f10q_082012.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 June 30, 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 August 20, 2012 the registrant had 22,186,540 shares of common stock outstanding.
 
 

 
 
 

 
TABLE OF CONTENTS

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PART I.  FINANCIAL INFORMATION

Item 1.   Financial Statements

CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
June 30,
2012
   
December 31,
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 8,572     $ 10,695  
Accounts receivable, net
    9,476       4,444  
Other receivables, net
    5,672       3,631  
Prepayment and deposit to suppliers
    13,485       15,360  
Due from related parties
    283       324  
Contingent consideration receivables
    160       159  
Other current assets
    103       129  
Deferred tax assets-current
    272       -  
Total current assets
    38,023       34,742  
                 
Investment in and advance to equity investment affiliates
    1,109       1,396  
Property and equipment, net
    1,666       1,902  
Intangible assets, net
    7,686       8,151  
Goodwill
    11,077       10,999  
Deferred tax assets-non current
    270       92  
Total Assets
  $ 59,831     $ 57,282  
                 
Liabilities and Equity
               
Current liabilities:
               
Accounts payable *
  $ 380     $ 268  
Advances from customers *
    1,800       724  
Accrued payroll and other accruals *
    1,037       616  
Due to equity investment affiliate *
    -       220  
Due to related parties *
    -       161  
Payable for acquisition *
    -       550  
Taxes payable *
    5,860       5,040  
Other payables *
    188       114  
Dividend payable
    -       5  
Total current liabilities
    9,265       7,698  
                 
 
 
F-1

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands, except for number of shares and per share data)
 
   
June 30,
2012
   
December 31,
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Long-term liabilities:
           
Deferred tax liability-non current *
    1,797       1,893  
Long-term borrowing from director
    138       137  
Total Liabilities
    11,200       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 June 30, 2012 and December 31, 2011, respectively)
    22       22  
Additional paid-in capital
    20,774       20,747  
Statutory reserves
    2,117       2,117  
Retained earnings
    17,217       16,688  
Accumulated other comprehensive income
    2,387       2,132  
Total ChinaNet Online Holdings, Inc.’s stockholders’ equity
    42,517       41,706  
                 
Noncontrolling interests
    6,114       5,848  
Total equity
    48,631       47,554  
                 
Total Liabilities and Equity
  $ 59,831     $ 57,282  
 
*All of the VIEs' assets can be used to settle obligations of their 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 INCOME AND COMPREHENSIVE INCOME
(In thousands)
 
   
Six Months Ended June 30,
   
Three Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(US $)
   
(US $)
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Sales
                       
From unrelated parties
  $ 27,996     $ 15,636     $ 13,076     $ 8,814  
From related parties
    66       457       51       267  
      28,062       16,093       13,127       9,081  
Cost of sales
    21,902       5,458       9,364       3,437  
Gross margin
    6,160       10,635       3,763       5,644  
                                 
Operating expenses
                               
Selling expenses
    1,402       1,620       713       908  
General and administrative expenses
    3,060       1,865       1,817       975  
Research and development expenses
    756       724       425       372  
      5,218       4,209       2,955       2,255  
                                 
Income from operations
    942       6,426       808       3,389  
                                 
Other income (expenses)
                               
Interest income
    121       4       116       3  
Gain on deconsolidation of subsidiaries
    -       230       -       -  
Other (expenses)/income
    -       5       1       (1 )
      121       239       117       2  
                                 
Income before income tax expense, equity method investments and noncontrolling interests
    1,063       6,665       925       3,391  
Income tax expense / (benefit)
    14       751       (222 )     319  
Income before equity method investments and noncontrolling interests
    1,049       5,914       1,147       3,072  
Share of losses in equity investment affiliates
    (297 )     (105 )     (104 )     (59 )
Net income
    752       5,809       1,043       3,013  
Net income attributable to noncontrolling interests
    (223 )     (3 )     (148 )     (19 )
Net income attributable to ChinaNet Online Holdings, Inc.
    529       5,806       895       2,994  
                                 
 
 
F-3

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME CONTINUED
(In thousands, except for number of shares and per share data)
 
   
Six Months Ended June 30,
   
Three Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(US $)
   
(US $)
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Net income attributable to ChinaNet Online Holdings, Inc.
  $ 529     $ 5,806     $ 895     $ 2,994  
Dividend of Series A convertible preferred stock
    -       (322 )     -       (153 )
                                 
Net income attributable to common stockholders of ChinaNet Online Holdings, Inc.
  $ 529     $ 5,484     $ 895     $ 2,841  
                                 
                                 
Net income
    752       5,809       1,043       3,013  
Foreign currency translation gain
    298       744       35       548  
Comprehensive Income
  $ 1,050     $ 6,553     $ 1,078     $ 3,561  
Comprehensive income attributable to noncontrolling interests
    (266 )     (26 )     (154 )     (39 )
Comprehensive income attributable to ChinaNet Online Holdings, Inc.
  $ 784     $ 6,527     $ 924     $ 3,522  
 
                               
Earnings per share
                               
Earnings per common share
                               
Basic
  $ 0.02     $ 0.32     $ 0.04     $ 0.16  
Diluted
  $ 0.02     $ 0.28     $ 0.04     $ 0.15  
                                 
Weighted average number of common shares outstanding:
                               
Basic
    22,184,562       17,387,336       22,186,540       17,528,785  
Diluted
    22,184,562       20,410,724       22,186,540       20,005,962  
 
See notes to consolidated financial statements
 
 
F-4

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
             
Cash flows from operating activities
           
Net income
  $ 752     $ 5,809  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation and amortization
    818       470  
Share-based compensation expenses
    27       172  
Allowances for doubtful debts
    561       -  
Share of losses in equity investment affiliates
    297       105  
Gain on deconsolidation of subsidiaries
    -       (230 )
Gain on disposal of property and equipment
    -       (3 )
Deferred taxes
    (558 )     (46 )
Changes in operating assets and liabilities
               
