f10k_041513.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 


S
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  
 
SECURITIES EXCHANGE ACT OF 1934
  
     
 
For the Fiscal Year Ended December 31, 2012
  
     
 
OR
  
     
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  
 
SECURITIES EXCHANGE ACT OF 1934
  
 
For the transition period from _____ to __________
  

 
COMMISSION FILE NO. 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
(Address of principal executive offices)
 
+86-10-5160-0828
(Issuer’s telephone number, including area code)

 
Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class
Name of Exchange On which Registered
   
$0.001 Common Stock
Nasdaq Global Market
 
Securities Registered Pursuant to Section 12(g) of the Act:  None.
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes £ No S
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes £ No S
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes S No £
 
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 S No £
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Yes £ No S
 
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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer £      Accelerated Filer £      Non-Accelerated Filer £      Smaller Reporting Company S
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes £   No S
 
The aggregate market value of the 14,324,705 shares of common equity stock held by non-affiliates of the Registrant was approximately $10,027,294 on the last business day of the Registrant’s most recently completed second fiscal quarter, based on the last sale price of the registrant’s common stock on such date of $0.70 per share, as reported on the Nasdaq Global Market.
 
The number of shares outstanding of the Registrant’s common stock, $0.001 par value as of April 12, 2013 was 22,186,540.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Registrant’s Proxy Statement relating to the Registrant’s 2013 Annual Meeting of Stockholders, are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.

 
 
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K 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. These statements relate to future events or our future financial performance. We have attempted to identify forward-looking statements by terminology including “anticipates”, “believes”, “expects”, “can”, “continue”, “could”, “estimates”, “expects”, “intends”, “may”, “plans”, “potential”, “predict”, “should” or “will” or the negative of these terms or other comparable terminology. These statements are only predictions. Uncertainties and other factors, including the risks outlined under Risk Factors contained in Item 1A of this Form 10-K, may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements.
 
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our expectations are as of the date this Form 10-K is filed, and we do not intend to update any of the forward-looking statements after the filing date to conform these statements to actual results, unless required by law.
 
We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended. You may read and copy these materials at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding us and other companies that file materials with the SEC electronically. You may also obtain copies of reports filed with the SEC, free of charge, via a link included on our website at www.chinanet-online.com.
 

 
 
 
 
PART I
 
ITEM 1  BUSINESS
 
We are a holding company that conducts our primary businesses through our PRC subsidiary and PRC operating entities (the “VIEs”). We are one of China’s leading business-to-businesses (“B2B”), fully integrated internet service providers for expanding small and medium enterprises’ (“SMEs”) sales networks in China. Our services were founded on proprietary internet and advertising technologies that include (i) preparing and publishing rich media enabled advertising and marketing campaigns for clients on the Internet, mobile phone, television and other valued added communication channels, (ii) hosting mini-sites with online messaging and consulting functionalities, (iii) generating effective sales leads, (iv) providing online management tools to help SMEs manage the expansion of their sales networks and (v) providing social networking and information sharing services to SMEs and entrepreneurs through interactive integrated social networking portal. 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. In February 2013, we received the awards of "The Most Leading Enterprise of Chinese Entrepreneurial Merchandising and Franchising Marketing Industry" and "The Most Trustworthy E-Commerce Platform in Entrepreneurial Merchandising and Franchising Industry" in China by the China Electronic Commerce Association (CECA). These awards are only awarded to one enterprise in each industry.
 
ChinaNet primarily operates an one-stop services for our clients on four major service platforms, including social networking service information platform, multi-channel advertising and promotion platform, brand management and sales channel building platform and management tools platform. Our social networking service information platform primarily consists of www. chuangye.com, an information and service portal for entrepreneurs or any individual who plans to start their own business. Our multi-channel advertising and promotion platform primarily consists of internet advertising and marketing portals, including www.28.com (“28.com”), www.liansuo.com (“liansuo.com”) and www.sooe.cn (“sooe.cn”), ChinaNet TV as our TV production and advertising unit and the bank kiosk advertising unit. We provide varieties of marketing campaigns through this platform by the combination of the Internet, mobile, television, bank kiosks and printed-medias to maximize market exposure and effectiveness for our clients. Our band management and sales channel expansion platform consists of our brand consulting and management service and offline sales channel expansion service, which is to physically help small businesses to recruit dealers, wholesalers, partners or franchisees based on their business needs. Management tools platform consists of a mobile-based sales and administrative management tools specifically designed for small business in China to match their simplicity.
 
Chuangye.com, operated through Beijing Chuang Fu Tian Xia Network Technology Co., Ltd., our majority-owned VIE, is built to serve the community of entrepreneurs to assist them with developing their business, as well as sharing their resources in a web2.0 and SNS2.0 driven interaction in combination with popular web/mobile tools and portals, such as Weibo, WeChat, Tianya, Baidu and so forth. 28.com, operated through Business Opportunity Online (Beijing) Network Technology Co., Ltd., is our key internet advertising web portal. Through this high traffic internet portal, SMEs advertise their business information, brands, products and services, as well as other related business opportunities through their mini-sites hosted by 28.com. The portal also offers campaign management tools for our clients, including lead generation and management, advanced tracking, search engine marketing, search engine optimization, resource scheduling and content management. In October 2012, 28.com launched a new value-added service, Clever Cloud Optimizer, which is an automated price adjustment service that allows users to optimize their online search advertising campaigns, to manage large and complex online search accounts and campaign more efficiently, and to analyze customer's search history in order to run more targeted sales promotions. Primarily through 28.com, our customers can potentially build sales channels and develop business relationships directly for franchisees, sales agents, distributors and/or resellers. It also functions as a one-stop destination for the general public seeking new business opportunities or other business ventures. Liansuo.com, operated through Beijing Chuang Fu Tian Xia Network Technology Co., Ltd., our majority-owned VIE, is built to serve larger SMEs than those served by 28.com. With additions of other internet related services, Liansuo.com is also intended to serve large international and overseas clients. In October 2012, Liansuo.com introduced a new cloud-based software system, Quick Connect, which allows businesses and existing and potential sales channel partners to communicate with each
 
