI was incorporated in the British Virgin Islands on August 13, 2007. On April 11, 2008, China Net BVI became the parent holding company of a group of companies comprised of CNET Online Technology Limited, a Hong Kong company (“China Net HK”), which established and is the parent company of Rise King Century Technology Development (Beijing) Co., Ltd., a wholly foreign-owned enterprise (“WFOE”) established in the PRC (“Rise King WFOE”). The Company refers to the transactions that resulted in China Net BVI becoming an indirect parent company of Rise King WFOE as the “Offshore Restructuring.”

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

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

 
F-7

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
As of the date of the Share Exchange, through the Contractual Agreements, the Company operates its business in China primarily through Business Opportunity Online and Beijing CNET Online. Beijing CNET Online owns 51% of Shanghai Borongdingsi Computer Technology Co., Ltd. (“Shanghai Borongdingsi”). Business Opportunity Online, Beijing CNET Online and Shanghai Borongdingsi, were incorporated on December 8, 2004, January 27, 2003 and August 3, 2005, respectively.

Shanghai Borongdingsi is 51% owned by Beijing CNET Online. Beijing CNET Online and Shanghai Borongdingsi entered into a cooperation agreement in June 2008, followed up with a supplementary agreement in December 2008, to conduct bank kiosk advertisement business. The business is based on a bank kiosk cooperation agreement between Shanghai Borongdingsi and Henan provincial branch of China Construction Bank which allows Shanghai Borongdingsi or its designated party to conduct in-door advertisement business within the business outlets throughout Henan Province. The bank kiosk cooperation agreement has a term of eight years starting August 2008. However, Shanghai Borongdingsi was not able to conduct the advertisement business as a stand-alone business due to the lack of an advertisement business license and supporting financial resources. Pursuant to the aforementioned cooperation agreements, Beijing CNET Online committed to purchase equipment, and to provide working capital, technical and other related support to Shanghai Borongdingsi. Beijing CNET Online owns the equipment used in the kiosk business, is entitled to sign contracts in its name on behalf of the business, and holds the right to collect the advertisement revenue generated from the bank kiosk business exclusively until the recovery of the cost of purchase of the equipment. Thereafter, Beijing CNET Online has agreed to distribute 49% of the succeeding net profit generated from the bank kiosk advertising business, if any, to the minority shareholders of Shanghai Borongdingsi.

On June 24, 2010, one of the Company’s VIEs, Business Opportunity Online, together with three other individuals, who were not affiliated with the Company, formed a new company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). Shenzhen Mingshan is 51% owned by Business Opportunity Online and 49% owned collectively by the other three individuals.  Shenzhen Mingshan is primarily engaged in developing and designing of internet based software, online games and the related operating websites and providing related internet and information technology services necessary to operate such games and websites. On January 6, 2011, as approved by the shareholders of Shenzhen Mingshan, an unaffiliated third party investor invested RMB15,000,000 (approximately US$2,371,654) cash into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan. Therefore, beginning on January 6, 2011, the new investor became the majority shareholder of Shenzhen Mingshan.  The Company’s share of the equity interest in ShenZhen Mingshan decreased from 51% to 20.4% and the Company ceased to have a controlling financial interest in ShenZhen Mingshan, but still retains an investment in, and significant influence over, Shenzhen Mingshan.

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

On December 8, 2010, the Company, through one of its VIEs, Shanghai Jing Yang acquired a 49% interest in a newly established company, Beijing Yang Guang Media Investment Co., Ltd. (“Beijing Yang Guang”).  In August, 2011, Shanghai Jing Yang sold back its 49% equity interest in Beijing Yang Guang to the majority shareholder of Beijing Yang Guang.

 
F-8

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The Company, through one of its VIEs, Beijing CNET Online, acquired a 51% equity interest in Quanzhou Zhi Yuan Marketing Planning Co., Ltd. (“Quanzhou Zhi Yuan”) and a 49% equity interest in Quanzhou Tian Xi Shun He Advertisement Co., Ltd. (“Quanzhou Tian Xi Shun He”) on January 4, 2011 and February 23, 2011, respectively.  Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He are both independent advertising companies based in Fujian province of the PRC, which provide comprehensive branding and marketing services to over fifty small to medium sized companies focused primarily in the sportswear and clothing industry. In June 2011, Beijing CNET Online acquired the remaining 49% equity interest in Quanzhou Tian Xi Shun He. Quanzhou Tian Xi Shun He became a wholly owned subsidiary of Beijing CNET Online accordingly.

On January 28, 2011, one of the Company’s VIEs, Business Opportunity Online, formed a new wholly owned subsidiary, Business Opportunity Online (Hubei) Network Technology Co., Ltd. (“Business Opportunity Online Hubei”).  Business Opportunity Online Hubei is primarily engaged in internet advertisement design, production and promulgation.

On March 1, 2011, one of the Company’s VIEs, Business Opportunity Online, together with an individual, who was not affiliated with the Company, formed a new company, Beijing Chuang Fu Tian Xia Network Technology Co., Ltd. (“Beijing Chuang Fu Tian Xia”). Beijing Chuang Fu Tian Xia is 51% owned by Business Opportunity Online and 49% owned by the co-founding individual. In addition to capital investment, the co-founding individual is required to provide the controlled domain names, www.liansuo.com and www.chuangye.com to be registered under the established company.  Beijing Chuang Fu Tian Xia is primarily engaged in providing and operating internet advertising, marketing and communication services to small and medium companies through the websites associated the above mentioned domain names.

On April 18, 2011, the Company, through one of its VIEs, Business Opportunity Online Hubei formed a new wholly owned company, Hubei CNET Advertising Media Co., Ltd. (“Hubei CNET”).  Hubei CNET is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancy services.

On April 18, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, together with an individual, who was not affiliated with the Company, formed a new company, Zhao Shang Ke Network Technology (Hubei) Co., Ltd. (“Zhao Shang Ke Hubei”). Zhao Shang Ke Hubei is 51% owned by Business Opportunity Online Hubei and 49% owned by the co-founding individual.  Zhao Shang Ke Hubei is primarily engaged in providing advertisement design, production, promulgation and sales channels building services. On December 29, 2011, as approved by the shareholders of Zhao Shang Ke Hubei, two unaffiliated third party investors invested RMB10,000,000 (approximately US$1,581,103) cash into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interest in Zhao Shang Ke Hubei in the enlarged registered capital. Therefore, beginning on December 29, 2011, the Company’s share of the equity interest in Zhao Shang Ke Hubei decreased from 51% to 25.5% and ceased to have a controlling financial interest in Zhao Shang Ke Hubei, but still retained an investment in, and significant influence over, Zhao Shang Ke Hubei.

On July 1, 2011, one of the Company’s VIEs, Quanzhou Zhi Yuan, formed a new wholly owned company, Xin Qi Yuan Advertisement Planning (Hubei) Co., Ltd. (“Xin Qi Yuan Hubei”). Xin Qi Yuan Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancy services.

On July 1, 2011, one of the Company’s VIEs, Quanzhou Tian Xi Shun He, formed a new wholly owned company, Mu Lin Sen Advertisement (Hubei) Co., Ltd. (“Mu Lin Sen Hubei”). Mu Lin Sen Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancy services.