Accounts receivable
    (5,346 )     (2,171 )
Other receivables
    226       1,320  
Prepayment and deposit to suppliers
    1,983       (309 )
Due from related parties
    43       (258 )
Other current assets
    26       (2 )
Accounts payable
    109       258  
Advances from customers
    1,070       (1,477 )
Accrued payroll and other accruals
    418       (50 )
Due to director
    -       (147 )
Due to Control Group
    -       (81 )
Due to related parties
    (162 )     (137 )
Other payables
    45       77  
Taxes payable
    783       797  
Net cash provided by operating activities
    1,092       4,097  
                 
Cash flows from investing activities
               
Purchases of vehicles and office equipment
    (46 )     (152 )
Purchase of intangible assets
    -       (1,429 )
Project development deposit to a third party
    (2,450 )     -  
Restricted cash for incorporation of VIEs
    -       (186 )
Cash from acquisition of VIEs
    -       24  
Cash effect on deconsolidation of VIEs
    -       (182 )
Long-term investment in and advance to equity investment affiliates
    -       (1,527 )
Disposal of investment in and loan repayment from equity investment affiliate
    -       1,527  
Payment for acquisition of VIEs
    (553 )     (1,451 )
Net cash used in investing activities
    (3,049 )     (3,376 )
 
 
F-5

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from financing activities
           
Cash investment contributed by noncontrolling interests
    -       224  
Dividend paid to convertible preferred stockholders
    (5 )     (283 )
Short-term loan borrowed from a equity investment affiliate
    316       -  
Short-term loan repaid to a equity investment affiliate
    (538 )     -  
Net cash used in financing activities
    (227 )     (59 )
                 
Effect of exchange rate fluctuation on cash and cash equivalents
    61       195  
                 
Net (decrease) / increase in cash and cash equivalents
    (2,123 )     857  
                 
Cash and cash equivalents at beginning of the period
    10,695       15,590  
Cash and cash equivalents at end of the period
  $ 8,572     $ 16,447  
                 
Supplemental disclosure of cash flow information
               
                 
Income taxes paid
  $ 73     $ 117  
                 
Non-cash transactions:
               
Restricted stock and options granted for future service
  $ 63     $ 128  
                 
 
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 the advertising 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.

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 a 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 it recovers the cost of purchasing 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 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 invested RMB15,000,000 (approximately US$2,373,530) 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 the advertising 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.

The Company, through one of its VIEs, Beijing CNET Online, acquired a 100% equity interest in Quanzhou Zhi Yuan Marketing Planning Co., Ltd. (“Quanzhou Zhi Yuan”) and a 51% 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.
 
 
F-8

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
On January 28, 2011, one of the Company’s VIEs, Business Opportunity Online, formed a new wholly owned subsidiary, Business Opportunity Online (Hubei) Network Technology Co., Ltd. (“Business Opportunity Online Hubei”).  Business Opportunity Online Hubei is 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 advertising 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$1,582,354) 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 advertising 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 advertising 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 Network Technology (Beijing) Co., Ltd. ("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 June 30, 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”). Summarized below is the information related to the consolidated VIEs’ assets and liabilities as of June 30, 2012 and December 31, 2011, respectively:

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 6,717     $ 8,322  
Accounts receivable, net
    9,210       3,705  
Other receivables, net
    5,495       3,619  
Prepayment and deposit to suppliers
    13,483       15,360  
Due from related parties
    153       192  
Contingent consideration receivables
    160       159  
Other current assets
    21       23  
Deferred tax assets-current
    272       -  
Total current assets
    35,511       31,380  
                 
Investment in and advance to equity investment affiliates
    1,067       1,354  
Property and equipment, net
    1,347       1,507  
Intangible assets, net
    7,658       8,111  
Goodwill
    11,077       10,999  
Deferred tax assets-non current
    187       92  
Total Assets
  $ 56,847     $ 53,443  
                 
Liabilities
               
Current liabilities:
               
Accounts payable
  $ 379     $ 268  
Advances from customers
    1,800       724  
Accrued payroll and other accruals
    789       251  
Due to equity investment affiliate
    -       220  
Due to related parties
    -       161  
Due to Control Group
    11       11  
Payable for acquisition
    -       550  
Taxes payable
    5,280       4,409  
Other payables
    182       107  
Total current liabilities
    8,441       6,701  
                 
Deferred tax Liabilities-non current
    1,797       1,893  
Total Liabilities
  $ 10,238     $ 8,594  

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

For the six months ended June 30, 2012, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$27,979,000, cost of sales of approximately US$21,897,000, operating expenses of approximately US$3,711,000 and net income before allocation to noncontrolling interests of approximately US$2,098,000.

For the three months ended June 30, 2012, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$13,083,000, cost of sales of approximately US$9,361,000, operating expenses of approximately US$2,055,000 and net income before allocation to noncontrolling interests of approximately US$1,865,000.

 
F-10

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
For the six months ended June 30, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$11,764,000 cost of sales of approximately US$5,250,000, operating expenses of approximately US$2,828,000 and net income before allocation to noncontrolling interests of approximately US$3,489,000.

For the three months ended June 30, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$7,978,000, cost of sales of approximately US$3,376,000, operating expenses of approximately US$1,585,000 and net income before allocation to noncontrolling interests of approximately US$2,713,000.
 
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 June 30, 2012 and for the six and three months ended June 30, 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 June 30, 2012, its consolidated results of operations for the six and three months ended June 30, 2012 and 2011, and its consolidated cash flows for the six months ended June 30, 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.

 
F-11

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
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.
 