 
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other directly and simultaneously. Quick Connect also keeps a detailed log of all incoming calls that businesses can port into their customer relations management ("CRM") database to track every sales lead. Upon acquiring Sou Yi Lian Mei Network Technology (Beijing) Co., Ltd., we obtained another established online advertising and marketing portal, sooe.cn, which focuses on emerging SMEs. The ChinaNet TV division, operated through Beijing CNET Online Advertising Co., Ltd., has in-house television productions and distribution capabilities. We produce and distribute television shows that are typically 10 or 20 minutes in length and are broadcasted on local television stations. The television shows are comprised of advertisements, similar to infomercials, and also include promotions for several clients. The bank kiosk division, operated through Shanghai Borongdongsi Computer Technology Co., Ltd., provides interactive LCD advertisement displays and targets banking customers. As of December 31, 2012, in cooperation with Henan provincial branch of China Construction Bank and Shanghai Rural Commercial Bank, we placed approximately 610 interactive kiosks in their branches in Henan province and Shanghai. Each kiosk has an LCD advertising display panel, which provides advertising aimed at bank customers. Each kiosk also provides Internet access on a separate screen so that customers can perform basic non-cash banking functions such as transferring money, purchasing annuities and/or insurance, and paying bills. Upon acquiring Quanzhou Zhi Yuan Marketing Planning Technology Co., Ltd., Quanzhou  Tian Xi Shun He Advertisement Co., Ltd. and incorporation of Zhao Shang Ke Network Technology (Hubei) Co., Ltd., we also provide brand consulting and management, and sales channel building services to our SME clients, including brand investigation, brand modulization, brand application, brand promotion, as well as sales channel expansion modeling, implementation and management. We also have invested in the cloud-computing based software technologies, operated through Sheng Tian Network Technology (Hubei) Co., Ltd. This technology is intended to help our SME clients manage their sales channels more effectively in China. The technology has been partially implemented into our existing online advertising and marketing platforms in 2012, and other features of the technology are still under integration and are expected to be incorporated into our another web portal, www.feitengyun.com, in 2013.
 
We derive our revenue principally by:
The five largest industries in terms of revenue in which our advertising and marketing clients operate are (1) cosmetics and health care, (2) footwear, apparel and garments, (3) food and beverage, (4) environmental protection equipment and (5) women accessories. Advertising revenue from these industries together accounted for approximately 77% of our revenue in 2012.
 
For the year ended December 31, 2012, we generated total revenues of US$46.6 million, compared to US$28.7 million in 2011, and net income (after allocation to the noncontrolling interest shareholders) of US$3.0 million, compared to US$3.0 million in 2011. Excluding the non-cash charge of changes in fair value of the contingent consideration receivables of approximately US$0.16 million and US$0.07 million for the year ended December 31, 2012 and 2011, respectively, the non-cash gain recognized for deconsolidation of subsidiaries of approximately US$0.93 million, the related deferred income tax expenses of approximately US$0.21 million, and the non-cash expenses of share-based compensation recognized for the restricted stock and common stock purchase options issued to our management, directors and employees on November 30, 2011 of approximately US$2.6 million for the year ended December 31, 2011, our adjusted Non-GAAP net income (after allocation to the noncontrolling interest shareholders) was US$3.2 million and US$5.0 million for the year ended December 31, 2012 and 2011, respectively.
 
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Our Corporate History, Background, Subsidiaries, Variable Interest Entities (VIEs) and Equity Investment Affiliates
 
As of December 31, 2012, our Corporate Structure is set forth below:
 
 
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We were 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 incorporation until June 26, 2009, when we consummated the Share Exchange (as defined below), our business development activities were primarily concentrated in web server access and company branding in hosting web based e-games.
 
  Our wholly owned subsidiary, China Net Online Media Group Limited, was incorporated in the British Virgin Islands on August 13, 2007 (“China Net BVI”).  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 People's Republic of China (“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.”
 
Restructuring
 
In October 2008, a restructuring plan was developed (the “Restructuring”).  The Restructuring was accomplished in two steps.  The first step was for Rise King WFOE to acquire control over Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”) and Beijing CNET Online Advertising Co., Ltd. (“Beijing CNET Online”) (collectively the “PRC Operating Entities” or the “VIEs”) by entering into a series of contracts (the “Contractual Agreements” or the “VIE Agreements”), which enabled Rise King WFOE to operate the business and manage the affairs of the PRC Operating Entities. At the time of the restructuring, Beijing CNET Online owned a 51% equity interest in Shanghai Borongdingsi Computer Technology Co., Ltd. (“Shanghai Borongdingsi”). Both of the PRC Operating Entities at that time were, and currently are, owned by Messrs. Handong Cheng, Xuanfu Liu and Ms. Li Sun (the “PRC Shareholders” or the “Control Group”). Mr. Cheng is now our Chief Executive Officer.  After the PRC Restructuring was consummated, the second step was for China Net BVI to enter into and complete a transaction with a U.S. public reporting company, whereby that company would acquire China Net BVI, China Net HK and Rise King WFOE, and control the PRC Operating Entities (the “China Net BVI Companies”).
 