On July 1, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, together with an individual who is not affiliated with the Company, formed a new company, Sheng Tian Network Technology (Hubei) Co., Ltd. (“Sheng Tian Hubei”). Sheng Tian Hubei is 51% owned by Business Opportunity Online Hubei and 49% owned by the co-founding individual.  Sheng Tian Hubei is primarily engaged in computer system design, development and promotion; software development and promotion, and providing the related technical consultancy services.

On September 5, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, formed a new wholly owned company, Chongqing Business Opportunity Online Technology Co., Ltd. (“Business Opportunity Online Chongqing”). Business Opportunity Online Chongqing is primarily engaged in internet advertisement design, production and promulgation.

On December 20, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei acquired a 51% equity interest in Sou Yi Lian Mei.  Sou Yi Lian Mei is primary engaged in providing online advertising and marketing services and operates its business primarily through its wholly-owned subsidiary, Jin Du Ya He (Beijing) Network Technology Co., Ltd (“Jin Du Ya He”).
 
As of March 31, 2012, the Company operated its business primarily in China through its PRC subsidiary and PRC operating entities, or VIEs as described above.

 
F-9

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
2.  
Variable Interest Entities

To satisfy PRC laws and regulations, the Company conducts certain business in the PRC through its Variable Interest Entities (“VIEs”).

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

The significant terms of the VIE Agreements are summarized below:

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

Exclusive Option Agreements: Under the Exclusive Option Agreements entered into by and among Rise King WFOE, each of the PRC Shareholders irrevocably granted to Rise King WFOE or its designated person an exclusive option to purchase, to the extent permitted by PRC law, a portion or all of their respective equity interest in any PRC Operating Entities for a purchase price of RMB 10, or a purchase price to be adjusted to be in compliance with applicable PRC laws and regulations. Rise King WFOE, or its designated person, has the sole discretion to decide when to exercise the option, whether in part or in full. Each of these agreements has a ten-year term, subject to renewal at the election of Rise King WFOE.

Equity Pledge Agreements: Under the Equity Pledge Agreements entered into by and among Rise King WFOE, the PRC Operating Entities and each of the PRC Shareholders, the PRC Shareholders pledged all of their equity interests in the PRC Operating Entities to guarantee the PRC Operating Entities’ performance of its obligations under the Exclusive Business Cooperation Agreements. If the PRC Operating Entities or any of the PRC Shareholders breaches its/his/her respective contractual obligations under these agreements, or upon the occurrence of one of the events regarded as an event of default under each such agreement, Rise King WFOE, as pledgee, will be entitled to certain rights, including the right to dispose of the pledged equity interests. The PRC Shareholders of the PRC Operating Entities agreed not to dispose of the pledged equity interests or take any actions that would prejudice Rise King WFOE's interest, and to notify Rise King WFOE of any events or upon receipt of any notices which may affect Rise King WFOE's interest in the pledge. Each of the equity pledge agreements will be valid until all the payments related to the services provided by Rise King WFOE to the PRC Operating Entities due under the Exclusive Business Cooperation Agreements have been fulfilled. Therefore, the equity pledge agreements shall only be terminated when the payments related to the ten-year Exclusive Business Cooperation Agreement are paid in full and the WFOE does not intend to extend the term of the Exclusive Business Cooperation Agreement.

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

 
F-10

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

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

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

In addition, as all of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through either arbitration or litigation in the PRC, they would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could further limit the Company’s ability to enforce these contractual arrangements. Furthermore, these contracts may not be enforceable in China if PRC government authorities or courts take a view that such contracts contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons. In the event the Company is unable to enforce these contractual arrangements, it may not be able to exert effective control over the VIEs, and its ability to conduct its business may be materially and adversely affected.
 
 
F-11

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Summarized below is the information related to the consolidated VIEs’ assets and liabilities as of March 31, 2012 and December 31, 2011, respectively:
 
   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
  Cash and cash equivalents
  $ 7,115     $ 8,322  
  Accounts receivable, net
    6,980       3,705  
  Other receivables, net
    5,275       3,619  
  Prepayment and deposit to suppliers
    13,717       15,360  
  Due from related parties
    151       192  
  Contingent consideration receivables
    160       159  
  Other current assets
    23       23  
  Deferred tax assets-current
    222       -  
Total current assets
    33,643       31,380  
                 
Investment in and advance to equity investment affiliates
    1,169       1,354  
Property and equipment, net
    1,418       1,507  
Intangible assets, net
    7,907       8,111  
Goodwill
    11,068       10,999  
Deferred tax assets-non current
    150       92  
Total Assets
  $ 55,355     $ 53,443  
                 
Liabilities
               
Current liabilities:
               
  Accounts payable
  $ 214     $ 268  
  Advances from customers
    1,890       724  
  Accrued payroll and other accruals
    269       251  
  Due to equity investment affiliate
    538       220  
  Due to related parties
    4       161  
  Due to Control Group
    11       11  
  Payable for acquisition
    553       550  
  Taxes payable
    5,093       4,409  
  Other payables
    147       107  
Total current liabilities
    8,719       6,701  
                 
Deferred tax Liabilities-non current
    1,850       1,893  
Total Liabilities
  $ 10,569     $ 8,594  

All of the VIEs' assets can be used to settle obligations of its primary beneficiary. Liabilities recognized as a result of consolidating these VIEs do not represent additional claims on the Company’s general assets.

For the three months ended March 31, 2012, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$14,896,000, cost of sales of approximately US$12,536,000, operating expenses of approximately US$1,655,000 and net income before allocation to noncontrolling interests of approximately US$233,000.

For the three months ended March 31, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$3,812,000, cost of sales of approximately US$1,853,000, operating expenses of approximately US$1,245,000 and net income before allocation to noncontrolling interests of approximately US$788,000.
 
 
F-12

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
3.  
Summary of significant accounting policies
 
a)  
Basis of presentation
 
The interim consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”).
 
The interim consolidated financial information as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures, which are normally included in annual consolidated financial statements prepared in accordance with U.S. GAAP, have been omitted pursuant to those rules and regulations. The interim consolidated financial information should be read in conjunction with the financial statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, previously filed with the SEC.
 
In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company’s consolidated financial position as of March 31, 2012, its consolidated results of operations for the three months ended March 31, 2012 and 2011, and its consolidated cash flows for the three months ended March 31, 2012 and 2011, as applicable, have been made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.
 
b)  
Principles of consolidation
 
The interim consolidated financial statements include the financial statements of all the subsidiaries and VIEs of the Company. All transactions and balances between the Company and its subsidiaries and VIEs have been eliminated upon consolidation. According to the agreements between Beijing CNET Online and Shanghai Borongdingsi, although Beijing CNET Online legally owns 51% of Shanghai Borongdingsi’s interests, Beijing CNET Online only controls the assets and liabilities related to the bank kiosks business, which has been included in the financial statements of Beijing CNET Online, but does not control other assets of Shanghai Borongdingsi, thus, Shanghai Borongdingsi’s financial statements were not consolidated by the Company.
 
c)  
Use of estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure of contingent assets and liabilities at the date of these consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. The Company continually evaluates these estimates and assumptions based on the most recently available information, historical experience and various other assumptions that the Company believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates.
 
d)  
Foreign currency translation and transactions
 
The functional currency of the Company is United States dollars (“US$”), and the functional currency of China Net HK is Hong Kong dollars (“HK$”).  The functional currency of the Company’s PRC operating subsidiary and VIEs is Renminbi (“RMB”), and PRC is the primary economic environment in which the Company operates.
 