The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows:
 

   
June 30, 2012
   
December 31, 2011
 
             
Balance sheet items, except for equity accounts
    6.3197       6.3647  
 
   
Six Months Ended June 30,
 
      2012       2011  
                 
Items in the statements of income and comprehensive income, and statements of cash flows
    6.3255       6.5482  
 
   
Three Months Ended June 30,
 
      2012       2011  
                 
Items in the statements of income and comprehensive income, and statements of cash flows
    6.3309       6.5074  
                 
 
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 six months ended June 30, 2012 and 2011, advertising expenses for the Company’s own brand building were approximately US$168,000 and US$1,019,000, respectively. For the three months ended June 30, 2012 and 2011, advertising expenses for the Company’s own brand building were approximately US$94,000 and US$555,000, 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 six months ended June 30, 2012 and 2011 were approximately US$756,000 and US$724,000, respectively. Expenses for research and development for the three months ended June 30, 2012 and 2011 were approximately US$425,000 and US$372,000, respectively.
 
g)  
Income taxes
 
The Company follows the guidance of 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.
 
 
F-12

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
h)  
Uncertain tax positions
 
The Company follows the guidance of ASC Topic 740 “Income taxes”, 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 six and three months ended June 30, 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
 
In July 2012, the FASB issued ASU 2012-02, “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment."  This ASU simplifies how entities test indefinite-lived intangible assets for impairment which improve consistency in impairment testing requirements among long-lived asset categories. These amended standards permit an assessment of qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. For assets in which this assessment concludes it is more likely than not that the fair value is more than its carrying value, these amended standards eliminate the requirement to perform quantitative impairment testing as outlined in the previously issued standards. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.
 
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
 
4.  
Cash and cash equivalent

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Cash
    757       181  
Bank deposit
    7,815       10,514  
      8,572       10,695  
 
5.  
Accounts receivable, net

 
   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accounts receivable
    11,943       6,546  
Allowance for doubtful debts
    (2,467 )     (2,102 )
Accounts receivable, net
    9,476       4,444  

 
F-13

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

All of the accounts receivable are non-interest bearing. Based on the assessment of the collectability of the accounts receivable as of June 30, 2012, the Company provided approximately US$2,467,000 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 six and three months ended June 30, 2012, approximately US$350,000 allowance for doubtful debts was provided.
 
6.  
Other receivables, net

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Short-term loan for marketing campaign
    3,006       2,985  
Project development deposit
    2,453       -  
Staff advances for normal business purpose
    213       279  
Overdue contract guarantee deposits
    740       891  
Allowance for doubtful debts
    (740 )     (524 )
Other receivables, net
    5,672       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 in 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’s logo will be shown during the credits at the end of each episode 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 since September 2011 and continues to sell its broadcasting rights to other provincial TV channels for additional exposure.  In November and December, 2011, the Company collected its first two repayments of an aggregate of RMB6,000,000 (approximately US$948,662) from the borrower. In accordance with the communication between the Company and the borrower, 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.

As of June 30, 2012, the Company made a project development deposit to a third party project development and management company for the participation in the TMT (“Technology, Media and Telecom”) Zone development and management in Xiaogan City, Hubei Province, the PRC (the “Xiaogan TMT Zone”). The Xiaogan TMT zone is intended to become the headquarters for SMEs, particularly those SMEs engaged in the small and medium sized franchising business. 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 of the Xiaogan TMT Zone 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 purchasing contracts signed by the Company with its resource providers, the Company is required to make contract guarantee deposits, which are either used to pay the actual contract amount of resources used in the last month of each contract period or to be refunded to the Company of the remaining balance upon expiration of the contract. Overdue contract guarantee deposits represented the portion of the contract guarantee deposits, which related advertising resources purchasing contracts had been completed as of each of the reporting dates. Based on the assessment of the collectability of these overdue contract guarantee deposits as of June 30, 2012, the Company provided approximately US$740,000 allowance for doubtful debts, which was related to the contract guarantee deposits of its TV advertising business segment. For the six and three months ended June 30, 2012, approximately US$211,000 allowance for doubtful debts was provided.
 
 
F-14

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
7.  
Prepayments and deposit to suppliers


   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Contract execution guarantees to TV advertisement and internet resources providers
    9,977       10,050  
Prepayments to TV advertisement and internet resources providers
    3,473       5,285  
Other deposits and prepayments
    35       25  
      13,485       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

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Beijing Fengshangyinli Technology Co., Ltd.
    106       113  
Beijing Saimeiwei Food Equipment Technology Co., Ltd.
    84       74  
Beijing Telijie Century Environmental Technology Co., Ltd.
    93       137  
      283       324  
 
These related parties are directly or indirectly owned by the Control Group of the Company. The 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 that the Company provided to these related parties as of each of the reporting date.
 
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 June 30, 2012 (unaudited)
    160  
 
 
F-15

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Contingent consideration receivables arose from certain “make good” provisions entered into by and between the Company and former stockholders of the VIEs upon the acquisition of the Company’s consolidated VIEs. These "make good" provisions provide that if the acquired VIEs' audited pretax profit or after tax profit for the year ended December 31, 2012 increases by less than certain amount or percentage as compared to that of the prior year, then the former VIE stockholders will be required to compensate the Company in cash for the difference between target pretax profit or after tax profit and the actual pretax profit or after tax profit, as applicable.
 
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 June 30, 2012 for the respective make good arrangement for the year ended December 31, 2012, based on their historical performance and other relevant assumptions, and determined that no material changes in fair value of these contingent consideration receivables incurred during the six and three months ended June 30, 2012.
 