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 e-banking advertisement business. The business is based on an e-banking 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 advertising business within the business outlets throughout Henan Province. The e-banking cooperation agreement has a term of eight years, which began in August 2008. However, Shanghai Borongdingsi was not able to conduct the advertising business as a stand-alone business due to the lack of an advertising 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 Shanghai Borongdingsi’s name on behalf of the business, and holds the right to collect the advertising revenue generated from the kiosk business exclusively until it recovers of the cost of purchasing the equipment. Thereafter, Beijing CNET Online has agreed to distribute 49% of the net profit generated from the e-banking advertising business, if any, to the minority shareholders of Shanghai Borongdingsi.
 
 Legal Structure of the PRC Restructuring
 
 The PRC Restructuring was consummated in a manner so as not to violate PRC laws relating to restrictions on foreign ownership of businesses in certain industries in the PRC and the PRC M&A regulations.
 
 
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 The Foreign Investment Industrial Guidance Catalogue jointly issued by the Ministry of Commerce (“MOFCOM”) and the National Development and Reform Commission in 2007 classified various industries/business into three different categories: (i) encouraged for foreign investment, (ii) restricted to foreign investment and (iii) prohibited from foreign investment.  For any industry/business not covered by any of these three categories, they will be deemed to be industries/business permitted to have foreign investment.  Except for those expressly provided restrictions, encouraged and permitted industries/businesses are usually open to foreign investment and ownership.  With regard to those industries/businesses restricted to or prohibited from foreign investment, there is always a limitation on foreign investment and ownership.
 
 The business of the PRC Operating Entities falls under the class of a business that provides Internet content or information services, a type of value added telecommunication services, for which restrictions upon foreign ownership apply. As a result, Rise King WFOE is not allowed to do the business the PRC Operating Entities companies are currently pursuing.  Advertising business is open to foreign investment but one of the requirements is that the foreign investors of a WFOE shall have been carrying out advertising business for over three years pursuant to the Foreign Investment Advertising Measures as amended by MOFCOM and the State Administration of Industry and Commerce (“SAIC”) on August 22, 2008.  Rise King WFOE is not allowed to engage in the advertising business because its shareholder, China Net HK, does not meet such requirements.  In order to control the business and operations of the PRC Operating Entities, and consolidate the financial results of the two companies in a manner that does not violate current PRC laws, Rise King WFOE executed the Contractual Agreements with the PRC Shareholders and each of the PRC Operating Entities. The Contractual Agreements allow us, through Rise King WFOE, to, among other things, secure significant rights to influence the two companies’ business operations, policies and management, approve all matters requiring shareholder approval, and receive 100% of the income earned by the PRC Operating Entities.  In return, Rise King WFOE provides consulting services to the PRC Operating Entities.  In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform their obligations under the Contractual Arrangements, the PRC Shareholders have pledged all of their equity interests in the PRC Operating Entities to Rise King WFOE.  They have also entered into an option agreement with Rise King WFOE which provides that at such time as when the current restrictions under PRC law on foreign ownership of Chinese companies engaging in the Internet content or information services in China are lifted, Rise King WFOE may exercise its option to purchase the equity interests in the PRC Operating Entities, directly.
 
 Each of the PRC Shareholders entered into a share transfer agreement (the “Share Transfer Agreement”) with Mr. Yang Li, the sole shareholder of Rise King Investment Limited, a British Virgin Islands company (“Rise King BVI”), which is a 55% shareholder of China Net BVI.  In entering into the Share Transfer Agreement, Ms. Li Sun was acting as the nominee of Mr. Zhige Zhang, our chief financial officer.  Mr. Zhang did not report his indirect ownership of ChinaNet BVI’s common stock by virtue of Ms. Li acting as his nominee on his original Form 3 filed with the SEC.  The PRC Shareholders were granted the incentive options for the contributions that they made and continue to make to Rise King BVI. Under the Share Transfer Agreements Mr. Li granted each of the PRC Shareholders an option to acquire, in the aggregate 10,000 shares of Rise King BVI, representing 100% of the issued and outstanding shares of Rise King BVI, provided that certain financial performance thresholds were met by the China Net BVI Companies.  The Share Transfer Agreement was formalized and entered into on April 28, 2009.  There is no prohibition under PRC laws for the PRC Shareholders to earn an interest in Rise King BVI after the PRC Restructuring is consummated in compliance with PRC law.
 
 Pursuant to the Share Transfer Agreement, the Option Shares vest and become exercisable in one-third increments upon the China Net BVI Companies attaining consolidated gross revenue performance targets for fiscal 2009, the six month period ended June 30, 2010 and the six month period ended December 31, 2010 of RMB 100 million, RMB 60 million and RMB 60 million, respectively. If China Net BVI Companies achieve the performance targets the exercise price will be $1.00 per share.  If the targets are not met, the exercise price will be $2.00 per share. As of February 14, 2011, 100% of the Option Shares were exercisable.  On March 30, 2011, Ms. Li Sun transferred the Option Shares held by her to Mr. Zhang.  On March 30, 2011, pursuant to the terms of the Share Transfer Agreement, each of Mr. Cheng, Mr. Liu and Mr. Zhang exercised their rights to acquire the Option Shares. Due to the fact that the China Net BVI Companies had achieved the performance targets set forth in the Share Transfer Agreement, each of Mr. Cheng, Mr. Liu and Mr. Zhang paid an exercise price of $1.00 per share to Mr. Yang Li.  As a result of this exercise, Mr. Cheng, Mr. Liu and Mr. Zhang became the shareholders of Rise King BVI. As of April 12, 2013,
 
 
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through Rise King BVI, Mr. Cheng, Mr. Liu and Mr. Zhang collectively hold 34% of issued and outstanding shares of our common stock.
 