For financial reporting purposes, the financial statements of the Company’s PRC operating subsidiary and VIEs, which are prepared using the RMB, are translated into the Company’s reporting currency, the United States Dollar (“U.S. dollar”). Assets and liabilities are translated using the exchange rate at each balance sheet date.  Revenue and expenses are translated using average rates prevailing during each reporting period, and stockholders’ equity is translated at historical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulated other comprehensive income in stockholders’ equity.
 
Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions.  The resulting exchange differences are included in the determination of net income of the consolidated statements of income and comprehensive income for the respective periods.
 
 
F-13

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows:
 
   
March 31,
2012
   
December 31,
2011
 
             
Balance sheet items, except for equity accounts
    6.3247       6.3647  
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
Items in the statements of income and comprehensive income, and statements cash flows
    6.3201       6.5894  
 
No representation is made that the RMB amounts could have been, or could be converted into US$ at the above rates.
 
e)  
Advertising costs
 
Advertising costs for the Company’s own brand building are not includable in cost of sales, they are expensed when incurred or amortized over the estimated beneficial period and are included in “selling expenses” in the statement of income and comprehensive income. For the three months ended March 31, 2012 and 2011, advertising expenses for the Company’s own brand building were approximately US$74,000 and US$465,000, respectively.
 
f)  
Research and development expenses
 
The Company accounts for the cost of developing and upgrading technologies and platforms and intellectual property that are used in its daily operations in research and development cost. Research and development costs are charged to expense when incurred. Expenses for research and development for the three months ended March 31, 2012 and 2011 were approximately US$331,000 and US$353,000, respectively.
 
g)  
Income taxes
 
The Company adopts ASC Topic 740 “Income taxes” and uses liability method to account for income taxes.  Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets, if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in statement of income and comprehensive income in the period that includes the enactment date.
 
h)  
Uncertain tax positions
 
The Company follows the guidance of ASC Topic 740-10-25-5 through 740-10-25-7 and 740-10-25-13, which prescribes a more likely than not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures.  For the three months ended March 31, 2012 and 2011, the Company did not have any interest and penalties associated with tax positions and did not have any significant unrecognized uncertain tax positions.
 
i)  
Recent accounting pronouncements
 
For the three months ended March 31, 2012, there were no new Accounting Standards Updates (ASUs) issued by the FASB to amend the FASB Accounting Standards Codification® (ASC).
 
 
F-14

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
4.  
Cash and cash equivalent
 
   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Cash
    497       181  
Bank deposit
    8,467       10,514  
      8,964       10,695  
 
5.  
Accounts receivable, net

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accounts receivable
    9,739       6,546  
Allowance for doubtful debts
    (2,116 )     (2,102 )
Accounts receivable, net
    7,623       4,444  

All of the accounts receivable are non-interest bearing. Based on the assessment of the collectability of the accounts receivable as of March 31, 2012, the Company provided approximately US$2,116,000 allowance for doubtful debts, which was related to the accounts receivable of the Company’s internet advertising business segment with an aging over six months. For the three months ended March 31, 2012, no additional allowance for doubtful debts was provided.
 
6.  
Other receivables, net

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Short-term loan for marketing campaign
    3,004       2,985  
Project development deposit
    2,451       -  
Staff advances for normal business purpose
    178       279  
Overdue contract execution deposits
    739       891  
Allowance for doubtful debts
    (528 )     (524 )
Other receivables, net
    5,844       3,631  

Short-term loan for marketing campaign: for one of the major marketing campaigns, the Company made a marketing-related loan of RMB25,000,000 (approximately US$3,952,757) to a TV series of 36 episodes, called “Xiao Zhang Feng Yun”. This TV series was produced for the commemoration of “The Republican Revolution of 1911” (the Chinese bourgeois democratic revolution led by Dr. Sun Yat-sen which overthrew the Qing Dynasty). By participating in this TV series, the Company will be shown during the credit at the closing of each episode with its logo presented and also shown as a separate card during the closing before the credit screen. This TV series has been broadcasted on CCTV 8 and www.sina.com.cn from September 2011 and is continually selling its broadcasting rights to other provincial TV channels for additional exposure.  In November and December, 2011, the Company collected its first two repayments of RMB6,000,000 (approximately US$948,662) in the aggregate from the borrower. In accordance with the communication between the Company and the debtor, the Company has extended the term of this loan from December 31, 2011 to December 31, 2012, as this TV series had only completed its first round selling broadcasting rights. The Company will continue to assess the collectability of this loan and if an event occurs or circumstances change that could indicate that the collectability of this loan is remote, a full allowance of bad debts provision will be provided for the remaining outstanding balance of this loan.

 
F-15

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
As of March 31, 2012, the Company made a project development deposit to a third party project development and management company for the participation of the TMT (“Technology, Media and Telecom”) Zone development and management in Xiaogan City, Hubei Province, the PRC (the “Xiaogan TMT Zone”). This TMT zone is intended to become the headquarters for the SMEs, especially the small and medium sized franchising business, with all the supporting TMT services. The deposit is refundable subject to upcoming planning and further evaluation of the development of the Xiaogan TMT Zone. If after evaluation, further involvement in the development and management is not economical or efficient for the Company and the Company decides to exit, the deposit will be refunded within the current calendar year.

For all advertising resources purchase contracts signed by the Company with its resources providers, the Company is required to deposit contract execution guarantees, the contract execution guarantees will be used to offset the contact amount need to be paid for the resources provided in the last month of each contract period or refunded to the company upon expiration of the purchase contract. Overdue contract execution deposits represented the portion of the contract execution deposits, which related advertising resources purchase contracts had been completed as of each of the reporting dates. Based on the assessment of the collectability of these overdue contract execution deposits as of March 31, 2012, the Company provided approximately US$528,000 allowance for doubtful debts, which was related to the contract execution deposits of its TV advertising business segment. For the three months ended March 31, 2012, no additional allowance for doubtful debts was provided.
 
7.  
Prepayments and deposit to suppliers

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Contract execution guarantees to TV advertisement and internet resources providers
     9,969        10,050  
Prepayments to TV advertisement and internet resources providers
    3,713       5,285  
Other deposits and prepayments
    36       25  
      13,718       15,360  
 
Contract execution guarantees to TV advertisement and internet resource providers are paid as contractual deposits to the Company’s resources and services providers.  These amounts will be used to offset the contact amount and service fee need to be paid for the resources and services provided in the last month of each contract period or refunded to the Company upon expiration of the purchase contracts.
 
According to the contracts signed between the Company and its suppliers, the Company is normally required to pay the contract amount in advance.  These prepayments will be transferred to cost of sales when the related services are provided.
 
8.  
Due from related parties

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Beijing Fengshangyinli Technology Co., Ltd.
    114       113  
Beijing Saimeiwei Food Equipment Technology Co., Ltd.
    76       74  
Beijing Telijie Century Environmental Technology Co., Ltd.
    88       137  
      278       324  
 
 
F-16

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
These related parties are directly or indirectly owned by the Control Group of the Company.  Control Group refers to Mr. Handong Cheng, Mr. Xuanfu Liu and Ms. Li Sun (acting as nominee for Mr. Zhige, Zhang), the owners of the Company’s PRC VIEs, Business Opportunities Online and Beijing CNET Online before the Offshore Restructuring. The Company provides advertising services to these related parties in its normal course of business on the same terms as those provide to its unrelated advertising clients. Due from related parties represented the outstanding receivables for the advertising services the Company provided to these related parties as of each of the reporting dates.
 