10.  
Investment in and advance to equity investment affiliates

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Investment in equity investment affiliates
    1,066       1,354  
Advance to equity investment affiliates
    43       42  
      1,109       1,396  
 
The following table summarizes the movement of the investment in and advance to equity investment affiliates for the six months ended June 30, 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
    (93 )     (204 )     (297 )
Exchange translation adjustment
    4       6       10  
Balance as of June 30, 2012 (unaudited)
    506       603       1,109  
 
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 VIE of the Company from the date of incorporation through January 6, 2011. On January 6, 2011, an unaffiliated third party invested RMB15,000,000 (approximately US$2,373,530) 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.

 
F-16

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the six months ended June 30, 2012 and 2011, the Company recognized its pro-rata shares of losses in Shenzhen Mingshan of approximately US$93,000 and US$135,000, respectively. For the three months ended June 30, 2012 and 2011, the Company recognized its pro-rata share of losses in Shenzhen Mingshan of approximately US$10,000 and US$72,000, respectively. These losses recognized were 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 VIE 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$1,582,354) 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 six and three months ended June 30, 2012, the Company recognized its pro-rata share of losses in Zhao Shang Ke Hubei of approximately US$204,000 and US$94,000, 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 Zhao Shang Ke Hubei in the Company’s consolidated balance sheet.
 
11.  
Property and equipment, net

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Vehicles
    719       683  
Office equipment
    1,424       1,399  
Electronic devices
    1,204       1,196  
Property and equipment, cost
    3,347       3,278  
Less: accumulated depreciation
    (1,681 )     (1,376 )
Property and equipment, net
    1,666       1,902  
 
Depreciation expenses in the aggregate for the six months ended June 30, 2012 and 2011 were approximately US$295,000 and $273,000, respectively.
 
Depreciation expenses in the aggregate for the three months ended June 30, 2012 and 2011 were approximately US$147,000 and $140,000, respectively.
 
 
F-17

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

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Intangible assets not subject to amortization:
           
Trade name
    309       306  
Domain name
    1,529       1,518  
Intangible assets subject to amortization:
               
Contract backlog
    196       195  
Customer relationship
    3,432       3,408  
Non-compete agreements
    1,358       1,348  
Software technologies
    324       322  
Cloud-computing based software platforms
    1,469       1,458  
Other computer software
    75       75  
Intangible assets, cost
    8,692       8,630  
Less: accumulated amortization
    (1,006 )     (479 )
Intangible assets, net
    7,686       8,151  
 
Amortization expenses in aggregate for the six months ended June 30, 2012 and 2011 were approximately US$523,000 and US$198,000, respectively.
 
Amortization expenses in aggregate for the three months ended June 30, 2012 and 2011 were approximately US$261,000 and US$132,000, respectively.
 
Based on the carrying value of the finite-lived intangible assets recorded as of June 30, 2012, and assuming no subsequent impairment of the underlying intangible assets, the estimated future amortization expenses is approximately US$511,000 for the six months ended December 31, 2012, approximately US$1,021,000 per year through December 31, 2015 and approximately US$982,000 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
    78  
Balance as of June 30, 2012 (unaudited)
    11,077  
 
14.  
Accrued payroll and other accruals

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accrued payroll and staff welfare
    852       344  
Accrued operating expenses
    185       272  
      1,037       616  
 
 
F-18

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

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Zhao Shang Ke Hubei
    -       220  
 
Zhao Shang Ke Hubei is an equity investment affiliate of the Company.  Amounts due to Zhao Shang Ke Hubei as of December 31, 2011 represented a temporary non-interest bearing working capital loans borrowed by one of the Company’s VIEs from Zhao Shang Ke Hubei, which was repaid during the three months ended June 30, 2012.
 
16.  
Due to related parties

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Beijing Saimeiwei Food Equipments Technology Co., Ltd
    -       4  
Due to legal (nominal) shareholders of Shanghai Jing Yang
    -       157  
      -       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, which was returned to the legal shareholders of Shanghai Jing Yang during the six months ended June 30, 2012.
 
17.  
Payable for acquisition

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Sou Yi Lian Mei
    -       550  

Payable for acquisition as of December 31, 2011 represented the outstanding payment of RMB3,500,000 for the 51% equity interest acquisition transaction of Sou Yi Lian Mei, which was paid to the transferee during the three months ended June 30, 2012.
 
18.  
Taxation
 
1)  
Income tax
 
The entities within the Company file separate tax returns in the respective tax jurisdictions in which they operate.
 
 
F-19

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
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 six and three months ended June 30, 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 six and three months ended June 30, 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.
 
·  
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 six and three months ended June 30, 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.
 
·  
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. On July 9, 2012, Business Opportunity Online passed this administrative review, which enabled the entity continue to enjoy the 15% preferential income tax rate as a High and New Technology Enterprise. Therefore, for the six and three months ended June 30, 2012 and 2011, the applicable income tax rate of Business Opportunity Online was 15%.
 
·  
Business Opportunity Online Hubei was incorporated in Xiaotian Industrial Park of Xiaogan Economic Development Zone in Xiaogan City, Hubei province of the PRC in 2011. It 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%. Therefore, for the six and three months ended June 30, 2011, Business Opportunity Online Hubei calculated its income tax expenses based on 2.5% of the total revenue recognized for each of the reporting periods. Starting from January 1, 2012, the local tax authorities cancelled the current applicable deemed income tax method for computation of income tax expenses for the entity and the applicable income tax rate for the entity increased to 25%. On June 15, 2012, Business Opportunity Online Hubei was approved by the related PRC governmental authorities to be qualified as a software company and was approved by the local tax authorities of Xiaogan City, Hubei province, the PRC, to be entitled to a two-year EIT exemption from its first profitable year, which are fiscal year 2012 and 2013, and a 50% reduction of its applicable EIT rate, which is 25% to 12.5% of its taxable income for the succeeding three years until December 31, 2016. Therefore, for the six and three months ended June 30, 2012, the applicable income tax rate of Business Opportunity Online Hubei is nil%. Accordingly, for the three months ended June 30, 2012, the Company reversed approximately US$0.42 million income tax expenses accrued for the three months ended March 31, 2012 before it was qualified as a software company and entitled to the EIT exemption for the year ended December 31, 2012.
 
