f10q_111914.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 September 30, 2014

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:  001-34647

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 November 19, 2014 the registrant had 22,416,540 shares of common stock outstanding.
 
 

 
TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
PAGE
     
 
     
 
     
 
     
 
     
 
     
   
   
     
PART II. OTHER INFORMATION
 
     
     
   
     
   
     
     
     
 
 
 

 
PART I.  FINANCIAL INFORMATION

Item 1. Interim Financial Statements

CHINANET ONLINE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
September 30,
2014
   
December 31,
2013
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 1,898     $ 3,442  
Term deposit
    3,444       3,467  
Accounts receivable, net
    2,614       7,673  
Other receivables, net
    1,766       4,299  
Prepayment and deposit to suppliers
    19,774       14,692  
Due from related parties
    104       502  
Other current assets
    73       27  
Deferred tax assets-current
    179       153  
Total current assets
    29,852       34,255  
                 
Investment in and advance to equity investment affiliates
    888       845  
Property and equipment, net
    994       1,057  
Intangible assets, net
    5,187       6,015  
Deposit and prepayment for purchasing of software technology
    3,281       2,453  
Goodwill
    11,371       11,450  
Deferred tax assets-non current
    901       759  
Total Assets
  $ 52,474     $ 56,834  
                 
Liabilities and Equity
               
Current liabilities:
               
Short term bank loan *
  $ 812     $ 818  
Accounts payable *
    434       421  
Advances from customers *
    1,401       995  
Accrued payroll and other accruals *
    450       676  
Due to noncontrolling interest of VIE *
    699       -  
Due to former VIE *
    1,400       -  
Taxes payable *
    3,502       7,029  
Other payables *
    603       288  
Total current liabilities
    9,301       10,227  
 
 
F-1

 
CHINANET ONLINE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands, except for number of shares and per share data)
 
   
September 30,
2014
   
December 31,
2013
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Long-term liabilities:
           
Deferred tax liability-non current *
    1,261       1,439  
Long-term borrowing from director
    142       143  
Total Liabilities
    10,704       11,809  
                 
Commitments and contingencies
               
                 
Equity:
               
ChinaNet Online Holdings, Inc.’s stockholders’ equity
               
Common stock (US$0.001 par value; authorized 50,000,000 shares; issued and outstanding 22,416,540 shares and 22,376,540 shares at September 30, 2014 and December 31, 2013, respectively)
      22         22  
Additional paid-in capital
    19,895       19,870  
Statutory reserves
    2,602       2,602  
Retained earnings
    16,059       18,965  
Accumulated other comprehensive income
    3,417       3,689  
Total ChinaNet Online Holdings, Inc.’s stockholders’ equity
    41,995       45,148  
                 
Noncontrolling interests
    (225 )     (123 )
Total equity
    41,770       45,025  
                 
Total Liabilities and Equity
  $ 52,474     $ 56,834  
 
 
*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 condensed consolidated financial statements
 
F-2

 
CHINANET ONLINE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS)/INCOME
(In thousands)
 
   
Nine Months Ended
September 30,
   
Three Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(US $)
   
(US $)
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Sales
                       
From unrelated parties
  $ 27,371     $ 23,108     $ 12,010     $ 7,341  
From related parties
    240       314       57       140  
      27,611       23,422       12,067       7,481  
Cost of sales
    22,483       13,123       9,996       3,366  
Gross margin
    5,128       10,299       2,071       4,115  
                                 
Operating expenses
                               
Sales and marketing expenses
    4,092       2,007       1,997       617  
General and administrative expenses
    3,023       4,690       1,014       1,544  
Research and development expenses
    1,417       1,490       525       578  
      8,532       8,187       3,536       2,739  
                                 
(Loss)/income from operations
    (3,404 )     2,112       (1,465 )     1,376  
                                 
Other income (expenses)
                               
Interest income
    91       94       31       30  
Interest expense
    (38 )     (10 )     (6 )     (10 )
Gain on disposal of VIE
    266       -       266       -  
Other expenses
    (12 )     (12 )     (9 )     (10 )
      307       72       282       10  
                                 
(Loss)/income before income tax expense, equity method investments and noncontrolling interests
    (3,097 )     2,184       (1,183 )     1,386  
Income tax benefit/(expense)
    39       (469 )     159       (201 )
(Loss)/income before equity method investments and noncontrolling interests
    (3,058 )     1,715       (1,024 )     1,185  
Share of gain/(loss) in equity investment affiliates
    49       (170 )     107       (45 )
Net (loss)/income
    (3,009 )     1,545       (917 )     1,140  
Net loss attributable to noncontrolling interests
    103       78       10       19  
Net (loss)/income attributable to ChinaNet Online Holdings, Inc.
  $ (2,906 )   $ 1,623     $ (907 )   $ 1,159  
 
 
F-3

 
CHINANET ONLINE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS)/INCOMECONTINUED
(In thousands, except for number of shares and per share data)
 
   
Nine Months Ended
September 30,
   
Three Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(US $)
   
(US $)
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
                         
Net (loss)/income
    (3,009 )     1,545       (917 )     1,140  
Foreign currency translation (loss)/gain
    (271 )     1,076       10       248  
Comprehensive (Loss)/income
  $ (3,280 )   $ 2,621     $ (907 )   $ 1,388  
Comprehensive loss attributable to noncontrolling interests
    102       71       10       24  
Comprehensive (loss)/income attributable to ChinaNet Online Holdings, Inc.
  $ (3,178 )   $ 2,692     $ (897 )   $ 1,412  
 
                               
(Loss)/earnings per share
                               
(Loss)/earnings per common share
                               
Basic
  $ (0.13 )   $ 0.07     $ (0.04 )   $ 0.05  
Diluted
  $ (0.13 )   $ 0.07     $ (0.04 )   $ 0.05  
                                 
Weighted average number of common shares outstanding:
                               
Basic
    22,385,478       22,253,463       22,403,062       22,371,649  
Diluted
    22,385,478       22,253,463       22,403,062       22,371,649  
 

 

 
See notes to condensed consolidated financial statements
 
 
F-4

 
CHINANET ONLINE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Nine Months Ended September 30,
 
   
2014
   
2013
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from operating activities
           
Net (loss)/income
  $ (3,009 )   $ 1,545  
Adjustments to reconcile net (loss)/income to net cash (used in)/provided by operating activities
               