Summary of the material terms of the VIE Agreements:
 
Exclusive Business Cooperation Agreements:
 
Pursuant to the Exclusive Business Cooperation Agreements entered into by and between Rise King WFOE and each of the PRC Operating Entities, Rise King WFOE has the exclusive right provide to the PRC Operating Entities complete technical support, business support and related consulting services during the term of these agreements, which includes but is not limited to technical services, business consultations, equipment or property leasing, marketing consultancy, system integration, product research and development, and system maintenance. In exchange for such services, each PRC Operating Entity has agreed to pay a service fee to Rise King WFOE equal to 100% of the net income of each PRC Operating Entity. Adjustments may be made upon approval by Rise King WFOE based on services rendered by Rise King WFOE and operational needs of the PRC Operating Entities. The payment shall be made on a monthly basis, if at year end, after an audit of the financial statements of any PRC Operating Entities, there is determined to be any shortfall in the payment of 100% of the annual net income, such PRC Operating Entity shall pay such shortfall to Rise King WFOE. Each agreement has a ten-year term. The term of these agreements may be extended if confirmed in writing by Rise King WFOE, prior to the expiration of the term. The extended term shall be determined by Rise King WFOE, and the PRC Operating Entities shall accept such extended term unconditionally.
 
Exclusive Option Agreements:
 
Under the Exclusive Option Agreements entered into by and among Rise King WFOE, each of the PRC Shareholders irrevocably granted to Rise King WFOE, or its designated person, an exclusive option to purchase, to the extent permitted by PRC law, a portion or all of their respective equity interest in any PRC Operating Entities for a purchase price of RMB10, or a purchase price to be adjusted to be in compliance with applicable PRC laws and regulations. Rise King WFOE, or its designated person, has the sole discretion to decide when to exercise the option, whether in part or in full. Each of these agreements has a ten-year term, subject to renewal at the election of Rise King WFOE.
 
Equity Pledge Agreements:
 
Under the Equity Pledge Agreements entered into by and among Rise King WFOE, the PRC Operating Entities and each of the PRC Shareholders, the PRC Shareholders pledged all of their equity interests in the PRC Operating Entities to guarantee the PRC Operating Entities’ performance of its obligations under the Exclusive Business Cooperation Agreements. If the PRC Operating Entities or any of the PRC Shareholders breaches its/his/her respective contractual obligations under these agreements, or upon the occurrence of one of the events regarded as an event of default under each such agreement, Rise King WFOE, as pledgee, will be entitled to certain rights, including the right to dispose of the pledged equity interests. The PRC Shareholders of the PRC Operating Entities agreed not to dispose of the pledged equity interests or take any actions that would prejudice Rise King WFOE's interest, and to notify Rise King WFOE of any events or upon receipt of any notices which may affect Rise King WFOE's interest in the pledge. Each of the equity pledge agreements will be valid until all the payments related to the services provided by Rise King WFOE to the PRC Operating Entities due under the Exclusive Business Cooperation Agreements have been fulfilled. Therefore, the equity pledge agreements shall only be terminated when the payments related to the ten-year Exclusive Business Cooperation Agreement are paid in full and the WFOE does not intend to extend the term of the Exclusive Business Cooperation Agreement.
 
Irrevocable Powers of Attorney:
 
The PRC Shareholders have each executed an irrevocable power of attorney to appoint Rise King WFOE as their exclusive attorneys-in-fact to vote on their behalf on all PRC Operating Entities matters requiring shareholder
 
 
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approval. The term of each power of attorney is valid so long as such shareholder is a shareholder of the respective PRC Operating Entity.
 
As a result of these VIE Agreements, we through our wholly-owned subsidiary, Rise King WFOE, was granted with unconstrained decision making rights and power over key strategic and operational functions that would significantly impact the PRC Operating Entities or the VIEs’ economic performance, which includes, but is not limited to, the development and execution of the overall business strategy; important and material decision making; decision making for merger and acquisition targets and execution of merger and acquisition plans; business partnership strategy development and execution; government liaison; operation management and review; and human resources recruitment and compensation and incentive strategy development and execution. Rise King WFOE also provides comprehensive services to the VIEs for their daily operations, such as operational technical support, OA technical support, accounting support, general administration support and technical support for products and services. As a result of the Exclusive Business Cooperation Agreements, the Equity Pledge Agreements and the Exclusive Option Agreements, we will bear all of the VIEs’ operating costs in exchange for 100% of the net income of the VIEs. Under these agreements, we have the absolute and exclusive right to enjoy economic benefits similar to equity ownership through the VIE Agreements with our PRC Operating Entities and their shareholders.
 