 
F-20

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
·  
Hubei CNET was incorporated in Xiaotian Industrial Park of Xiaogan Economic Development Zone in Xiaogan City, Hubei province of the PRC in 2011. It 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%.  Therefore, for the six and three months ended June 30, 2011, Hubei CNET calculated its income tax expenses based on 2.5% of the total revenue recognized for each of the reporting periods. Starting from January 1, 2012, the local tax authorities cancelled the current applicable deemed income tax method for computation of income tax expenses for the entity and the applicable income tax rate for the entity increased to 25%. Therefore, for the six and three months ended June 30, 2012, the applicable income tax rate for Hubei CNET is 25%.
 
·  
The applicable income tax rate for other PRC operating entities of the Company is 25% for the six and three months ended June 30, 2012 and 2011.
 
·  
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 six and three months ended June 30, 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
 
Beginning in January 1, 2012, PRC tax authorities increased the local business tax rate by 0.1%-0.2%. Therefore, from fiscal 2012, revenue from 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 from 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 June 30, 2012 and December 31, 2011, taxes payable consists of:
       
   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Business tax payable
    2,417       2,210  
Culture industry development surcharge payable
    4       2  
Enterprise income tax payable
    3,290       2,770  
Individual income tax payable
    149       58  
      5,860       5,040  

 
F-21

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
For the six and three months ended June 30, 2012 and 2011, the Company’s income tax expense consisted of:
 

   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
Current-PRC
    572       798  
Deferred-PRC
    (558 )     (47 )
      14       751  
 

 
   
Three Months Ended June 30,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
Current-PRC
    379       351  
Current-PRC-adjustment due to new tax rate enactment
    (424 )     -  
Deferred-PRC
    (177 )     (32 )
      (222 )     319  
 
The Company’s deferred tax liabilities at June 30, 2012 and changes for the six months then ended were as follows:
       
   
Amount
 
   
US$(’000)
 
       
Balance as of December 31, 2011 (audited)
    1,893  
Reversal during the period
    (109 )
Exchange translation adjustment
    13  
Balance as of June 30, 2012 (unaudited)
    1,797  

Deferred tax liabilities arose on the recognition of the identifiable intangible assets acquired from acquisition transactions consummated in 2011. Reversal for the six and three months ended June 30, 2012 of approximately US$109,000 and US$54,000, respectively, was due to the amortization of these acquired intangible assets.

 
F-22

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The Company’s deferred tax assets at June 30, 2012 and December 31, 2011 were as follows:

   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Tax effect of net operating losses carried forward
    2,574       1,975  
Bad debts provision
    795       651  
Valuation allowance
    (2,827 )     (2,534 )
      542       92  
 
 
   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Deferred tax assets reclassified as current asset
    272       -  
Deferred tax assets reclassified as non-current asset
    270       92  
      542       92  


The net operating losses carried forward incurred by the Company (excluding its PRC operating subsidiary and VIEs) were approximately US$5,806,000 and US$5,381,000 at June 30, 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$3,011,000 and US$361,000 at June 30, 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 bad debts provision recorded by the Company’s PRC subsidiary and VIEs were approximately US$3,207,000. 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.
 
The Company’s non-current portion of deferred tax assets and deferred tax liabilities were attributable to different tax-paying components of the entity, which were under different tax jurisdictions. Therefore, in accordance with ASC Topic 740 “Income taxes”, the non-current portion of deferred tax assets and deferred tax liabilities were presented separately in the Company’s balance sheets.
 
19.  
Dividend payable

   
June 30,
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 six months ended June 30, 2012 and 2011, the Company paid dividends of approximately US$5,000 and US$283,000 to its Series A convertible preferred stockholders, respectively. For the three months ended June 30, 2012 and 2011, the Company paid US$nil and approximately US$112,000 to its Series A convertible preferred stockholders, respectively.
 
 
F-23

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
20.  
Long-term borrowing from director


   
June 30,
2012
   
December 31,
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Long-term borrowing from director
    138       137  
 
Long-term borrowing from director is 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.
 
21.  
Warrants
 
The Company issued warrants in its August 2009 Financing. Warrants issued and outstanding at June 30, 2012 and changes during the six 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, June 30, 2012 (unaudited)
    3,005,456     $ 3.41       1.71       3,005,456     $ 3.41       1.71  
 
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.

 
F-24

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
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 June 30, 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.

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:
 
·  
Foreign Exchange Administration Rules (1996), as amended in August 2008, or the Exchange Rules;
·  
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 June 30, 2012 and December 31, 2011, there was approximately US$35.2 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 June 30, 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 June 30, 2012 and December 31, 2011, respectively, as discussed above.
 
 
F-25

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
23.  
Related party transactions
 
Revenue from related parties:
   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
-Beijing Saimeiwei Food Equipment Technology Co., Ltd,
    55       59  
-Beijing Fengshangyinli Technology Co., Ltd.
    1       231  
-Beijing Telijie Century Environmental Technology Co., Ltd.
    10       167  
      66       457  
 

 
   
Three Months Ended June 30,
 
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
-Beijing Saimeiwei Food Equipment Technology Co., Ltd,
    41       59  
-Beijing Fengshangyinli Technology Co., Ltd.
    -       113  
-Beijing Telijie Century Environmental Technology Co., Ltd.
    10       95  
      51       267  
 
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 employee benefits were expensed as incurred. The Company has no legal obligation for the benefits beyond the contributions made. The total amounts for such employee benefits were approximately US$195,000 and US$158,000 for the six months ended June 30, 2012 and 2011, respectively. The total amounts for such employee benefits were approximately US$91,000 and US$81,000 for the three months ended June 30, 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 June 30, 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.
 