Depreciation and amortization
    1,079       1,252  
Share-based compensation expenses
    25       114  
Allowances for doubtful accounts
    (120 )     1,024  
Share of (gain)/loss in equity investment affiliates
    (49 )     170  
Gain on disposal of VIE
    (266 )     -  
Deferred taxes
    (419 )     (696 )
Changes in operating assets and liabilities
               
Accounts receivable
    4,095       (2,269 )
Other receivables
    1,842       101  
Prepayment and deposit to suppliers
    (5,246 )     (127 )
Due from related parties
    395       (225 )
Other current assets
    (57 )     89  
Accounts payable
    45       284  
Advances from customers
    458       388  
Accrued payroll and other accruals
    (192 )     (84 )
Other payables
    347       (67 )
Taxes payable
    114       1,313  
Net cash (used in)/provided by operating activities
    (958 )     2,812  
                 
Cash flows from investing activities
               
Purchases of vehicles and office equipment
    (242 )     (65 )
Prepayment/deposit for purchasing of software technology
    (845 )     (2,411 )
Repayment of short-term loan from unrelated entities
    670       -  
Cash effect on deconsolidation of VIE
    (358 )     -  
Long-term investment in and advance to equity investment affiliates
    -       (32 )
Payment for acquisition of VIEs
    -       (1,768 )
Net cash used in investing activities
    (775 )     (4,276 )
 
 
F-5

 
CHINANET ONLINE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
 
   
Nine Months Ended September 30,
 
   
2014
   
2013
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from financing activities
           
Repayment of short-term bank loan
    (813 )     -  
Proceeds from short-term bank loan
    813       804  
Short-term loan from noncontrolling interest of VIE
    716       -  
Repayment of short-term loan to noncontrolling interest of VIE
    (16 )     -  
Repayment to former VIE
    (488 )     -  
Net cash provided by financing activities
    212       804  
                 
Effect of exchange rate fluctuation on cash and cash equivalents
    (23 )     110  
                 
Net decrease in cash and cash equivalents
    (1,544 )     (550 )
                 
Cash and cash equivalents at beginning of the period
    3,442       5,483  
Cash and cash equivalents at end of the period
  $ 1,898     $ 4,933  
                 
Supplemental disclosure of cash flow information
               
                 
Income taxes paid
  $ 204     $ 39  
Interest expense paid
  $ 38     $ 10  
                 
Non-cash transactions:
               
                 
Restricted stock and options granted for future service
  $ 9     $ 11  
 
See notes to condensed consolidated financial statements

 
F-6

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

ChinaNet Online Holdings, Inc. (the “Company”) was incorporated in the State of Texas in April 2006 and re-domiciled to become a Nevada corporation in October 2006. On June 26, 2009, the Company consummated a share exchange transaction with China Net Online Media Group Limited (the “Share Exchange”), a company organized under the laws of British Virgin Islands (“China Net BVI”). 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 (“SMEs”) in China.

The Company’s wholly owned subsidiary, China Net BVI was incorporated in the British Virgin Islands. China Net BVI is the parent holding company 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”).

To satisfy PRC laws and regulations, the Company conducts certain business in the PRC through its Variable Interest Entities (“VIEs”). Through a series of contractual agreements 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”) and Rise King (Shanghai) Advertisement Media Co., Ltd. (“Shanghai Jing Yang”), the Company, through the WFOE, secures significant rights to influence the three companies’ business operations, policies and management, approve all matters requiring shareholder approval, and the right to receive 100% of the income earned by the three companies.

The Company integrated and merged all business activities and resources (excluding tangible assets and liabilities incurred) of its former VIE, Sou Yi Lian Mei Network Technology (Beijing) Co., Ltd. (“Sou Yi Lian Mei”) and its sole wholly-owned subsidiary, Jin Du Ya He (Beijing) Network Technology Co., Ltd. (“Jin Du Ya He”) to the Company’s other internet advertising and marketing companies for continued operation. Sou Yi Lian Mei and its subsidiary Jin Du Ya He were subsequently disposed by the Company with an approximately US$0.27 million gain achieved in late August 2014.

As of September 30, 2014, the Company’s VIE, Business Opportunity Online is a 51% shareholder of Beijing Chuang Fu Tian Xia Network Technology Co., Ltd. (“Beijing Chuang Fu Tian Xia”), the sole shareholder of Business Opportunity Online (Hubei) Network Technology Co., Ltd. (“Business Opportunity Online Hubei”), the sole shareholder of Quanzhou City Zhilang Network Technology Co., Ltd (“Quanzhou Zhi Lang”), the sole shareholder of Beijing Chuang Shi Xin Qi Advertising Media Co., Ltd. (“Beijing Chuang Shi Xin Qi”), the sole shareholder of Beijing Hong Da Shi Xing Network Technology Co., Ltd. (“Beijing Hong Da Shi Xing”), the sole shareholder of Beijing Shi Ji Cheng Yuan Advertising Media Co., Ltd. (“Beijing Shi Ji Cheng Yuan”) and a 23.18% shareholder of Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). Business Opportunity Online Hubei is the sole shareholder of Hubei CNET Advertising Media Co., Ltd. (“Hubei CNET”), the sole shareholder of Sheng Tian Network Technology (Hubei) Co., Ltd. (“Sheng Tian Hubei”) and a 25.5% shareholder of Zhao Shang Ke Network Technology (Hubei) Co., Ltd. (“Zhao Shang Ke Hubei”).
 
 
F-7

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

Summarized below is the information related to the consolidated VIEs’ assets and liabilities as of September 30, 2014 and December 31, 2013, respectively:

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 1,539     $ 3,326  
Term deposit
    3,444       3,467  
Accounts receivable, net
    2,454       7,637  
Other receivables, net
    1,586       3,416  
Prepayment and deposit to suppliers
    19,772       14,690  
Due from related parties
    -       174  
Other current assets
    65       27  
Deferred tax assets-current
    144       118  
Total current assets
    29,004       32,855  
                 
Investment in and advance to equity investment affiliates
    844       801  
Property and equipment, net
    904       918  
Intangible assets, net
    5,186       6,013  
Deposit and prepayment for purchasing of software technology
    3,281       2,453  
Goodwill
    11,371       11,450  
Deferred tax assets-non current
    626       482  
Total Assets
  $ 51,216     $ 54,972  
                 
Liabilities
               
Current liabilities:
               
Short-term bank loan
  $ 812     $ 818  
Accounts payable
    434       421  
Advances from customers
    1,401       995  
Accrued payroll and other accruals
    339       279  
Due to Control Group
    11       11  
Due to noncontrolling interest of VIE
    699       -  
Due to former VIE
    1,400       -  
Taxes payable
    3,018       6,542  
Other payables
    504       142  
Total current liabilities
    8,618       9,208  
                 
Deferred tax Liabilities-non current
    1,261       1,439  
Total Liabilities
  $ 9,879     $ 10,647  

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 nine months ended September 30, 2014, the financial performance of the VIEs reported in the Company’s consolidated statements of operations and comprehensive loss includes sales of approximately US$27,049,000, cost of sales of approximately US$22,481,000, operating expenses of approximately US$7,294,000 and net loss before allocation to noncontrolling interests of approximately US$2,331,000.