Accounting Treatment of the Restructuring:
 
The Restructuring is accounted for as a transaction between entities under common control in a manner similar to pooling of interests, with no adjustment to the historical basis of the assets and liabilities of the PRC Operating Entities.  The operations of the PRC Operating Entities are consolidated as if the current corporate structure had been in existence throughout the period presented in the audited financial statements. The Restructuring is accounted for in this manner because, pursuant to an Entrustment Agreement dated June 5, 2009 (the “Entrustment Agreement”) between Rise King BVI and the PRC Shareholders, Rise King BVI granted to the PRC Shareholders, on a collective basis, managerial control over each of the China Net BVI Companies by delegating the PRC Shareholders its shareholder rights, including the right to vote, and its rights to designate management of China Net BVI.  The Entrustment Agreement, together with the Contractual Arrangements demonstrates the ability of the PRC Shareholders to continue to control Business Opportunity Online and Beijing CNET Online, which are under our common control.  On March 30, 2011, in connection with the exercise of the options pursuant to the Share Transfer Agreement, the Entrustment Agreement was terminated.
 
Share Exchange
 
On June 26, 2009, we entered into a Share Exchange Agreement (the “Exchange Agreement”), with (i) ChinaNet BVI, (ii) ChinaNet 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 “ChinaNet BVI Shareholders”), who together own shares constituting 100% of the issued and outstanding ordinary shares of ChinaNet BVI (the “ChinaNet BVI Shares”), and (iii) G. Edward Hancock, the former principal stockholder of the Company. Pursuant to the terms of the Exchange Agreement, the ChinaNet BVI Shareholders transferred to the Company all of the ChinaNet BVI Shares in exchange for the issuance of 13,790,800 (the “Exchange Shares”) shares of Common Stock (the “Share Exchange”). As a result of the Share Exchange, ChinaNet BVI became a wholly owned subsidiary of our company and we are now a holding company, which, through certain contractual arrangements with operating companies in the PRC, is engaged in providing advertising, marketing and communication services to small and medium companies in China.
 
Name Change
 
Prior to July 14, 2009, our company name was Emazing Interactive, Inc.  On July 14, 2009, our company formed a corporation under the laws of the State of Nevada called ChinaNet Online Holdings, Inc. (the "Merger Sub") and acquired one hundred shares of its common stock for cash. As such, Merger Sub was merged with and into our
 
 
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company.  As a result of the merger, the separate corporate existence of the Merger Sub ceased.  As a further result of the merger, our corporate name was changed to “ChinaNet Online Holdings, Inc.” We are the surviving corporation in the merger and, except for the name change provided for in the Agreement and Plan of Merger, there was no change in our directors, officers, capital structure or business.
 
2009 Financing
 
On August 21, 2009 (the “Closing Date”), we entered into a securities purchase agreement (the “Purchase Agreement”), with several investors, including institutional, accredited and non-US persons and entities (the “Investors”), pursuant to which we sold units, comprised of 10% Series A Convertible Preferred Stock, par value $.001 per share (the “Series A Preferred Stock”), and two series of warrants, for a purchase price of $2.50 per unit and gross proceeds of approximately $10.3 million (the “Financing”). Net proceeds from the Financing were approximately $9.2 million. We sold 4,121,600 units in the aggregate, which included (i) 4,121,600 shares of our Series A Preferred Stock, (ii) Series A-1 Warrants to purchase 2,060,800 shares of Common Stock at an exercise price of $3.00 per share with a three-year term, and (iii) Series A-2 Warrants to purchase 2,060,800 shares of Common Stock at an exercise price of $3.75 with a five-year term. In connection with the Financing, we issued to TriPoint Global Equities, LLC warrants to purchase 329,728 shares of our Common Stock at an exercise price of $2.50 per share, 164,864 at an exercise price of $3.00 and 164,864 at an exercise price of $3.75. The warrants expire on August 20, 2014.
 
On August 21, 2011, pursuant to the Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock, all outstanding shares of the Series A Convertible Preferred Stock were converted into shares of our common stock.
 
On December 1, 2011, we launched a tender offer pursuant to which we offered all holders of our outstanding Series A-1 Warrants and Series A-2 Warrants the opportunity to exchange their warrants in accordance with the following exchange ratios: (A) with respect to any Series A-1 Warrant, one share of our common stock in exchange for every twenty shares for which such Series A-1 Warrant was exercisable, and (B) with respect to any Series A-2 Warrant, one share of our common stock  in exchange for every ten shares for which such Series A-2 Warrant was exercisable.  The tender offer expired on December 30, 2011 and 1,418,800 Series A-1 Warrants were tendered in exchange for approximately 70,940 shares of our common stock and 356,800 Series A-2 Warrants were tendered in exchange for approximately 35,680 shares of our common stock.
 
On August 20, 2012, the remaining Series A-1 warrants to purchase up to 642,000 share of our common stock issued on August 21, 2009 expired. The remaining Series A-2 warrants to purchase up to 1,704,000 shares of our common stock and placement agent warrants to purchase up to 659,456 shares of our common stock will expire on August 20, 2014.
 
Our VIEs, VIEs’ subsidiaries and equity investment affiliates
 
As discussed above, we beneficially own two VIEs: Business Opportunities Online and Beijing CNET Online. Beijing CNET Online owns a 51% equity interest in Shanghai Borongdingsi.
 