 
F-26

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
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 customers
 
For the six months ended June 30, 2012, two customers accounted for 15% and 14% of the Company’s sales, respectively. Except for the aforementioned customers, there was no other single customer who accounted for more than 10% of the Company’s sales for the six months ended June 30, 2012 and 2011, respectively.
 
For the three months ended June 30, 2012, one customer accounted for 13% of the Company’s sales. For the three months ended June 30, 2011, one customer accounted for 11% of the Company’s sales. Except for the aforementioned customer, there was no other single customer who accounted for more than 10% of the Company’s sales for the three months ended June 30, 2012 and 2011, respectively.
 
As of June 30, 2012, one customer accounted for 17% of the Company’s accounts receivables. As of December 31, 2011, one customer accounted for 21% of the Company’s accounts receivables. Except for the aforementioned customer, there was no other single customer who accounted for more than 10% of the Company’s accounts receivable as of June 30, 2012 and December 31, 2011, respectively.
 
Concentration of suppliers
 
For the six months ended June 30, 2012, two suppliers accounted for 62% and 13% of the Company’s cost of sales, respectively. For the six months ended June 30, 2011, three suppliers accounted for 25%, 21% and 14% of the Company’s cost of sales, respectively. Except for the aforementioned suppliers, there was no other single supplier who accounted for more than 10% of the Company’s cost of sales for the six months ended June 30, 2012 and 2011, respectively.
 
For the three months ended June 30, 2012, two suppliers accounted for 57% and 13% of the Company’s cost of sales, respectively. For the three months ended June 30, 2011, three suppliers accounted for 28%, 23% and 18% of the Company’s cost of sales, respectively. Except for the aforementioned suppliers, there was no other single supplier who accounted for more than 10% of the Company’s cost of sales for the three months ended June 30, 2012 and 2011, respectively.
 
26.  
Commitments
 
The following table sets forth the Company’s contractual obligations as of June 30, 2012:
 

 
Office Rental
 
Purchase of TV
advertisement time
 
Total
 
US$(’000)
 
US$(’000)
 
US$(’000)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
           
Six months ending December 31,
         
-2012
147
 
14,905
 
15,052
Year ending December 31,
         
-2013
293
 
-
 
293
-2014
293
 
-
 
293
-2015
293
 
-
 
293
-2016
73
 
-
 
73
Total
1,099
 
14,905
 
16,004
 
 
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.
 
Six Months Ended June 30, 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
    9,703       16,513       142       1,704       -       -       28,062  
Cost of sales
    4,925       16,357       12       608       -       -       21,902  
Total operating expenses
    3,353       467       103       474       821 *     -       5,218  
Depreciation and amortization expense included in total operating expenses
    521       35       103       107       52       -       818  
Operating income (loss)
    1,425       (311 )     27       622       (821 )     -       942  
                                                         
Share of losses in equity investment affiliates
    -       -       -       (204 )     (93 )     -       (297 )
Expenditure for long-term assets
    46       -       -       -       -       -       46  
Net income (loss)
    1,586       (293 )     27       262       (830 )     -       752  
Total assets June 30,2012
    42,234       16,732       702       7,367       15,500       (22,704 )     59,831  

*Including approximate US$27,000 share-based compensation expenses.
 
Three Months Ended June 30, 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
    5,358       6,144       71       1,554       -       -       13,127  
Cost of sales
    2,833       6,013       6       512       -       -       9,364  
Total operating expenses
    1,839       307       51       404       354 *     -       2,955  
Depreciation and amortization expense included in total operating expenses
    263       18       51       53       24       -       409  
Operating income (loss)
    686       (176 )     14       638       (354 )     -       808  
                                                         
Share of losses in equity investment affiliates
    -       -       -       (94 )     (10 )     -       (104 )
Expenditure for long-term assets
    37       -       -       -       -       -       37  
Net income (loss)
    1,154       (181 )     14       383       (327 )     -       1,043  
Total assets June 30,2012
    42,234       16,732       702       7,367       15,500       (22,704 )     59,831  

*Including approximate US$11,000 share-based compensation expenses.
 
 
F-28

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Six Months Ended June 30, 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
    12,541       2,791       275       500       -       (14 )     16,093  
Cost of sales
    3,105       2,186       24       157       -       (14 )     5,458  
Total operating expenses
    2,542       317       131       290       929 *     -       4,209  
Depreciation and amortization expense included in total operating expenses
    92       38       96       195       49       -       470  
Operating income (loss)
    6,894       288       120       53       (929 )     -       6,426  
                                                         
Gain on deconsolidation of subsidiaries
    -       -       -       -       230       -       230  
Share of earnings (losses) in equity investment affiliates
    -       30       -       -       (135 )     -       (105 )
Expenditure for long-term assets
    37       -       111       3       1,430       -       1,581  
Net income (loss)
    6,144       311       120       64       (830 )     -       5,809  
Total assets-June 30,2011
    46,253       4,493       807       4,815       22,737       (29,902 )     49,203  

*Including approximate US$172,000 share-based compensation expenses.
 
Three Months Ended June 30, 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
    6,457       2,073       138       427       -       (14 )     9,081  
Cost of sales
    1,683       1,634       13       121       -       (14 )     3,437  
Total operating expenses
    1,421       163       57       194       420 *     -       2,255  
Depreciation and amortization expense included in total operating expenses
    46       19       50       132       25       -       272  
Operating income (loss)
    3,353       276       68       112       (420 )     -       3,389  
                                                         
Gain on deconsolidation of subsidiaries
    -       -       -       -       -       -       -  
Share of earnings (losses) in equity investment affiliates
    -       13       -       -       (72 )     -       (59 )
Expenditure for long-term assets
    16       -       77       3       1,426       -       1,522  
Net income (loss)
    3,045       281       70       109       (492 )     -       3,013  
Total assets-June 30,2011
    46,253       4,493       807       4,815       22,737       (29,902 )     49,203  

*Including approximate US$65,000 share-based compensation expenses.
 