For the three months ended September 30, 2014, the financial performance of the VIEs reported in the Company’s consolidated statements of operations and comprehensive loss includes sales of approximately US$11,742,000, cost of sales of approximately US$9,995,000, operating expenses of approximately US$2,957,000 and net loss before allocation to noncontrolling interests of approximately US$663,000.

For the nine months ended September 30, 2013, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$23,120,000, cost of sales of approximately US$13,121,000, operating expenses of approximately US$6,482,000 and net income before allocation to noncontrolling interests of approximately US$2,824,000.

For the three months ended September 30, 2013, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$7,380,000, cost of sales of approximately US$3,365,000, operating expenses of approximately US$2,160,000 and net income before allocation to noncontrolling interests of approximately US$1,579,000.
 
 
F-8

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
3.
Summary of significant accounting policies
 
 
a)
Basis of presentation
 
The interim consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
 
The interim consolidated financial information as of September 30, 2014 and for the nine and three months ended September 30, 2014 and 2013 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, 2013, previously filed with the SEC (the “2013 Form 10-K”).
 
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 September 30, 2014, its consolidated results of operations for the nine and three months ended September 30, 2014 and 2013, and its consolidated cash flows for the nine months ended September 30, 2014 and 2013, 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.
 
 
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 believes 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
 
The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows:
 
   
September 30, 2014
   
December 31, 2013
 
             
Balance sheet items, except for equity accounts
    6.1560       6.1140  
 
   
Nine Months Ended September 30,
 
    2014     2013  
Items in the statements of income and comprehensive income, and statements of cash flows
    6.1502       6.2215  
 
   
Three Months Ended September 30,
 
    2014     2013  
Items in the statements of income and comprehensive income, and statements of cash flows
    6.1623       6.1695  
 
 
F-9

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
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 “sales and marketing expenses” in the statements of operations and comprehensive (loss)/income. For the nine months ended September 30, 2014 and 2013, advertising expenses for the Company’s own brand building were approximately US$2,412,000 and US$292,000, respectively. For the three months ended September 30, 2014 and 2013, advertising expenses for the Company’s own brand building were approximately US$1,439,000 and US$148,000, 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 nine months ended September 30, 2014 and 2013 were approximately US$1,417,000 and US$1,490,000, respectively. Expenses for research and development for the three months ended September 30, 2014 and 2013 were approximately US$525,000 and US$578,000, respectively.
 
 
g)
Transaction between entities under common control
 
The Company integrated and merged all business activities and resources (excluding tangible assets and liabilities incurred) of its former VIE, Sou Yi Lian Mei Network Technology (Beijing) Co., Ltd. (“Sou Yi Lian Mei”) and its sole wholly-owned subsidiary, Jin Du Ya He (Beijing) Network Technology Co., Ltd. (“Jin Du Ya He”) to the Company’s other internet advertising and marketing companies for continued operation. Sou Yi Lian Mei and its subsidiary Jin Du Ya He were subsequently disposed by the Company in late August 2014.
 
The Company considered the integration and merger transaction as transaction between entities under common control and accounted for this transaction in accordance with ASC 805-50, which provided guidance on measuring assets and liabilities transferred between entities under common control. In accordance with ASC 805-50, transferring assets between entities under common control, the entity that receives the net assets should initially measure the recognized assets and liabilities transferred at their carrying amounts in the accounts of the transferring entity at the date of transfer.
 
 
h)
Recent accounting standards
 
In April 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This ASU changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
 
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU supercedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) 605-Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. For a public entity, the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. For all other entities (nonpublic entities), the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.
 
 
F-10

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
In June 2014, the FASB issued ASU No. 2014-12, “Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period”. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. For all entities, the amendments in this ASU are effective for annual periods beginning after December 15, 2015, including interim periods within that reporting period. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position or 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.
Term deposit

Term deposit as of September 30, 2014 and December 31, 2013 represented the amount of cash placed as a term deposit by one of the Company’s operating VIEs in a major financial institution of China, which management believes is of high credit quality. The interest rate of the term deposit is 3.3% per annual. The term deposit matured on July 5, 2014 and was extended to July 7, 2015.
 
5.
Accounts receivable, net

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accounts receivable
    6,519       13,358  
Allowance for doubtful accounts
    (3,905 )     (5,685 )
Accounts receivable, net
    2,614       7,673  

All of the accounts receivable are non-interest bearing. Based on the assessment of the collectability of the accounts receivable as of September 30, 2014, the Company provided approximately US$3,905,000 allowance for doubtful accounts, which were related to the accounts receivable of the Company’s internet advertising and TV advertising business segment with an aging over six months. For the nine and three months ended September 30, 2014, the Company reversed approximately US$120,000 and US$90,000 of allowance for doubtful accounts, respectively. For the nine and three months ended September 30, 2013, approximately US$233,000 allowance for doubtful debts was provided. For the nine and three months ended September 30, 2014, the decrease in accounts receivable and the related allowance of approximately US$2.7 million and US$1.6 million, respectively, was due to disposal of a VIE during the period.
 