9.  
Contingent consideration receivables

   
Amount
 
   
US$(’000)
 
       
Balance as of December 31, 2011 (audited)
    159  
Recognized from acquisition of VIEs
    -  
Changes in fair value of contingent consideration receivables recognized
    -  
Exchange translation adjustment
    1  
Balance as of March 31, 2012 (unaudited)
    160  
 
Contingent consideration receivables arose from certain “make good” provisions entered into by and between the Company and the equity interest’s sellers upon acquisition of the Company’s consolidated VIEs for the year ended December 31, 2011, which were that if audited pretax profit or after tax profit for the year ended December 31, 2012 increases by less than certain amount or percentage while compared to the audited pretax profit or after tax profit of the prior year, the sellers need to compensate the Company in cash for the difference between target pretax profit or after tax profit and actual result achieved then.
 
As of December 31, 2011, the aggregate amount of the fair value of the contingent consideration receivables for the acquisition transactions that occurred in 2011 was approximately US$159,000. The Company reassessed the fair value of these contingent consideration receivables as of March 31, 2012 for the respective make good arrangement for the year ended December 31, 2012, based on their respectively historical performance and other relevant assumptions, and determined that no material changes in fair value of these contingent consideration receivables incurred during the three months ended March 31, 2012.
 
10.  
Investment in and advance to equity investment affiliates

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Investment in equity investment affiliates
    1,169       1,354  
Advance to equity investment affiliates
    43       42  
      1,212       1,396  
 
 
F-17

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The following table summarizes the movement of the investment in and advance to equity investment affiliates for the three months ended March 31, 2012:
 
   
Shenzhen
Mingshan
   
Zhao Shang
Ke Hubei
   
Total
 
   
US$(’000)
   
US$(’000)
   
US$(’000)
 
                   
Balance as of December 31, 2011 (audited)
    595       801       1,396  
Share of losses in equity investment affiliates
    (83 )     (110 )     (193 )
Exchange translation adjustment
    4       5       9  
Balance as of March 31, 2012 (unaudited)
    516       696       1,212  
 
Shenzhen Mingshan:

Shenzhen Mingshan was incorporated on June 24, 2010 by one of the Company’s VIEs, Business Opportunities Online and three other individuals who were not affiliated with the Company.  Shenzhen Mingshan was 51% owned by the Company and was a consolidated subsidiary of the Company from the date of incorporation through January 6, 2011.  On January 6, 2011, an unaffiliated third party investor invested RMB15,000,000 (approximately US$2,371,654) cash into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan. The Company’s share of equity interest decreased from 51% to 20.4% accordingly.
 
The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the three months ended March 31, 2012 and 2011, the Company recognized its pro-rata share of losses in Shenzhen Mingshan of approximately US$83,000 and US$64,000, respectively, which was reflected in the caption of “Share of losses in equity investment affiliates” in the Company’s consolidated statements of income and comprehensive income with a corresponding decrease to the carrying value of the investment in Shenzhen Mingshan in the Company’s consolidated balance sheet.

Zhao Shang Ke Hubei:
 
Zhao Shang Ke Hubei was incorporated on April 18, 2011 by one of the Company’s VIEs, Business Opportunities Online Hubei and a co-founding individual who was not affiliated with the Company.  Zhao Shang Ke Hubei was 51% owned by the Company and was a consolidated subsidiary of the Company from the date of incorporation through December 29, 2011.  On December 29, 2011, two unaffiliated third party investors invested RMB10,000,000 (approximately US$1,581,103) cash into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interest in Zhao Shang Ke Hubei. The Company’s share of equity interest decreased from 51% to 25.5% accordingly.
 
The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the three months ended March 31, 2012, the Company recognized its pro-rata share of losses in Zhao Shang Ke Hubei of approximately US$110,000, which was reflected in the caption of “Share of losses in equity investment affiliates” in the Company’s consolidated statements of income and comprehensive income with a corresponding decrease to the carrying value of the investment in Zhao Shang Ke Hubei in the Company’s consolidated balance sheet.
 
11.  
Property and equipment, net

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Vehicles
    688       683  
Office equipment
    1,417       1,399  
Electronic devices
    1,203       1,196  
Property and equipment, cost
    3,308       3,278  
Less: accumulated depreciation
    (1,533 )     (1,376 )
Property and equipment, net
    1,775       1,902  
 
Depreciation expenses in aggregate for the three months ended March 31, 2012 and 2011 were approximately US$148,000 and $133,000, respectively.
 
 
F-18

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
12.  
Intangible assets, net

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Intangible assets not subject to amortization:
           
Trade name
    308       306  
Domain name
    1,527       1,518  
Intangible assets subject to amortization:
               
Contract backlog
    196       195  
    Customer relationship
    3,429       3,408  
    Non-compete agreements
    1,357       1,348  
Software technologies
    324       322  
Cloud-computing based software platforms
    1,468       1,458  
Other computer software
    76       75  
Intangible assets, cost
    8,685       8,630  
Less: accumulated amortization
    (744 )     (479 )
Intangible assets, net
    7,941       8,151  
 
Amortization expenses in aggregate for the three months ended March 31, 2012 and 2011 were approximately US$262,000 and US$66,000, respectively.
 
Based on the carrying value of the finite-lived intangible assets recorded as of March 31, 2012, and assuming no subsequent impairment of the underlying intangible assets, the estimated future amortization expenses is approximately US$765,000 for the nine months ended December 31, 2012, approximately US$1,020,000 per year through December 31, 2015 and approximately US$981,000 for the year ended December 31, 2016.
 
13.  
Goodwill

   
Amount
 
   
US$(’000)
 
       
Balance as of December 31, 2011 (audited)
    10,999  
Recognized from acquisition of VIEs
    -  
Impairment loss recognized
    -  
Exchange translation adjustment
    69  
Balance as of March 31, 2012 (unaudited)
    11,068  
 
14.  
Accrued payroll and other accruals
 
   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accrued payroll and staff welfare
    345       344  
Accrued operating expenses
    140       272  
      485       616  
 
 
F-19

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
15.  
Due to equity investment affiliate

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Zhao Shang Ke Hubei
    538       220  
 
Zhao Shang Ke Hubei is an equity investment affiliate of the Company.  Amounts due to Zhao Shang Ke Hubei represented the aggregate balance of the temporary non-interest bearing working capital loans borrowed by the Company’s VIEs from Zhao Shang Ke Hubei as of each of the report dates.
 
16.  
Due to related parties

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Beijing Saimeiwei Food Equipments Technology Co., Ltd
    4       4  
Due to legal (nominal) shareholders of Shanghai Jing Yang
    80       157  
      84       161  

Shanghai Jing Yang was incorporated in December 2009 by the Company’s senior management, prior to entering into the Contractual Agreements with the Company (see Note 1), the legal shareholders contributed RMB1,000,000 (approximately US$157,000) as the original paid-in capital of Shanghai Jing Yang upon incorporation. For the three months ended March 31, 2012, the Company returned approximately US$77,000 to the legal shareholders of Shanghai Jing Yang and the remaining balance of approximately US$80,000 as of March 31, 2012 was returned to the legal shareholders of Shanghai Jing Yang in April 2012.
 
17.  
Payable for acquisition

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Sou Yi Lian Mei
    553       550  
 
Payable for acquisition represented the outstanding payment of RMB3,500,000 for the acquisition transaction of Sou Yi Lian Mei as of March 31, 2012 and December 31, 2011, respectively.
 