 
F-29

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
28.  
Earnings per share
 
Basic and diluted 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):
 

   
Six months ended
June 30,
   
Three months ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
US$(’000)
   
US$(’000)
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
   
(Amount in thousands except for the
number of shares and per share data)
   
(Amount in thousands except for the
number of shares and per share data)
 
             
Net income attributable to ChinaNet Online Holdings, Inc. (numerator for diluted earnings per share)
  $ 529     $ 5,806     $ 895     $ 2,994  
Less: Dividend for Series A convertible preferred stock
    -       322       -       153  
Net income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for basic earnings per share)
    529       5,484       895       2,841  
                                 
Weighted average number of common shares outstanding - Basic
    22,184,562       17,387,336       22,186,540       17,528,785  
Effect of diluted securities:
                               
Series A Convertible preferred stock
    -       2,592,584       -       2,451,135  
Warrants
    -       430,804       -       26,042  
Weighted average number of common shares outstanding -Diluted
    22,184,562       20,410,724       22,186,540       20,005,962  
                                 
Earnings per share-Basic
  $ 0.02     $ 0.32     $ 0.04     $ 0.16  
Earnings per share-Diluted
  $ 0.02     $ 0.28     $ 0.04     $ 0.15  
 
For the six and three months ended June 30, 2012, the diluted earnings per share calculation did not include the warrants and options to purchase up to 3,005,456 and 939,440 shares of common stock, respectively, because their effect was anti-dilutive.
 
For the six June 30, 2011, the diluted earnings per share calculation did not include the warrants and options to purchase up to 2,237,960 and 54,000 shares of common stock, respectively, because their effect was anti-dilutive.
 
For the three months ended June 30, 2011, the diluted earnings per share calculation did not include the warrants and options to purchase up to 4,451,328 and 54,000 shares of common stock, respectively, because their effect was anti-dilutive.
 
29.  
Share-based compensation expenses

On July 12, 2010, the Company renewed its investor relations service contract with Hayden Communications International, Inc. (“HCI”) for an18-month period commencing on 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. The related compensation expenses were amortized over the 18-month service period. Total compensation expenses recognized for the six months ended June 30, 2012 and 2011 was U$$6,333 and US$76,000 respectively. Total compensation expenses recognized for the three months ended June 30, 2012 and 2011 was US$nil and US$38,000, respectively.

 
F-30

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
As a result of the merger of HCI and MZ Group, the Company terminated the service contract with HCI and engaged MZHCI, LLP (“MZ-HCI”) to provide investor relations services for a 24-month period commencing on 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. The related compensation expenses were amortized over the requisite service period. Total compensation expenses recognized for the six months ended June 30, 2012 and 2011 was US$21,000 and US$nil, respectively. Total compensation expenses recognized for the three months ended June 30, 2012 and 2011 was US$10,500 and US$nil, respectively.

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$4.05 per option. The related compensation expenses were amortized over its vesting period. Total compensation expenses recognized for these options for the six months ended June 30, 2012 and 2011 was US$nil and US$95,920, respectively. Total compensation expenses recognized for these options for the three months ended June 30, 2012 and 2011 was US$nil and US$27,340, 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 June 30, 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, June 30, 2012 (unaudited)
    939,440       9.01     $ 1.42       939,440       9.01     $ 1.42  
 
The aggregate unrecognized share-based compensation expenses as of June 30, 2012 and 2011 is approximately US$63,000 and US$128,000, respectively.

 
F-31

 
Item 2   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
 
 
32

 
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.
 
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 a result of the Share Exchange on June 26, 2009, the former China Net BVI shareholders owned a majority of our common stock.  The transaction was regarded as a reverse acquisition whereby China Net BVI was considered to be the accounting acquirer as its shareholders retained control of our company after the Share Exchange, although we are the legal parent company.  The share exchange was treated as a recapitalization of our company.  As such, China Net BVI (and its historical financial statements) is the continuing entity for financial reporting purposes. Following the Share Exchange, we changed our name from Emazing Interactive, Inc. to ChinaNet Online Holdings, Inc. The financial statements have been prepared as if China Net BVI had always been the reporting company and then on the share exchange date, had changed its name and reorganized its capital stock.
 
As of the date of the Share Exchange, through 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 and Shanghai Borongdingsi, were incorporated on December 8, 2004, January 27, 2003 and August 3, 2005, respectively.
 
On June 24, 2010, one of our 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 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 invested RMB15,000,000 (approximately US$2,373,530) into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan. As a result of this transaction, our share of the equity interest in Shenzhen Mingshan decreased from 51% to 20.4% and we ceased to have a controlling financial interest in ShenZhen Mingshan, but still retained an investment in, and significant influence over, Shenzhen Mingshan. Therefore, as of June 30, 2012, Shenzhen Mingshan was an equity investment affiliate of ours.
 
On December 6, 2010, through our wholly-owned subsidiary, Rise King WFOE, we 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 PRC laws in December 2009. The contractual arrangements that we entered into with Shanghai Jing Yang allow us, through Rise King WFOE, to, among other things, secure significant rights to influence Shanghai Jing Yang’s business operations, policies and management, approve all matters requiring shareholder approval, and receive 100% of the income earned by Shanghai Jing Yang. From the date of incorporation until December 6, 2010, Shanghai Jing Yang did not conduct any business activities. Therefore, Shanghai Jing Yang’s accounts were included in our consolidated financial statements with no goodwill recognized in accordance with ASC Topic 810 “Consolidation”.
 