6.
Other receivables, net

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Short-term loan made for marketing campaign
    697       1,636  
Short-term loans to unrelated entities
    120       790  
Term deposit interest receivable
    28       57  
Receivable on disposal of fixed assets
    97       98  
Receivable on disposal of VIEs
    699       1,611  
Staff advances for normal business purpose
    125       107  
Overdue deposits
    688       968  
Allowance for doubtful accounts
    (688 )     (968 )
Other receivables, net
    1,766       4,299  
 
 
F-11

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Short-term loan made for marketing campaign: for one of the major marketing campaigns, the Company made a marketing-related loan of RMB25,000,000 (approximately US$4,060,000) to a TV series of 36 episodes, called “Xiao Zhang Feng Yun.” By participating in this TV series, the Company’s logo is shown during the credits at the end of each episode and also shown as a separate card during the closing before the credit screen. In accordance with an agreement between the Company and the borrower, the Company extended the term of this loan from December 31, 2013 to December 31, 2014. For the nine months ended September 30, 2014 and the subsequent period through the date hereof, the borrower repaid RMB5,710,000 (approximately US$928,000) and RMB3,890,000 (approximately US$632,000) of this debt, respectively. The Company will continue to assess the collectability of this loan. 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.
 
Short-term loans to unrelated entities represented temporary loans advanced to unrelated entities, which were unsecured, non-interest bearing and repayable on demand.

Receivable on disposal of fixed assets was subsequently settled in October 2014.

Receivables on disposal of VIEs represented the cash consideration to be received from the successors of shareholders of the Company’s two former VIEs, which were disposed in November 2013. As of the date hereof, the Company has collected RMB5,550,000 (approximately US$902,000) of this receivable in the aggregate, the remaining balance will be collected within fiscal 2014.

For advertising resources purchase contracts signed by the Company with its resource providers, the Company was required to make deposits, which were either applied to the contract amounts that were needed to be paid with the consent of the counterparty or to be refunded to the Company of the remaining balance upon expiration of the cooperation. Overdue deposits represented the portion of the contractual deposits, which related advertising resources purchase contracts had been completed as of each of the reporting dates with no further cooperation. Based on the assessment of the collectability of these overdue deposits as of September 30, 2014 and December 31, 2013, the Company provided full allowance for doubtful accounts against these balances, which was related to the deposits of its internet advertising and TV advertising business segment. For the nine and three months ended September 30, 2014, no additional allowance for doubtful accounts was provided. For the nine and three months ended September 30, 2013, approximately US$791,000 allowance for doubtful accounts was provided. For the nine and three months ended September 30, 2014, the decrease in overdue deposits and the related allowance was due to disposal of a VIE during the period.
 
 
F-12

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

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Deposits to TV advertisement and internet resources providers
    11,182       8,907  
Prepayments to TV advertisement and internet resources providers
    8,212       5,292  
Other deposits and prepayments
    380       493  
      19,774       14,692  

In order to provide advertising and marketing services, the Company partners with provincial satellite TV stations or its agents to obtain time slots for resale through broadcast advertisements to advertise brands, business information, products and services of its customers. The Company also purchases internet resources from large internet search engines to attract more internet traffic to its advertising portals and provide value-added services to its customers.

In October 2013, the State Administration of Press, Publication, Radio, Film and Television of the People’s Republic of China (the “SARFT”) issued a notice to enhance the management of TV shopping infomercials broadcasted in provincial satellite television stations, which further restricts the contents, air time and duration of these infomercials (the “Restriction Notice”).

Deposits to TV advertisement and internet resources providers are paid as contractual deposits to the Company’s resources and services suppliers.

As of September 30, 2014, the deposits to suppliers primarily consisted of deposit to an agent of one of the provincial satellite TV stations partnered with the Company. The Company has partnered with this TV station to broadcast its advertisements for over three years. According to the contract signed between the Company and this agent for the time slots to be resold in fiscal 2014, the deposit will be either applied to the contract amounts of time slots cost that are needed to be paid with the consent of the counterparty or transferred as contractual deposit for fiscal 2015 upon renewal of the purchase contact. Although the Restriction Notice has had and may continue to have a negative impact on the Company’s TV advertising business with this TV station, the Company believes that the cooperation with this TV station will continue and expand with the efforts of development of new form of TV advertising programs and non-TV shopping advertising customers. All deposits are refundable to the Company upon expiration of cooperation with suppliers.

According to the contracts signed between the Company and its suppliers, the Company is normally required to pay the contract amounts in advance. These prepayments will be transferred to cost of sales when the related services are provided.

As of September 30, 2014, the Company also had advanced payment carried forward from prior years paid to another TV station which has been partnered with the Company for over five years, which amount the Company originally expected to be utilized in fiscal 2013. However, the Company became aware of that since the second half year of 2013, this TV station had decreased its broadcasting of TV shopping infomercials and adjusted their broadcasting schedule due to the adoption of the Restriction Notice. In response to the restrictions on TV advertisement set forth in the Restriction Notice, the Company discussed with the TV station possible alternatives of applying the balance of the advanced payment, as the amount was unlikely to be refunded to the Company, due to internal administrative policies of the TV station. The TV station and the Company agreed that the unconsumed advanced payment balance can be consumed by any third parties designated by the Company and approved by the TV station, who will broadcast advertisements or other similar TV programs using the balance of available time slots, and the Company will directly collect the amounts from the third parties for the time slots they utilized. The Company expects that the advanced payment balance will be utilized within fiscal 2014. As of the date hereof, the Company has utilized RMB12.88 million (approximately US$2.1 million) of this advanced payment through an unrelated third party.

As of September 30, 2014, the increase in deposit to resources suppliers primarily consisted of an approximately US$2.2 million contractual deposit to the Company’s largest internet resources supplier, as compared to that as of December 31, 2013.

As of September 30, 2014, the increase in the prepayments primarily consisted of an approximately US$3 million prepayment to three of the Company’s major internet resources suppliers and an approximately US$0.6 million prepayment to one of the TV stations that provides TV advertising slots to the Company, as compared to that as of December 31, 2013.
 
 
F-13

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
8.
Due from related parties

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Beijing Fengshangyinli Technology Co., Ltd.
    -       36  
Beijing Saimeiwei Food Equipment Technology Co., Ltd.
    51       295  
Beijing Telijie Century Environmental Technology Co., Ltd.
    53       171  
      104       502  
 
These related parties are directly or indirectly owned by Mr. Handong Cheng or Mr. Xuanfu Liu, 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 provided 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 reporting date.
 