On June 24, 2010, one of our VIEs, Business Opportunity Online, together with three other individuals, who were not affiliated with us, 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 independent third party investor, who was not affiliated with us or any of our affiliates, invested RMB15,000,000 (approximately US$2,374,883) into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan. As a result of this transaction, our share of the equity interests 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. On December 19, 2012, as
 
 
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approved by the shareholders of Shenzhen Mingshan, Shenzhen Mingshan reduced its registered and paid-in capital from RMB25,000,000 (approximately US$3,958,139) to RMB22,000,000 (approximately US$3,483,162), resulted from a decrease of paid-in capital from three other noncontrolling shareholders, except Business Opportunity Online. As a result, our share of the equity interest in Shenzhen Mingshan increased from 20.4% to 23.18% and we continued to retain significant influence over Shenzhen Mingshan. Therefore, as of December 31, 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.
 
 On December 8, 2010, Shanghai Jing Yang acquired a 49% equity 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, entered into an equity interest acquisition agreement with the shareholders of Quanzhou Zhi Yuan Marketing Planning Co., Ltd. (“Quanzhou Zhi Yuan”) and Quanzhou Tian Xi Shun He Advertisement Co., Ltd. (“Quanzhou Tian Xi Shun He”), (collectively “the acquirees”) on December 18, 2010 and December 22, 2010, to acquire a 100% equity interest in Quanzhou Zhi Yuan and a 51% equity interest in Quanzhou Tian Xi Shun He, respectively. These acquisitions were subsequently consummated 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 entered into an additional agreement with the noncontrolling interest holders of Quanzhou Tian Xi Shun He to purchase the remaining 49% equity interest of Quanzhou Tian Xi Shun He. On June 27, 2011, this transaction was approved by, and registered with, the relevant PRC government authorities of Quanzhou City, Fujian Province of PRC. Quanzhou Tian Xi Shun He became a wholly owned subsidiary of Beijing CNET Online.
 
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
 
 
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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 independent third party investors, who were not affiliated with us or any of our affiliates, invested RMB10,000,000 (approximately US$1,583,255) into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interest 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 December 31, 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. In September 2012, the Company sold all of its equity interest in Business Opportunity Online Chongqing to two unaffiliated parties. Business Opportunity Online Chongqing was dormant from the time of its incorporation through the date the Company disposed of its equity interest to two unaffiliated parties.
 
On December 15, 2011, Business Opportunity Online Hubei entered into an equity transfer agreement with Sou Yi Lian Mei Network Technology (Beijing) Co. Ltd. (“Sou Yi Lian Mei”) and its shareholders, to acquire a 51% equity interests in Sou Yi Lian Mei. In September 2012, Business Opportunity Online Hubei acquired the remaining 49% equity interest in Sou Yi Lian Mei. Sou Yi Lian Mei became a wholly owned subsidiary of Business Opportunity Online Hubei accordingly. Sou Yi Lian Mei is based in Beijing, China, and is primarily 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 December 31, 2012, we operated our business primarily in China through our PRC subsidiary and operating entities, or VIEs, as summarized above.
 
Industry and Market Overview
 
Overview of the Advertising Market in China
 
China has the largest advertising market in Asia, excluding Japan. According to ZenithOptimedia in 2012, China’s advertising market was the third-largest in the world by media expenditure, which was estimated to be approximately US$32.30 billion, accounting for 24.4% of the total advertising spending in the Asia-Pacific region. ZenithOptimedia also projected that the advertising market in China will be one of the fastest growing advertising markets in the world, at a compound annual growth rate of 10.8% from 2011 to 2014. By 2014, China is projected to account for 28.0% of the total advertising spending in the Asia-Pacific region. The growth of China’s advertising market is driven by a number of factors, including the rapid and sustained economic growth and increases in disposable income and consumption in China. China was the second largest economy in the world in 2012 in terms of gross domestic product, which amounted to US$8.3 trillion.
 
 
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 According to the National Bureau of Statistics of China, the annual disposable income per capita in urban households increased from RMB21,810 in 2011 to RMB24,565 in 2012, representing an increase of 12.6%. Adjusted by the price factors, the actual increase was 9.6%.
 
According to ZenithOptimedia (October, 2012), China became the third largest advertising market in the world, and by 2014, China will contribute approximately US$43.94 billion to global advertising spending, following the United States and Japan, which contributes approximately US$173.95 billion and US$52.96 billion to global advertising spending, respectively. Japan, the largest advertising spender in the Asia-Pacific region, is only expected to grow its advertising spending by 6% between 2011 and 2014, whereas an emerging market, like China, will grow its advertising spending by 36% in the same period. Overall, the Asia-Pacific region, excluding Japan, is estimated to have one of the highest growth rates on a year-over-year basis from 2011 to 2014, with an average growth rate of 8.9%. China is expected to lead the growth in the region.
 
Overview of the Internet Advertising Industry
 
ZenithOptimedia projected that the global internet advertising market will grow by 52.5% between 2011 and 2014 and reach US$116.8 billion in 2014. Within China, the internet advertising market was particularly strong and grew to approximately US$11.6 billion in 2012, according to Enfodesk (February 2013). This growth is expected to stem primarily from a higher internet penetration rate of just 42.1% by the end of 2012 (The Ministry of Industry and Information Technology of China, February 2012), the use of search engine, rich media and video and game embedded advertisements. According to “2012 China Internet Economy Report (Brief Edition)” issued by iResearch Consulting Group, the China Internet Advertising is expected to reach RMB102.4 billion Yuan ( approximately US$16.2 billion) in 2013, representing an approximate 36.0% year-over-year growth. The diagram below depicts the Market Scale of China Internet Advertising from 2006 to 2016:
 
 
High Demand for the Internet Advertising from the Franchise and Chain Store Business in China
 
 
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We believe that the Internet advertising market in China also has significant potential for future growth due to high demand from the rapid development of franchise and chain store businesses and SMEs. According to the 2011 China Franchise Annual Development Report by China Chain Store & Franchise Association, by the end of 2010, there were approximately 4,500 franchise enterprises and 400,000 chain stores in China, which covered approximately 70 industries and offered over 5 million direct employment opportunities.
 