 On December 8, 2010, 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.
 
We, through one of our VIEs, Beijing CNET Online, acquired a 100% equity interest in Quanzhou Zhi Yuan Marketing Planning Co., Ltd. (“Quanzhou Zhi Yuan”) and a 51% 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 SMEs focused primarily in the sportswear and clothing industry. In June 2011, Beijing CNET Online acquired the remaining 49% equity interest of Quanzhou Tian Xi Shun He. Quanzhou Tian Xi Shun He became a wholly owned subsidiary of Beijing CNET Online.
 
 
33

 
On January 28, 2011, one of our 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 our VIEs, Business Opportunity Online, together with an individual, who was not affiliated with us, formed a new company, Beijing Chuang Fu Tian Xia Network Technology Co., Ltd. (“Beijing Chuang Fu Tian Xia”). Business Opportunity Online and the co-founding individual owned 51% and 49% of the equity interests of Beijing Chuang Fu Tian Xia, respectively. In addition to capital investment, the co-founding individual is required to provide the controlled domain names, www.liansuo.com and www.chuangye.com to be registered under the established company.  Beijing Chuang Fu Tian Xia is primarily engaged in providing and operating internet advertising, marketing and communication services to SMEs through the websites associated the above mentioned domain names.
 
On April 18, 2011, 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 advertising and marketing consultancy services.
 
On April 18, 2011, Business Opportunity Online Hubei, together with an individual, who was not affiliated with us, formed a new company, Zhao Shang Ke Network Technology (Hubei) Co., Ltd. (“Zhao Shang Ke Hubei”). Business Opportunity Online Hubei and the co-founding individual owned 51% and 49% of the equity interests of Zhao Shang Ke Hubei, respectively.  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$1,582,354) into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interests in Zhao Shang Ke Hubei. As a result of this transaction, our share of the equity interests in Zhao Shang Ke Hubei decreased from 51% to 25.5% and we 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. Therefore, as of June 30, 2012, Zhao Shang Ke Hubei was an equity investment affiliate of ours.
 
On July 1, 2011, 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 advertising and marketing consultancy services.
 
On July 1, 2011, 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 advertising and marketing consultancy services.
 
On July 1, 2011, Business Opportunity Online Hubei, together with an individual who is not affiliated with us, formed a new company, Sheng Tian Network Technology (Hubei) Co., Ltd. (“Sheng Tian Hubei”).  Business Opportunity Online Hubei and the co-founding individual owned 51% and 49% of the equity interests of Sheng Tian Hubei, respectively. 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, 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, 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”).
 
Through our PRC operating subsidiary and VIEs, we are one of China’s leading B2B fully integrated internet service providers for expanding SMEs’ sales networks in China and our services primarily include proprietary internet and advertising technologies which prepare and publish rich media enabled advertising and marketing campaigns for clients on the Internet, television and other valued added communication channels, host mini-sites with online messaging and consulting functionalities, generate effective sales leads and provide online management tools to help SMEs manage the expansion of their sales networks. Our goal is to strengthen our position as the leading diversified one-stop internet service provider to SMEs for their sales network expansion in China. Our multi-channel advertising and promotion platform consists of the websites www.28.com (“28.com”), www.liansuo.com
 
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(“liansuo.com”), www.chuangye.com (“chuangye.com”) and www.sooe.cn (“sooe.cn”), our Internet advertising portals, ChinaNet TV, our TV production and advertising unit, our bank kiosk advertising unit, which is primarily used as an advertising platform for clients in the financial services industry and will be further utilized as an additional value-added communication channel for SME clients and our brand management and sales channel building services unit.
 
Basis of presentation, management estimates and critical accounting policies
 
Our unaudited interim consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, as promulgated by the SEC, and include the accounts of our Company, and all of our subsidiaries and VIEs.  We prepare financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of revenues and expenses during the financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we 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. Some of our accounting policies require higher degrees of judgment than others in their application. In order to understand the significant accounting policies that we adopted for the preparation of our interim consolidated financial statements, you should refer to the information set forth in Note 3 “Summary of significant accounting policies” to our audited financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
 
  Recent Accounting Pronouncements
 
In July 2012, the FASB issued ASU 2012-02, “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment."  This ASU simplifies how entities test indefinite-lived intangible assets for impairment which improve consistency in impairment testing requirements among long-lived asset categories. These amended standards permit an assessment of qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. For assets in which this assessment concludes it is more likely than not that the fair value is more than its carrying value, these amended standards eliminate the requirement to perform quantitative impairment testing as outlined in the previously issued standards. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, early adoption is permitted. The adoption of this standard is not expected to have a material impact on our consolidated financial position and results of operations.
 
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
 
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A.       RESULTS OF OPERATIONS FOR THE SIX AND THREE MONTHS ENDED JUNE 30, 2012 AND 2011
 
The following table sets forth a summary, for the periods indicated, of our consolidated results of operations. Our historical results presented below are not necessarily indicative of the results that may be expected for any future period. All amounts, except number of shares and per share data, are presented in thousands of US dollars.
 
   
Six Months Ended June 30,
   
Three Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
US$
   
US$
   
US$
   
US$
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Sales
                       
From unrelated parties
  $ 27,996     $ 15,636     $ 13,076     $ 8,814  
From related parties
    66       457       51       267  
      28,062       16,093       13,127       9,081  
Cost of sales
    21,902       5,458       9,364       3,437  
Gross margin
    6,160       10,635       3,763       5,644  
                                 
Operating expenses
                               
Selling expenses
    1,402       1,620       713       908  
General and administrative expenses
    3,060       1,865       1,817       975  
Research and development expenses
    756       724       425       372  
      5,218       4,209       2,955       2,255  
                                 
Income from operations
    942       6,426       808       3,389  
                                 
Other income (expenses)