9.
Investment in and advance to equity investment affiliates

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Investment in equity investment affiliates
    803       760  
Advance to equity investment affiliates
    85       85  
      888       845  
 
The following table summarizes the movement of the investment in and advance to equity investment affiliates for the nine months ended September 30, 2014:
 
   
Shenzhen
Mingshan
   
Zhao Shang
Ke Hubei
   
Total
 
   
US$(’000)
   
US$(’000)
   
US$(’000)
 
                   
Balance as of December 31, 2013 (audited)
    466       379       845  
Share of (loss)/gain in equity investment affiliates
    (2 )     51       49  
Exchange translation adjustment
    (3 )     (3 )     (6 )
Balance as of September 30, 2014 (unaudited)
    461       427       888  
 
For the nine months ended September 30, 2014 and 2013, the Company recognized its pro-rata shares of loss in Shenzhen Mingshan of approximately US$2,000 and US$41,000, respectively. For the three months ended September 30, 2014 and 2013, the Company recognized its pro-rata shares of loss in Shenzhen Mingshan of approximately US$nil and US$6,000, respectively.
 
For the nine and three months ended September 30, 2014, the Company recognized its pro-rata share of gain in Zhao Shang Ke Hubei of approximately US$51,000 and US$107,000, respectively. For the nine and three months ended September 30, 2013, the Company recognized its pro-rata share of loss in Zhao Shang Ke Hubei of approximately US$129,000 and US$39,000, respectively.
 
 
F-14

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
10.
Property and equipment, net

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Leasehold improvement
    179       -  
Vehicles
    883       865  
Office equipment
    1,372       1,433  
Electronic devices
    1,236       1,245  
Property and equipment, cost
    3,670       3,543  
Less: accumulated depreciation
    (2,676 )     (2,486 )
Property and equipment, net
    994       1,057  
 
Depreciation expenses in the aggregate for the nine months ended September 30, 2014 and 2013 were approximately US$291,000 and $461,000, respectively.
 
Depreciation expenses in the aggregate for the three months ended September 30, 2014 and 2013 were approximately US$102,000 and $150,000, respectively.
 
11.
Intangible assets, net
 
   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
Intangible assets not subject to amortization:
           
Domain name
    1,569       1,580  
Intangible assets subject to amortization:
               
Contract backlog
    201       203  
Customer relationship
    3,523       3,548  
Non-compete agreements
    1,394       1,403  
Software technologies
    333       335  
Cloud-computing based software platforms
    1,508       1,518  
Other computer software
    79       78  
Intangible assets, cost
    8,607       8,665  
Less: accumulated amortization
    (3,420 )     (2,650 )
Intangible assets, net
    5,187       6,015  
 
Amortization expenses in aggregate for the nine months ended September 30, 2014 and 2013 were approximately US$788,000 and US$791,000, respectively.
 
Amortization expenses in aggregate for the three months September 30, 2014 and 2013 were both approximately US$262,000.
 
Based on the carrying value of the finite-lived intangible assets recorded as of September 30, 2014, and assuming no subsequent impairment of the underlying intangible assets, the estimated future amortization expenses is approximately US$262,000 for the three months ended December 31, 2014, approximately US$1,048,000 for the year ended December 31, 2015, approximately US$1,008,000 for the year ended December 31, 2016, approximately US$508,000 for the year ended December 31, 2017 and approximately US$310,000 for the year ended December 31, 2018.
 
 
F-15

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
12.
Deposit for purchasing of software technology
 
For further development of comprehensive value-added services to its customers, which are mostly SMEs, the Company made a deposit to an unrelated technical consulting entity of RMB15 million (approximately US$2.44 million) for the purchasing of software technology related to operation management applications for SMEs. As of the date hereof, the Company is trial testing these software applications, and is in the process of negotiations and determination of the transaction details. The Company expects to complete the trial testing of the software by the end of fiscal 2014 and consummate the transaction in March 2015.
 
In October 2013, the Company entered into a contract to engage an unrelated third party to develop several software systems related to internet environment monitoring and system optimization to enhance the overall safety and efficiency of the Company’s network system. The total contract amount was RMB13 million (approximately US$2.11 million). The Company has paid the first installment of RMB5.2 million (approximately US$0.84 million). The transaction as contemplated under the contract is expected to be consummated in the first fiscal quarter of 2015.
 
13.
Goodwill

   
Amount
 
   
US$(’000)
 
       
Balance as of December 31, 2013 (audited)
    11,450  
Exchange translation adjustment
    (79 )
Balance as of September 30, 2014 (unaudited)
    11,371  
 
14.
Short-term bank loan

Short-term bank loan as of September 30, 2014 and December 31, 2013 represented a short-term bank loan of approximately RMB5.0 million (approximately US$0.8 million) borrowed by one of the Company’s VIEs from a major financial institution of China to supplement its short-term working capital needs. The short-term loan as of December 31, 2013 matured on July 31, 2014 and was renewed on September 30, 2014, which will mature on September 29, 2015. The interest rate of the current short-term bank loan is a floating lending rate, which is 40% over the benchmark rate of the People’s Bank of China (the “PBOC”). As of September 30, 2014, the interest rate of the short-term loan was 8.4%.
 
15.
Accrued payroll and other accruals

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accrued payroll and staff welfare
    398       382  
Accrued operating expenses
    52       294  
      450       676  
 
16.
Due to noncontrolling interest of VIE
 
As of September 30, 2014, due to noncontrolling interest of VIE represented the outstanding balance of the short-term loan borrowed by one of the Company’s VIEs from its noncontrolling interest to supplement the short-term working capital needs of this VIE. The short-term loan is unsecured, interest free and is payable on demand.
 
 
F-16

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
17.
Due to former VIE
 
As of September 30, 2014, due to former VIE represented the outstanding balance of the former inter-company loan borrowed from the Company’s former VIE, which was disposed in late August 2014. This loan is unsecured, interest free and is required to be fully settled before June 30, 2015.
 