 
F-20

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
18.  
Taxation
 
1)  
Income tax
 
The entities within the Company file separate tax returns in the respective tax jurisdictions in which they operate.
 
i). The Company is incorporated in the state of Nevada.  Under the current law of Nevada, the company is not subject to state corporate income tax.  Following the Share Exchange, the Company became a holding company and does not conduct any substantial operations of its own. No provision for federal corporate income tax has been made in the financial statements as the Company has no assessable profits for the three months ended March 31, 2012 or any prior periods.    The Company does not provide for U.S. taxes or foreign withholding taxes on undistributed earnings from its non-U.S. subsidiaries because such earnings are intended to be reinvested indefinitely. If undistributed earnings were distributed, foreign tax credits could become available under current law to reduce the resulting U.S. income tax liability.
 
ii). China Net BVI was incorporated in the British Virgin Islands (“BVI”).  Under the current law of the BVI, China Net BVI is not subject to tax on income or capital gains.  Additionally, upon payments of dividends by China Net BVI to its shareholders, no BVI withholding tax will be imposed.
 
iii). China Net HK was incorporated in Hong Kong and does not conduct any substantial operations of its own. No provision for Hong Kong profits tax has been made in the financial statements as China Net HK has no assessable profits for the three months ended March 31, 2012 or any prior periods. Additionally, upon payments of dividends by China Net HK to its shareholders, no Hong Kong withholding tax will be imposed.
 
iv).  The Company’s PRC operating subsidiary and VIEs, being incorporated in the PRC, are governed by the income tax law of the PRC and is subject to PRC enterprise income tax (“EIT”).  Effective from January 1, 2008, the EIT rate of PRC was changed from 33% to 25%, and applies to both domestic and foreign invested enterprises.
 
l  
Rise King WFOE is a software company qualified by the related PRC governmental authorities and was approved by the local tax authorities of Beijing, the PRC, to be entitled to a two-year EIT exemption from its first profitable year and a 50% reduction of its applicable EIT rate, which is 25% to 12.5% of its taxable income for the succeeding three years.  Rise King WFOE had a net loss for the year ended December 31, 2008 and its first profitable year was fiscal year 2009 which has been verified by the local tax bureau by accepting the application filed by the Company.  Therefore, it was approved to be entitled to a two-year EIT exemption for fiscal year 2009 through fiscal year 2010 and a 50% reduction of its applicable EIT rate which is 25% to 12.5% for fiscal year 2011 through fiscal year 2013. Therefore, for the three months ended March 31, 2012 and 2011, the applicable income tax rate for Rise King WFOE was 12.5%. After fiscal year 2013, the applicable income tax rate for Rise King WFOE will be 25% under the current EIT law of PRC.
 
l  
Business Opportunity Online was approved as a High and New Technology Enterprise under the New EIT law on September 4, 2009, and was approved by the local tax authorities to be entitled to a favorable statutory tax rate of 15%.  Business Opportunity Online’s High and New Technology Enterprise certificate will expire on September 4, 2012 and subject to an administrative review by the relevant PRC governmental regulatory authorities for obtaining the renewed certificate. As confirmed with the local tax authorities, if Business Opportunity Online fails to pass the administrative review, the enacted tax rate will be increased to 25% starting from January 1, 2012. Business Opportunity Online assessed the situation and concluded that more likely than not it will be able to pass this administrative review and continue to enjoy the 15% preferential income tax rate as a High and New Technology Enterprise. For the three months ended March 31, 2012, Business Opportunity Online incurred a net loss, for the three months ended March 31, 2011, the applicable income tax rate of Business Opportunity Online was 15%.
 
 
F-21

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
l  
Business Opportunity Online Hubei and Hubei CNET were incorporated in Xiaotian Industrial Park of Xiaogan Economic Development Zone in Xiaogan City, Hubei province of the PRC in 2011. These operating entities was approved by the related local government authorities to apply the deemed income tax method for its computation of income tax expense for the year ended December 31, 2011. Under the deemed income tax method, the deemed profit is calculated based on 10% of the total revenue and the applicable income tax rate is 25%.  In December 2011, the local tax authorities of these operating entities informed the Company, that they would cancel the current applicable deemed income tax method for computation of income tax expenses starting from January 1, 2012 for these entities, but may refund certain amount of the income tax paid by these operating entities as an local subsidy to these entities, i.e. the applicable income tax rate for these operating entities was 25% starting from January 1, 2012. Therefore, the income tax expenses for these operating entities were calculated based on 25% income tax rate for the three months ended March 31, 2012 and 2.5% of the total revenue recognized of each of these operating entities for the three months ended March 31, 2011.
 
l  
The applicable income tax rate for other PRC operating entities of the Company is 25% for the three months ended March 31, 2012 and 2011.
 
l  
The New EIT also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous enterprise income tax law and rules.  A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate.  Rise King WFOE is invested by immediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company.
 
All of the preferential income tax treatments enjoyed by the Company’s PRC subsidiary and VIEs were based on the current applicable laws and regulations of the PRC and approved by the related government regulatory authorities and local tax authorities where the Company’s respective PRC subsidiary and VIEs operate. Rise King WFOE, Business Opportunity Online, Business Opportunity Online Hubei and Hubei CNET were most affected by these preferential income tax treatments within the structure of the Company for the three months ended March 31, 2012 and 2011. The preferential income tax treatments are subject to change in accordance with the PRC government economic development policies and regulations. These preferential income tax treatments are mainly determined by the regulation and policies of the PRC government in the context of the overall economic policy and strategy. As a result, the uncertainty of theses preferential income tax treatments are subject to, but not limited to, the PRC government policy on supporting any specific industry’s development under the outlook and strategy of overall macroeconomic development.
 
2) Business tax and relevant surcharges
 
Commencing from January 1, 2012, PRC tax authorities increased the local business tax rate by 0.1%-0.2%. Therefore, from fiscal 2012, revenue of advertisement services is subject to 5.6%-5.7% business tax, depending on which tax jurisdiction the Company’s PRC operating subsidiary and VIE operates, and 3% cultural industry development surcharge of the net service income after deducting amount paid to ending media promulgators. Revenue of internet technical support services is subjected to 5.6%-5.7% business tax, depending on which tax jurisdiction the Company’s PRC operating subsidiary and VIE operates.  Business tax charged was included in cost of sales.
 
As of March 31, 2012 and December 31, 2011, taxes payable consists of:
       
   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Business tax payable
    2,250       2,210  
Culture industry development surcharge payable
    3       2  
Enterprise income tax payable
    3,389       2,770  
Individual income tax payable
    59       58  
      5,701       5,040  

 
F-22

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
For the three months ended March 31, 2012 and 2011, the Company’s income tax expense consisted of:

   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
Current-PRC
    617       446  
Deferred-PRC
    (381 )     (15 )
      236       431  
 
The Company’s deferred tax liabilities at March 31, 2012 and changes for the three months then ended were as follows:
 
   
Amount
 
   
US$(’000)
 
       
Balance as of December 31, 2011 (audited)
    1,893  
Reversal during the period
    (55 )
Exchange  translation adjustment
    12  
Balance as of March 31, 2012 (unaudited)
    1,850  

Deferred tax liabilities arose on the recognition of the identifiable intangible assets acquired from acquisition transactions consummated in 2011. Reversal for the three months ended March 31, 2012 of approximately US$55,000, was due to the amortization of these acquired intangible assets.