The development of the SME market is still in its early stages in China and since their sales channels and distribution networks are still underdeveloped, they are driven to search for new participants by utilizing Internet advertising and marketing. The SMEs tend to be smaller, less-developed brands primarily focused on restaurants, garments, building materials, home appliances, and entertainment with low start-up costs, ranging between US$1,000 to US$15,000. The Chinese government has promulgated a series of laws and regulations to protect and promote the development of SMEs which appeals to entrepreneurs looking to benefit from the central government’s support of increased domestic demand. SMEs are now responsible for about 60% of China’s industrial output and employment of approximately 80% of the urban Chinese workforce. SMEs are creating new urban jobs, and they are the main destination for new graduates entering the workforce and workers laid-off from state-owned enterprises (SOEs) that re-enter the workforce.
 
Our Principal Products and Services
 
Our products and services include:
 
Internet Advertising
 
Founded in 2003, 28.com is a leading Internet portal for information about small business opportunities in China. It was one of the earliest entrants in this sector, allowing it to currently hold a market share of over 33% in China. In 2011, we also developed two new advertising web portals, which are liansuo.com and chuangye.com. Liansuo.com is built to serve larger SMEs than 28.com with additions of other internet related services. Liansuo.com is also intended to serve large international clients. Chuangye.com is built to serve the community of entrepreneurs to assist them developing their business, as well as sharing their resources in a web2.0 and SNS2.0 driven interaction in combination with popular web social tools. In 2012, we further developed and upgraded the system and tools of these two websites, including customer user interface, additional integrated mobile function and cloud-based search engine marketing and optimization in preparation for mobile search marketing and mobile search optimization. Upon acquiring Sou Yi Lian Mei Network Technology (Beijing) Co., Ltd., we obtained another established online advertising and marketing portal, sooe.cn, which focuses on the smaller sized and emerging SMEs.
 
Our internet advertising services provide advertisers with tools to build sales channels directly in the form of franchisees, sales agents, distributors, and/or resellers, and have the following features which enable them to be attractive to the advertisers:
We charge our clients a fixed monthly or annual membership fee for the internet advertising services and the related value-added technical services that we provide. As of December 31, 2012, we have approximately 1,300 clients and our total revenue per month reached approximately US$1.78 million in 2012, as compared to approximately US$1.67 million in 2011. This segment accounted for 46% of our revenue in 2012 and 70% of our revenue in 2011.
 
 
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Television Advertising
 
As part of our advertising and marketing services, we produce and distribute television shows that are comprised of advertisements similar to infomercials, but include promotions for several clients during the allotted time. Our clients pay us for advertising spots, production and editorial coverage. The shows produced by our TV unit are distributed during airtime purchased on several provincial satellite television stations including Henan TV, Jiangxi TV, and Neimenggu TV. Our total show time reached approximately 18,510 minutes in 2012, as compared to approximately 6,040 minutes in 2011. This segment accounted for 44% of our revenue in 2012 and 22% of our revenue in 2011. This increase in TV advertising time selling was due to enhanced cooperation with the TV station responsible for launching the entrepreneurial reality show, which is intended to get the general public to visit our websites, Chuanye.com and create additional traffic on our two advertising portals, 28.com and Liansuo.com, and in return to monetize more branded larger size small and medium enterprises to use our services while securing our competitive advantage in the TV business segment against our competitors.
 
Bank Kiosks
 
We operate our bank kiosk advertising network, through Shanghai Borongdingsi. We place our kiosk machines, which include a large LCD advertising display, in bank branches to target banking patrons. We market our LCD display network to advertisers in the financial services and insurance industries. As of December 31, 2012, we had a total of 610 flat-panel displays placed in branches of China Construction Bank in Henan province and Shanghai Rural Commercial Bank in Shanghai. The kiosks are useful to the banks because, in addition to the LCD advertising display, they provide bank customers with free Internet access to on-line banking services, thereby potentially making wait times in branches for teller services more enjoyable for the bank customer. For the year ended December 31, 2012, we generated US$0.28 million revenue from this segment as compared to US$0.49 million revenue for the year ended December 31, 2011. The bank kiosk advertising business is still in the early stages and many details still need to be further analyzed and finalized before we allocate more capital into this business unit. It was not a significant contributor to revenue for either the year ended December 31, 2012 and 2011. Management currently believes that this business is unlikely to expand in the near future and that some of the technology used in this business unit will be fully integrated into the overall advertising and marketing platform.
 
Brand management and sales channel building
 
Brand management and sales channel building services, primarily include brand “iMAP” management services (investigation, modulizaiton, application and promotion) and sales channel development services. We started this business in 2011 and continue to oversee its development. With the integration of two advertising firms in Quanzhou City, Fujian province, the PRC, we are gradually moving our business reach into the southern part of China, where many SMEs are located. Currently, this business unit has 39 clients and generated approximately US$4.5 million revenue in 2012.
 