18.
Taxation
 
 
1)
Income tax
 
The entities within the Company file separate tax returns in the respective tax jurisdictions in which they operate.
 
i). The Company is incorporated in the state of Nevada. Under the current law of Nevada, the Company is not subject to state corporate income tax. Following the Share Exchange, the Company became a holding company and does not conduct any substantial operations of its own. No provision for federal corporate income tax has been made in the financial statements as the Company has no assessable profits for the nine and three months ended September 30, 2014, 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 nine and three months ended September 30, 2014 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”). The EIT rate of PRC is 25%, which applies to both domestic and foreign invested enterprises.
 
 
l
Rise King WFOE was 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 for fiscal 2009 and 2010, and a 50% reduction of its applicable EIT rate, which was 25% to 12.5% of its taxable income for the succeeding three years through fiscal 2013. The applicable income tax rate for Rise King WFOE is 25% after fiscal 2013. Therefore, for the nine and three months ended September 30, 2014, the applicable income tax rate for Rise King WFOE was 25%, for the nine and three months ended September 30, 2013, the applicable income tax rate for Rise King WFOE was 12.5%.
 
 
l
In July 2012, Business Opportunity Online was approved by the related PRC governmental authorities as a High and New Technology Enterprise under the current EIT law, and was approved by the local tax authorities of Beijing, the PRC, to be entitled to a favorable statutory tax rate of 15% until December 31, 2014. Therefore, the applicable income tax rate of Business Opportunity Online was 15% for the nine and three months ended September 30, 2014 and 2013. After fiscal year 2014, the applicable income tax rate for Business Opportunity Online will be 25% under the current EIT law of PRC unless the entity regains the qualification as a High and New Technology Enterprise in fiscal 2015. The Company believes that more likely than not Business Opportunity Online will be able to regain its qualification as a High and New Technology Enterprise and continue to enjoy the favorable statutory tax rate of 15% after fiscal 2014.
 
 
l
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 EIT exemption for fiscal 2012, as its first profitable year was determined as fiscal 2011 instead of fiscal 2012 in August 2013 by the local tax authorities of Xiaogan City, Hubei province, and a 50% reduction of its applicable EIT rate which is 25% to 12.5% of its taxable income for the succeeding three years through fiscal 2015. Therefore, the applicable income tax rate for Business Opportunity Online Hubei was 12.5% for the nine and three months ended September 30, 2014 and 2013. After fiscal 2015, the applicable income tax rate for Business Opportunity Online Hubei will be 25% under the current EIT law of PRC.
 
 
F-17

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
 
l
The applicable income tax rate for other PRC operating entities of the Company was 25% for the nine and three months ended September 30, 2014 and 2013.
 
 
l
The current EIT law also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. 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% withholding tax 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.
 
For the nine and three months ended September 30, 2014 and 2013, 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 in. Rise King WFOE, Business Opportunity Online and Business Opportunity Online Hubei were most affected by these preferential income tax treatments within the structure of the Company. 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 primarily 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)
Turnover taxes and the relevant surcharges
 
Service revenues provided by the Company’s PRC operating subsidiary and VIEs were subject to Value Added Tax (“VAT”). VAT rate for provision of modern services (other than lease of corporeal movables) is 6% and for small scale taxpayer, 3%. Therefore, for the nine and three months ended September 30, 2014 and 2013, the Company’s service revenues are subject to VAT at a rate of 6%, after deducting the VAT paid for the services purchased from suppliers, or at a rate of 3% without any deduction of VAT paid for the services purchased from suppliers. The surcharges of the VAT is 12%-14% of the VAT, depending on which tax jurisdiction the Company’s PRC operating subsidiary and VIE operate in.
 
As of September 30, 2014 and December 31, 2013, taxes payable consists of:
 
   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Turnover tax and surcharge payable
    1,174       2,343  
Enterprise income tax payable
    2,328       4,686  
      3,502       7,029  
 
For the nine and three months ended September 30, 2014, the decrease in taxes payable was primarily due to disposal of a VIE during the period.
 
For the nine and three months ended September 30, 2014 and 2013, the Company’s income tax benefit/(expense) consisted of:
 
   
Nine Months Ended September 30,
   
Three Months Ended September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
US$(’000)
   
US$(’000)
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Current-PRC
    (380 )     (1,165 )     (3 )     (460 )
Deferred-PRC
    419       696       162       259  
      39       (469 )     159       (201 )
 
 
F-18

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The Company’s deferred tax liabilities at September 30, 2014 and changes for the nine months then ended were as follows:
 
   
Amount
 
   
US$(’000)
 
       
Balance as of December 31, 2013 (audited)
    1,439  
Reversal during the period
    (168 )
Exchange  translation adjustment
    (10 )
Balance as of September 30, 2014 (unaudited)
    1,261  
 
Deferred tax liabilities arose on the recognition of the identifiable intangible assets acquired from acquisition transactions and deconsolidation of subsidiaries consummated in 2011. Reversal for the nine and three months ended September 30, 2014 of approximately US$168,000 and US$56,000, respectively, was due to amortization of the acquired intangible assets.
 
The Company’s deferred tax assets at September 30, 2014 and December 31, 2013 were as follows:

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Tax effect of net operating losses carried forward
    4,849       3,899  
Bad debts provision
    1,119       1,594  
Valuation allowance
    (4,888 )     (4,581 )
      1,080       912  

   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Deferred tax assets reclassified as current asset
    179       153  
Deferred tax assets reclassified as non-current asset
    901       759  
      1,080       912  

The net operating losses carried forward incurred by the Company (excluding its PRC operating subsidiary and VIEs) were approximately US$7,095,000 and US$6,840,000 at September 30, 2014 and December 31, 2013, respectively, which loss carry forwards gradually expire over time, the last of which expires in 2034. 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.
 
 
F-19

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

 
The net operating losses carried forward (excluding bad debts provision, amortization of intangible assets acquired from business combinations and non-deductible expenses) incurred by the Company’s PRC subsidiary and VIEs were approximately US$12,103,000 and US$7,253,000 at September 30, 2014 and December 31, 2013, respectively, which loss carry forwards gradually expire over time, the last of which expires in 2019. 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 losses are expected to be utilized. The Company recorded approximately US$697,000 and US$125,000 valuation allowance for the nine and three months ended September 30, 2014, respectively, because it is considered more likely than not that this portion of the deferred tax assets will not be realized through sufficient future earnings of the entities to which the operating losses relate.

Full valuation allowance to bad debts provision related deferred tax assets were recorded because it is considered more likely than not that this portion of deferred tax assets will not be realized through bad debts verification by the local tax authorities where the PRC subsidiary and VIEs operate in.

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.

The tax authority of the PRC government conducts periodic and ad hoc tax filing reviews on business enterprises operating in the PRC after those enterprises had completed their relevant tax filings, hence the Company’s tax filings may not be finalized. It is therefore uncertain as to whether the PRC tax authority may take different views about the Company’s tax filings which may lead to additional tax liabilities.
 
19.
Long-term borrowing from director
 
   
September 30,
2014
   
December 31,
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Long-term borrowing from director
    142       143  
 
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, which is not expected to be repaid within one year.
 