The Company’s deferred tax assets at March 31, 2012 and December 31, 2011 were as follows:

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Tax effect of net operating losses carried forward
    2,373       1,975  
Bad debts provision
    655       651  
Valuation allowance
    (2,610 )     (2,534 )
      418       92  
 
   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Deferred tax assets reclassified as current asset
    222       -  
Deferred tax assets reclassified as non-current asset
    196       92  
      418       92  

 
F-23

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

 
The net operating losses carried forward incurred by the Company (excluding its PRC operating subsidiary and VIEs) were approximately US$5,586,000 and US$5,381,000 at March 31, 2012 and December 31, 2011, respectively, which loss carry forwards gradually expire over time, the last of which expires in 2032. A full valuation allowance has been recorded because it is considered more likely than not that the deferred tax assets will not be realized through sufficient future earnings of the entity to which the operating losses relate.

The net operating losses carried forward incurred by the Company’s PRC subsidiary and VIEs were approximately US$2,291,000 and US$361,000 at March 31, 2012 and December 31, 2011, respectively, which loss carry forwards gradually expire over time,  the last of which expires in 2017. The related deferred tax assets was calculated based on the respective net operating losses incurred by each of the PRC subsidiary and VIEs and the respective corresponding enacted tax rate that will be in effect in the period in which the differences are expected to reverse. No valuation allowance has been recorded because it is considered more likely than not that the deferred tax assets will be realized through sufficient future earnings of the entities to which the operating losses relate.

The bed debts provision recorded by the Company’s PRC subsidiary and VIEs were approximately US$2,643,000. A full valuation allowance has been recorded because it is considered more likely than not that the deferred tax assets will not be realized through bad debts verification by the local tax authorities where the PRC subsidiary and VIEs operate.
 
19.  
Dividend payable

   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Dividend payable to Series A convertible stock holders
    -       5  

 
Dividend to Series A convertible preferred stockholders was accrued at the per annum rate of 10% and calculated based on US$2.5 per share liquidation preference and the actual number of days of each share of the Series A convertible preferred stock outstanding for each of the reporting periods.
 
On August 21, 2011, all of the Company’s outstanding Series A convertible preferred stock, which had not been voluntarily converted into the Company’s common shares, were fully converted into the Company’s common shares under the mandatory conversion clause entered into by and between the Company and its Series A convertible preferred stockholders.
 
For the three months ended March 31, 2012 and 2011, the Company paid dividends of approximately US$5,000 and US$171,000 to its Series A convertible preferred stockholders, respectively.
 
20.  
Long-term borrowing from director


   
March 31,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Long-term borrowing from director
    138       137  
 
Long-term borrowing from director was a non-interest bearing loan from a director of the Company relating to the original paid-in capital contribution in the Company’s wholly-owned subsidiary Rise King WFOE.
 
 
F-24

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
21.  
Warrants
 
The Company issued warrants in its August 2009 Financing. Warrants issued and outstanding at March 31, 2012 and changes during the three months then ended are as follows:
 
   
Warrants Outstanding
   
Warrants Exercisable
 
   
Number of
underlying
shares
   
Weighted
Average
Exercise
Price
   
Average
Remaining
Contractual
Life (years)
   
Number of
underlying
shares
   
Weighted
Average
Exercise
Price
   
Average
Remaining
Contractual
Life (years)
 
Balance, December 31, 2011 (audited)
    3,005,456     $ 3.41       2.21       3,005,456     $ 3.41       2.21  
Granted / Vested
    -                       -                  
Forfeited
    -                       -                  
Exercised
    -                       -                  
Balance, March 31, 2012 (unaudited)
    3,005,456     $ 3.41       1.96       3,005,456     $ 3.41       1.96  
 
22.  
Restricted Net Assets

As most of the Company’s operations are conducted through its PRC subsidiary and VIEs, the Company’s ability to pay dividends is primarily dependent on receiving distributions of funds from its PRC subsidiary and VIEs. Relevant PRC statutory laws and regulations permit payments of dividends by its PRC subsidiary and VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations and after it has met the PRC requirements for appropriation to statutory reserves. Paid in capital of the PRC subsidiary and VIEs included in the Company’s consolidated net assets are also non-distributable for dividend purposes.
 
In accordance with the PRC regulations on Enterprises with Foreign Investment, a WFOE established in the PRC is required to provide certain statutory reserves, namely general reserve fund, the enterprise expansion fund and staff welfare and bonus fund which are appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A WFOE is required to allocate at least 10% of its annual after-tax profit to the general reserve until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. Appropriations to the enterprise expansion fund and staff welfare and bonus fund are at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. Rise King WFOE is subject to the above mandated restrictions on distributable profits. Additionally, in accordance with the Company Law of the PRC, a domestic enterprise is required to provide a statutory common reserve of at least 10% of its annual after-tax profit until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide for a discretionary surplus reserve, at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends.  All of the Company’s PRC VIEs are subject to the above mandated restrictions on distributable profits.

As a result of these PRC laws and regulations, the Company’s PRC subsidiary and VIEs are restricted in their ability to transfer a portion of their net assets to the Company.  As of March 31, 2012 and December 31, 2011, net assets restricted in the aggregate, which include paid-in capital and statutory reserve funds of the Company’s PRC subsidiary and VIEs that are included in the Company’s consolidated net assets, was approximately US$4.8 million and US$4.7 million, respectively.

 
F-25

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The New PRC Enterprise Income Tax (“EIT”) Law, which was effected on January 1, 2008, also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous EIT law.  A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate.  Rise King WFOE is invested by its immediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company.

The ability of the Company’s PRC subsidiary and VIEs to make dividends and other payments to the Company may also be restricted by changes in applicable foreign exchange and other laws and regulations.

Foreign currency exchange regulation in China is primarily governed by the following rules:

l  
Foreign Exchange Administration Rules (1996), as amended in August 2008, or the Exchange Rules;
l  
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.

Currently, under the Administration Rules, Renminbi is freely convertible for current account items, including the distribution of dividends, interest payments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities outside of China, unless the prior approval of the State Administration of Foerign Exchange (the “SAFE”) is obtained and prior registration with the SAFE is made. Foreign-invested enterprises like Rise King WFOE that need foreign exchange for the distribution of profits to its shareholders may effect payment from their foreign exchange accounts or purchase and pay foreign exchange rates at the designated foreign exchange banks to their foreign shareholders by producing board resolutions for such profit distribution. Based on their needs, foreign-invested enterprises are permitted to open foreign exchange settlement accounts for current account receipts and payments of foreign exchange along with specialized accounts for capital account receipts and payments of foreign exchange at certain designated foreign exchange banks.

Although the current Exchange Rules allow the convertibility of Chinese Renminbi into foreign currency for current account items, conversion of Chinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of SAFE, which is under the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign currency conversion. The Company cannot be sure that it will be able to obtain all required conversion approvals for its operations or the Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Currently, most of the Company’s retained earnings are generated in Renminbi. Any future restrictions on currency exchanges may limit the Company’s ability to use its retained earnings generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible business activities outside China.