20.
Warrants
 
The Company issued warrants in its August 2009 Financing. The changes of the warrants during the nine months ended September 30, 2014 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, 2013 (audited)
    2,363,456     $ 3.52       0.63       2,363,456     $ 3.52       0.63  
Granted / Vested
    -                       -                  
Forfeited
    -                       -                  
Exercised
    -                       -                  
Expired
    (2,363,456 )                     (2,363,456 )                
Balance, September 30, 2014 (unaudited)
    -                       -                  
 
All warrants outstanding as of December 31, 2013 expired on August 20, 2014.
 
 
F-20

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
 
21.
Restricted Net Assets

As most of the Company’s operations are conducted through its PRC subsidiary and VIEs, the Company’s ability to pay dividends is primarily dependent on receiving distributions of funds from its PRC subsidiary and VIEs. Relevant PRC statutory laws and regulations permit payments of dividends by its PRC subsidiary and VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations and after it has met the PRC requirements for appropriation to statutory reserves. Paid in capital of the PRC subsidiary and VIEs included in the Company’s consolidated net assets are also non-distributable for dividend purposes.

In accordance with the PRC regulations on Enterprises with Foreign Investment, a WFOE established in the PRC is required to provide certain statutory reserves, namely general reserve fund, the enterprise expansion fund and staff welfare and bonus fund which are appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A WFOE is required to allocate at least 10% of its annual after-tax profit to the general reserve until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. Appropriations to the enterprise expansion fund and staff welfare and bonus fund are at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. Rise King WFOE is subject to the above mandated restrictions on distributable profits. Additionally, in accordance with the Company Law of the PRC, a domestic enterprise is required to provide a statutory common reserve of at least 10% of its annual after-tax profit until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide for a discretionary surplus reserve, at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. All of the Company’s PRC VIEs are subject to the above mandated restrictions on distributable profits.

As a result of these PRC laws and regulations, the Company’s PRC subsidiary and VIEs are restricted in their ability to transfer a portion of their net assets to the Company. As of September 30, 2014 and December 31, 2013, 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 both approximately US$7.3 million.

The current PRC Enterprise Income Tax (“EIT”) Law also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate. Rise King WFOE is invested by its immediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company.

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

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

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

Currently, under the Administration Rules, Renminbi is freely convertible for current account items, including the distribution of dividends, interest payments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities outside of China, unless the prior approval of the State Administration of Foreign 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.
 
 
F-21

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

 
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 September 30, 2014 and December 31, 2013, there was approximately US$36.4 million and US$39.3 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$2.8 million statutory reserve funds as of September 30, 2014 and December 31, 2013, that may be affected by increased restrictions on currency exchanges in the future and accordingly may further limit the Company’s PRC subsidiary’s and VIEs’ ability to make dividends or other payments in U.S. dollars to the Company, in addition to the approximately US$7.3 million restricted net assets as of September 30, 2014 and December 31, 2013, as discussed above.
 
22.
Related party transactions
 
Revenue from related parties:
 
   
Nine Months Ended September 30,
 
   
2014
   
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
-Beijing Saimeiwei Food Equipment Technology Co., Ltd.
    239       213  
-Beijing Fengshangyinli Technology Co., Ltd.
    1       7  
-Beijing Telijie Century Environmental Technology Co., Ltd.
    -       94  
      240       314  
 

   
Three Months Ended September 30,
 
   
2014
   
2013
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
   
(Unaudited)
 
             
-Beijing Saimeiwei Food Equipment Technology Co., Ltd.
    57       91  
-Beijing Fengshangyinli Technology Co., Ltd.
    -       1  
-Beijing Telijie Century Environmental Technology Co., Ltd.
    -       48  
      57       140  
 
23.
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$424,000 and US$352,000 for the nine months ended September 30, 2014 and 2013, respectively. The total amounts for such employee benefits were approximately US$159,000 and US$121,000 for the three months ended September 30, 2014 and 2013, respectively.
 
 
F-22

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
24.
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 September 30, 2014 and December 31, 2013, substantially all of the Company’s cash and cash equivalents were held by major financial institutions located in Mainland China and Hong Kong Special Administrative Region of the PRC, which management believes are of high credit quality.
 
Risk arising from operations in foreign countries
 
All of the Company’s operations are conducted within the PRC. The Company’s operations in the PRC are subject to various political, economic, and other risks and uncertainties inherent in the PRC. Among other risks, the Company’s operations in the PRC are subject to the risks of restrictions on transfer of funds, changing taxation policies, foreign exchange restrictions; and political conditions and governmental regulations.
 
Currency convertibility risk
 
Significant part of the Company’s businesses is transacted in RMB, which is not freely convertible into foreign currencies. All foreign exchange transactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requires submitting a payment application form together with suppliers’ invoices and signed contracts. These exchange control measures imposed by the PRC government authorities may restrict the ability of the Company’s PRC subsidiary and VIEs to transfer its net assets, which to the Company through loans, advances or cash dividends.
 
Concentration of customers
 
For the nine months ended September 30, 2014, two customers individually accounted for 29% and 17% 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 nine months ended September 30, 2014 and 2013, respectively.
 
For the three months ended September 30, 2014, the same two customers individually accounted for 42% and 15% of the Company’s sales, respectively. 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 September 30, 2014 and 2013, respectively.
 
As of September 30, 2014, two customers individually accounted for 18% and 10% of the Company’s accounts receivables, respectively. As of December 31, 2013, three customers individually accounted for 13%, 12% and 10% of the Company’s accounts receivables, respectively. Except for the afore-mentioned, there was no other single customer who accounted for more than 10% of the Company’s accounts receivable as of September 30, 2014 and December 31, 2013, respectively.
 
Concentration of suppliers
 
For the nine months ended September 30, 2014, two suppliers individually accounted for 69% and 20% of the Company’s cost of sales, respectively. For the three months ended September 30, 2014, the same two suppliers individually accounted for 75% and 17% of the Company’s cost of sales, respectively. Except for the afore-mentioned, there was no other single supplier who accounted for more than 10% of the Company’s cost of sales for the nine and three months ended September 30, 2014, respectively.
 
For the nine months ended September 30, 2013, three suppliers individually accounted for 34%, 26% and 14% of the Company’s cost of sales, respectively. For the three months ended September 30, 2013, two suppliers individually accounted for 47% and 14% of the Company’s cost of sales, respectively. Except for the afore-mentioned, there was no other single supplier who accounted for more than 10% of the Company’s cost of sales for the nine and three months ended September 30, 2013, respectively.
 
 
F-23

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
25.
Commitments
 
The following table sets forth the Company’s operating lease commitment as of September 30, 2014:
 
   
Office Rental
 
   
US$(’000)
 
   
(Unaudited)
 
Three months ending December 31,
     
-2014
    83  
Year ending December 31,
       
-2015
    343  
-2016
    83  
Total
    509  
 
For the nine months ended September 30, 2014 and 2013, rental expenses under operating leases were approximately US$393,000 and US$379,000, respectively. For the three months ended September 30, 2014 and 2013, rental expenses under operating leases were approximately US$132,000 and US$130,000, respectively.
 
In October 2013, the Company entered into a contract to engage an unrelated third party to develop several software systems related to internet environment monitoring and system optimization to enhance the overall safety and efficiency of the Company’s network system. The total contract amount was RMB13 million (approximately US$2.11 million) and the first installment of RMB5.2 million (approximately US$0.84 million) was paid in the first fiscal quarter of 2014. The transaction as contemplated under the contract is expected to be consummated in the first fiscal quarter of 2015 and the remaining unpaid contract amount is expected to be paid in the first fiscal quarter of 2015.
 
Legal Proceedings
 
Business Opportunity Online, Handong Cheng, Chairman and CEO of the Company, and Jinbo Yao, Legal Representative of Beijing 58 Information Technology Co., Ltd. (the “Beijing 58”) have been named as defendants in a civil lawsuit filed in the PRC. The action was filed by Xuanfu Liu, an approximate 34% shareholder of the Company, on October 19, 2013, in the Xiaogan City Xiaonan District People’s Court in Hubei Province, China. The complaint alleges that Mr. Cheng abused operation and management rights and that Mr. Cheng’s disposition of equity interests that Business Opportunity Online held in Beijing 58 (the “Equity Interests”), without the consent of the plaintiff, was an act of infringement and in violation of the articles of association of Business Opportunity Online and Chinese corporate law. The complaint seeks a court order to declare the contract allegedly entered into by and between Mr. Cheng, on behalf of Business Opportunity Online, and Mr. Yao, null and void. The Company denied all of the allegations against the Company and intends to defend vigorously against the lawsuit. During the course of the civil litigation, Jinbo Yao, the defendant, filed an objection to remove this case from the Xiaogan City Xiaonan District People’s Court to a Beijing court. Xiaogan City Xiaonan District People’s Court denied the defendant’s objection to remove the case. Jinbo Yao then filed an appeal of that decision to the Intermediate People’s Court of Xiaogan. On March 10, 2014, the Intermediate People’s Court of Xiaogan rendered a final ruling holding that the dispute shall be transferred and heard by the Haidian District People’s Court of Beijing. Business Opportunity Online is awaiting a hearing date from the Haidian District People’s Court of Beijing.
 
Rise King WFOE, Handong Cheng, Zhige Zhang, CFO of the Company and Xuanfu Liu, have been named as defendants in a civil lawsuit filed in the PRC. The action was filed by Shanghai Pan Gu Investment Management Co., Ltd. (the “Shanghai Pan Gu”), on December 17, 2013, in the Haidian District People’s Court of Beijing, China. The complaint alleges that the defendants breached a consulting agreement entered into on April 22, 2011 by and among Shanghai Pan Gu and the defendants. The complaint seeks a court order for liquidated damages in the amount of RMB0.56 million (equal to approximately US$92,100) under the consulting agreement. The Company denies all of the allegations against it and intends to defend vigorously against the lawsuit.
 
 
F-24

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Business Opportunity Online has been named as a defendant in another civil lawsuit filed in the PRC. The action was filed by Haifeng Wang in the Haidian District People’s Court, Beijing, PRC, on April 29, 2014. The complaint alleges that the plaintiff neither attended any shareholders meeting in respect of the transfer of the plaintiff’s investment in Business Opportunity Online to another party, nor executed any written shareholders resolutions approving such transfer. The complaint seeks a court order to declare such shareholders resolutions null and void. The Company denies all of the allegations against it and intends to defend vigorously against the lawsuit.
 
The Company currently cannot estimate the amount or range of possible losses from the litigations described above.
 
26.
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 Company’s Chief Executive Officer, who is the chief operating decision maker (“CODM”) to make decisions about resources to be allocated to the segment and assess each operating segment’s performance.
 
Nine Months Ended September 30, 2014 (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
    21,777       4,806       207       821       -       -       27,611  
Cost of sales
    17,562       4,467       8       446       -       -       22,483  
Total operating expenses
    6,744       345       93       442       908 *     -       8,532  
Depreciation and amortization expense included in total operating expenses
    743       31       93       151       61       -       1,079  
Operating income (loss)
    (2,529 )     (6 )     106       (67 )     (908 )     -       (3,404 )
                                                         
Share of  gain/(loss)  in equity investment affiliates
    -       -       -       51       (2 )     -       49  
Gain on disposal of VIE
    266       -       -       -       -       -       266  
Expenditure for long-term assets
    1,072       -       -       3       12       -       1,087  
Net income (loss)
    (2,133 )     (57 )     106       (15 )     (910 )     -       (3,009 )
Total assets – September 30, 2014
    47,551       15,411       325       4,522       6,324       (21,659 )     52,474  
Total assets – December 31, 2013
    51,324       17,022       420       4,524       7,065       (23,521 )     56,834  

*Including approximately US$25,000 share-based compensation expenses.
 
Three Months Ended September 30, 2014 (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
    9,969       1,812       69       217       -       -       12,067  
Cost of sales
    8,167       1,695       3       131       -       -       9,996  
Total operating expenses
    2,894       123       30       159       330 *     -       3,536  
Depreciation and amortization expense included in total operating expenses
      254         9         30         51         20         -         364  
Operating income (loss)
    (1,092 )     (6 )     36       (73 )     (330 )     -       (1,465 )
                                                         
Share of  gain/(loss)  in equity investment affiliates
    -       -       -       107       -       -       107  
Gain on disposal of VIE
    266       -       -       -       -       -       266  
Expenditure for long-term assets
    222       -       -       2       -       -       224  
Net income (loss)
    (640 )     (25 )     36       42       (330 )     -       (917 )

*Including approximately US$8,000 share-based compensation expenses.
 
 
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