As of March 31, 2012 and December 31, 2011, there was approximately US$34.1 million and US$34.0 million retained earnings in the aggregate, respectively, which was generated by the Company’s PRC subsidiary and VIEs in Renminbi included in the Company’s consolidated net assets, aside from US$2.3 million and US$2.2 million statutory reserve funds as of March 31, 2012 and December 31, 2011, respectively, that may be affected by increased restrictions on currency exchanges in the future and accordingly may further limit the Company’s PRC subsidiary’ and VIEs’ ability to make dividends or other payments in U.S. dollars to the Company, in addition to the approximately US$4.8 million and US$4.7 million restricted net assets as of March 31, 2012 and December 31, 2011, respectively, as discussed above.
 
23.  
Related party transactions
 
Revenue from related parties:
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
-Beijing Saimeiwei Food Equipment Technology Co., Ltd,
    14       -  
-Beijing Fengshangyinli Technology Co., Ltd.
    1       118  
-Beijing Telijie Century Environmental Technology Co., Ltd.
    -       72  
      15       190  
 
 
F-26

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
24.  
Employee defined contribution plan
 
Full time employees of the Company in the PRC participate in a government mandated defined contribution plan, pursuant to which certain pension benefits, medical care, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require that the PRC subsidiaries of the Company make contributions to the government for these benefits based on certain percentages of the employees’ salaries. The Company has no legal obligation for the benefits beyond the contributions made. The total amounts for such employee benefits, which were expensed as incurred, were approximately US$104,000 and US$77,000 for the three months ended March 31, 2012 and 2011, respectively.
 
25.  
Concentration of risk
 
Credit risk
 
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable, other receivables and prepayments and deposits to suppliers. As of March 31, 2012 and December 31, 2011, substantially all of the Company’s cash and cash equivalents were held by major financial institutions located in the PRC and Hong Kong, which management believes are of high credit quality.
 
Risk arising from operations in foreign countries
 
All of the Company’s operations are conducted within the PRC. The Company’s operations in the PRC are subject to various political, economic, and other risks and uncertainties inherent in the PRC. Among other risks, the Company’s operations in the PRC are subject to the risks of restrictions on transfer of funds, changing taxation policies, foreign exchange restrictions; and political conditions and governmental regulations.
 
Currency convertibility risk
 
Significant part of the Company’s businesses is transacted in RMB, which is not freely convertible into foreign currencies. All foreign exchange transactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requires submitting a payment application form together with suppliers’ invoices and signed contracts. These exchange control measures imposed by the PRC government authorities may restrict the ability of the Company’s PRC subsidiary and VIEs to transfer its net assets, which to the Company through loans, advances or cash dividends.
 
Concentration of Suppliers
 
For the three months ended March 31, 2012, two suppliers individually accounted for 65% and 17% of the Company’s cost of sales, respectively. For the three months ended March 31, 2011, three suppliers individually accounted for 19%, 16% and 12% of the Company’s cost of sales, respectively. Except for the afore-mentioned, there was no other single supplier who accounted for more than 10% of the Company’s cost of sales for the three months ended March 31, 2012 and 2011, respectively.
 
26.  
Commitments
 
The following table sets forth the Company’s contractual obligations as of March 31, 2012:
 
   
Server hosting and
board-band lease
   
Purchase of TV
advertisement time
   
Total
 
   
US$(’000)
   
US$(’000)
   
US$(’000)
 
                   
Nine months ending December 31,
                 
-2012
    48       27,702       27,750  
Total
    48       27,702       27,750  
 
 
F-27

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
27.  
Segment reporting
 
The Company follows ASC Topic 280 “Segment Reporting”, which requires that companies disclose segment data based on how management makes decisions about allocating resources to segments and evaluating their performance. Reportable operating segments include components of an entity about which separate financial information is available and which operating results are regularly reviewed by the chief operating decision maker (“CODM”) to make decisions about resources to be allocated to the segment and assess each operating segment’s performance.
 
Three Months Ended March 31, 2012 (Unaudited)

   
 
 
Internet
Ad.
   
 
 
TV
Ad.
   
 
 
Bank
kiosk
   
Brand
management
and sales
channel
building
   
 
 
 
Others
   
Inter-
segment and
reconciling
item
   
 
 
 
Total
 
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
 
                                           
Revenue
    4,345       10,369       71       150       -       -       14,935  
Cost of sales
    2,092       10,344       6       96       -       -       12,538  
Total operating expenses
    1,514       160       52       70       467 *     -       2,263  
Depreciation and amortization expense included in total operating expenses
    258       17       52       54       28       -       409  
Operating income(loss)
    739       (135 )     13       (16 )     (467 )     -       134  
                                                         
Share of  losses  in equity investment affiliates
    -       -       -       (110 )     (83 )     -       (193 )
Expenditure for long-term assets
    9       -       -       -       -       -       9  
Net income (loss)
    432       (112 )     13       (121 )     (503 )     -       (291 )
Total assets-March 31,2012
    42,061       17,206       753       5,302       16,389       (22,557 )     59,154  

*Including approximate US$16,833 share-based compensation expenses.
 
Three Months Ended March 31, 2011 (Unaudited)
 
   
Internet
Ad.
   
TV
Ad.
   
Bank
kiosk
   
Brand
management
and sales
channel
building
   
 
Others
   
Inter-
segment and
reconciling
item
   
 
Total
 
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
   
US$
(‘000)
 
                                           
Revenue
    6,086       726       137       75       -       -       7,024  
Cost of sales
    1,423       558       12       37       -       -       2,030  
Total operating expenses
    1,122       153       74       97       510 *     -       1,956  
Depreciation and amortization expense included in total operating expenses
    46       20       46       64       23       -       199  
Operating income(loss)
    3,541       15       51       (59 )     (510 )     -       3,038  
                                                         
Gain on deconsolidation of subsidiaries
    -       -       -       -       229       -       229  
Share of earnings (losses) in equity investment affiliates
    -       17       -       -       (64 )     -       (47 )
Expenditure for long-term assets
    -       -       34       -       34       -       68  
Net income (loss)
    3,099       31       51       (44 )     (341 )     -       2,796  
Total assets-March 31,2011
    36,947       4,423       733       3,998       23,970       (23,606 )     46,465  
 
*Including approximate US$106,580 share-based compensation expenses.
 
 
F-28

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
28.  
(Loss)/earnings per share
 
Basic and diluted (loss)/earnings per share for each of the periods presented are calculated as follows (All amounts, except number of shares and per share data, are presented in thousands of US dollars):
 

   
Three Month Ended March 31,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
Net (loss)/income attributable to ChinaNet Online Holdings, Inc.
  $ (366 )   $ 2,812  
Dividend for Series A convertible preferred stock
    -       (169 )
Net (loss)/income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for basic earnings per share)
    (366 )      2,643  
Dividend for Series A convertible preferred stock
    -       169  
Net (loss)/income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for diluted earnings per share)
    (366 )      2,812  
                 
Weighted average number of common shares outstanding - Basic
    22,182,584       17,244,315  
 Effect of diluted securities:
               
   Series A Convertible preferred stock
    -       2,735,605  
   Warrants and options
    -       840,062  
Weighted average number of common shares outstanding -Diluted
    22,182,584       20,819,982  
                 
(Loss)/earnings per share-Basic
  $ (0.02 )   $ 0.15  
(Loss)/earnings per share-Diluted
  $ (0.02 )   $ 0.14  
 
29.  
Share-based compensation expenses

On July 12, 2010, the Company renewed the investor relations service contract with Hayden Communications International, Inc. (“HCI”) for an18-month service contract commencing July 12, 2010.  As additional compensation, the Company issued HCI 60,000 restricted shares of the Company’s common stock. These shares were valued at $3.80 per share, the closing bid price of the Company’s common stock on the date of grant and the related compensation expense were amortized over the requisite service period.  Total compensation expenses recognized for the three months ended March 31, 2012 and 2011 was US$6,333 and US$38,000, respectively.

As a result of the merger of HCI and MZ Group, the Company terminated the above discussed service contract with HCI and engaged MZHCI, LLP (“MZ-HCI”) to provide investor relations services for a 24-month service period commencing January 1, 2012. As additional compensation, the Company granted 80,000 restricted shares of the Company’s common stock. These shares were valued at $1.05 per share, the closing bid price of the Company’s common stock on the date of grant and the related compensation expense were amortized over the requisite service period.  Total compensation expenses recognized for the three months ended March 31, 2012 and 2011 was US$10,500 and US$nil, respectively.

 
F-29

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
On November 30, 2009, the Company granted 5-year options to each of its three independent directors, Mr. Douglas MacLellan, Mr. Mototaka Watanabe and Mr. Zhiqing Chen, to purchase in the aggregate 54,000 shares of the Company’s common stock at an exercise price of US$5.00 per share, in consideration of their services to the Company. These options vest quarterly at the end of each 3-month period, in equal installments over the 24-month period from the date of grant.  The company utilized Black-Scholes option pricing model to gauge the grant date fair value of these options of US$4.05 per option. The related compensation expenses were amortized over its vesting period. Total compensation expenses recognized for these options for the three months ended March 31, 2012 and 2011 was US$nil and US$68,580, respectively.

On November 30, 2011, under the Company’s 2011 Omnibus Securities and Incentive Plan, the Company issued its management, employees and directors in the aggregate of 885,440 options to purchase up the same number of the company’s common stock at an exercise price of US$1.20 per share. These options were fully vested and exercisable upon issuance and subject to forfeiture upon an employee's cessation of employment at the discretion of the Company.

Options issued and outstanding at March 31, 2012 and their movements during the three months then ended are as follows:

   
Option Outstanding
   
Option Exercisable
 
   
Number of
underlying
shares
   
Weighted
Average
Remaining
Contractual
Life (Years)
   
Weighted
Average
Exercise
Price
   
 
 
Number of
underlying
shares
   
Weighted
Average
Remaining
Contractual
Life (Years)
   
Weighted
Average
Exercise
Price
 
                                     
Balance, December 31, 2011 (audited)
     939,440        9.51     $  1.42        939,440        9.51     $  1.42  
Granted/Vested
    -                       -                  
Forfeited
    -                       -                  
Exercised
    -                       -                  
Balance, March 31, 2012 (unaudited)
    939,440       9.26     $ 1.42       939,440       9.26     $ 1.42  
 
The aggregate unrecognized share-based compensation expenses as of March 31, 2012 and March 31, 2011 is approximately US$74,000 and US$193,000, respectively.
 
 
F-30

 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this interim report. Our consolidated financial statements have been prepared in accordance with U.S. GAAP. The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information set forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Readers are cautioned not to place undue reliance on these forward-looking statements.
 
Overview
 
Our company (formerly known as Emazing Interactive, Inc.) was incorporated in the State of Texas in April 2006 and re-domiciled to become a Nevada corporation in October 2006. From the date of our company’s incorporation until June 26, 2009, when our company consummated the Share Exchange (as defined below), our company’s activities were primarily concentrated in web server access and company branding in hosting web based e-games.
 
On June 26, 2009, our company entered into a Share Exchange Agreement (the “Exchange Agreement”), with (i) China Net Online Media Group Limited, a company organized under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s shareholders, Allglad Limited, a British Virgin Islands company (“Allglad”), Growgain Limited, a British Virgin Islands company (“Growgain”), Rise King Investments Limited, a British Virgin Islands company (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus Elegant Investment Limited, a British Virgin Islands company (“Surplus”), Clear Jolly Holdings Limited, a British Virgin Islands company (“Clear” and together with Allglad, Growgain, Rise King BVI, Star and Surplus, the “China Net BVI Shareholders”), who together owned shares constituting 100% of the issued and outstanding ordinary shares of China Net BVI (the “China Net BVI Shares”) and (iii) G. Edward Hancock, our principal stockholder at such time. Pursuant to the terms of the Exchange Agreement, the China Net BVI Shareholders transferred to us  all of the China Net BVI Shares in exchange for the issuance of 13,790,800 shares (the “Exchange Shares”) in the aggregate of our common stock (the “Share Exchange”). As a result of the Share Exchange, China Net BVI became our wholly owned subsidiary and we are now a holding company which, through certain contractual arrangements with operating companies in the People’s Republic of China (the “PRC”), is engaged in providing advertising, marketing, communication and brand management and sales channel building services to small and medium companies in China.
 
Our wholly owned subsidiary, China Net BVI, was incorporated in the British Virgin Islands on August 13, 2007.  On April 11, 2008, China Net BVI became the parent holding company of a group of companies comprised of CNET Online Technology Limited, a Hong Kong company (“China Net HK”), which established, and is the parent company of, Rise King Century Technology Development (Beijing) Co., Ltd., a wholly foreign-owned enterprise (“WFOE”) established in the PRC (“Rise King WFOE”). We refer to the transactions that resulted in China Net BVI becoming an indirect parent company of Rise King WFOE as the “Offshore Restructuring.”
 
PRC regulations prohibit direct foreign ownership of business entities providing internet content, or ICP services in the PRC, and restrict foreign ownership of business entities engaging in the advertising business. In October 2008, a series of contractual arrangements (the “Contractual Agreements” or the “VIE Agreements) were entered between Rise King WFOE and Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”), Beijing CNET Online Advertising Co., Ltd. (“Beijing CNET Online”) (collectively the “PRC Operating Entities”) and its common individual owners (the “PRC Shareholders” or the “Control Group”). The Contractual Agreements allowed China Net BVI through Rise King WFOE to, among other things, secure significant rights to influence the PRC Operating Entities’ business operations, policies and management, approve all matters requiring shareholder approval, and receive 100% of the income earned by the PRC Operating Entities.  In return, Rise King WFOE provides consulting services to the PRC Operating Entities.  In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform their obligations under the Contractual Arrangements, the PRC Shareholders have pledged all of their equity interests in the PRC Operating Entities to Rise King WFOE.  They have also entered into an option agreement with Rise King WFOE which provides that at such time as when the current restrictions under PRC law on foreign ownership of Chinese companies engaging in the Internet content, information services or advertising business in China are lifted, Rise King WFOE may exercise its option to purchase the equity interests in the PRC Operating Entities directly.
 
 
31

 
Pursuant to the Contractual Agreements, all of the equity owners’ rights and obligations of the VIEs were assigned to Rise King WFOE, which resulted in the equity owners lacking the ability to make decisions that have a significant effect on the VIEs, and Rise King WFOE’s ability to extract the profits from the operation of the VIEs, and assume the residual benefits of the VIEs. Because Rise King WFOE and its indirect parent are the sole interest holders of the VIEs, we included the assets, liabilities, revenues and expenses of the VIEs in our consolidated financial statements, which is consistent with the provisions of FASB Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” subtopic 10.
 
As of the date of the Share Exchange, through a series of contractual agreements, we operate our business in China primarily through Business Opportunity Online and Beijing CNET Online. Beijing CNET Online owns 51% of Shanghai Borongdingsi Computer Technology Co., Ltd. (“Shanghai Borongdingsi”). Business Opportunity Online, Beijing CNET Online