Our Competitive Strengths
 
Over our eight year operating history, we believe that we have built a strong track record of significant competitive strengths. We believe that these competitive strengths include:
 
Innovative Operations
 
·  
Client-based innovation. Our advertising and marketing services are intended to be a one-stop shop for advertising and marketing solutions to our clients.  These services are based on the needs of our existing clients. All of our value added services, including lead generation and capture, online messaging and consulting, search engine marketing and optimization, mini-site hosting and, content management, simplify the business process for our clients by allowing them to effectively allocate their resources and budget for various advertising and marketing tools and channels.
 
 
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·  
Target market innovation and expansion of audience base.  We believe that by offering a multichannel communication platform, we enable SMEs to reach a wide range of consumers with complementary and mutually reinforcing advertising and marketing campaigns. We are better able to attract business owners who want to reach targeted consumer groups through a number of different advertising channels in different venues and regions, and at different times of the day.
 
Strong Technological Advantages
 
·  
Advanced campaign tracking & monitoring tools. We have deployed advanced tracking, search engine optimization, resource scheduling and content management and ad campaign management tools to achieve effective and efficient advertising effects.
 
·  
Valuable intellectual property. We have twenty-six copyright certificates and property rights for twenty-six software products in connection with the advertising business, all of which were developed by our research and development team.
 
·  
Experienced management team. We have an experienced management team. In particular, Handong Cheng, our founder, chairman and chief executive officer has over ten years’ experience in management. He demonstrated his entrepreneurship and business leadership by starting our business and he has successfully grown our business to become a leader in online media marketing and advertising services. He also secured our status as the sole strategic alliance partner of China Construction Bank in Henan province with respect to bank kiosk advertising. George Chu, our Chief Operating Officer, has diversified and international industry experience that will help us to scale to the next level. Zhige Zhang, our Chief Financial Officer has over seven years’ experience in software development and Internet ad technology. In June 2012, we appointed Mr. Zhenghong Yang as our Chief Technology Officer, who will oversee our information technology infrastructure and development roadmap. With in-depth knowledge of software and cloud computing technology, Mr. Yang will help us to deepen our strategic relationships with search engine partners in China and to strengthen our brand in the SME space and accelerate the penetration of our target market in China.
 
First Mover Advantages

We have over six years of operations as a vertically integrated ad portal and ad agency. We have nine years of experience as an Internet advertising agency. We commenced our Internet advertising services business in 2003 and were among the first companies in China to create a site and a business focused on Internet advertising. We rapidly established a sizeable national network, secured a significant market share and enhanced awareness of our brand. Our early entry into the market has also enabled us to accumulate a significant amount of knowledge and experience in this nascent segment of the advertising industry and to be able to maintain a strong market share position. We are also the first company that is providing O2O (online-to-offline) sales channel expansion services in China to small business.
 
Growth Strategy
 
Our objectives are to strengthen our position as the leading B2B Internet service provider on advertising, marketing, brand and sales channel management solutions for sales channel expansion of SMEs in China and to continue to achieve sustainable and healthy growth on a consistent basis. We intend to achieve these objectives by implementing the following strategies:
 
Continue expanding the size of our potential client base with advertising solution provided by Liansuo.com and brand and sales channel expansion management and expansion solutions provided by our Brand management and sales channel building segment
 
We have been expanding our target client group to the non-franchised SMEs in 2012 with focusing on enterprises which have been in the manufacturing and exporting business and turned to domestic market in China. These businesses all experienced sharp decline in sales account of slow economic recovery and lower consumption demand in Europe and United States. We estimate that there are 4 million businesses that fall into the category of
 
 
15
 
non-franchised SMEs, and we aim to assist them in expanding their business nationally in China. We are continuing to expanding the size of our potential client base with advertising solution provided by Liansuo.com and brand and sales channel expansion management and expansion solutions by brand IMAP (investigation, modulizaiton, application and promotion) management service and the offline sales channel expansion service, provided by our operating VIEs in Quanzhou and Zhao Shang Ke Hubei, our equity investment affiliate. Since 2011, we have increased our engaged client base from 2000 enterprises in 2010 to more than 10,000 enterprises in 2012.
 
Monetizing the existing customer base through the addition of cloud-computing based mobile services and management tools
 
We intend to launch integrated cloud-computing based management tools and/or solutions to our existing clients in 2013.  These tools include, among other things, elite point of sales (POS), inventory supply chain management, office automation (OA) and customer relationship management (CRM).  This service is intended to increase our recurring revenues and enhance the loyalty and service satisfaction of our clients. We will continue to cross-sale the services that were launched in 2012, including clever cloud optimizer and quick connect.  Throughout the next few years, we intend to increase the depth of this type of service through partnerships and/or through mergers and acquisitions.
 
Increasing our business opportunity through mergers and acquisitions to boost operational and cross-selling synergies
 
We plan to maximize opportunities for our business with a broader client base to increase recurring revenue with lower cost by merging with, or acquiring, small regional advertising firms. We plan to accomplish cross-selling after expanding our client base through these regional advertising firms to materialize the synergies obtained through mergers and acquisitions.  As a result, we will be able to provide additional, flexible and bundled advertising and marketing packages that will allow SMEs to reach consumers through various communication channels. In addition, all other value added services previously discussed will be provided to them, including management tools platform in the future.
 
Building up a competitive barrier by means of technology and strategic partnerships with key internet and mobile players in China or globally
 
Technology and strategic partnerships will allow us to solidify our industry’s leading position and broaden our client base by higher customer satisfaction and growing market awareness of our services.  It will also enhance our ability to target discrete consumer groups. These technologies include technology area of mobile advertising with location based functionality, advertising tracking and conversion, database mining and management. Strategic partnerships include partnerships with key mobile search engine in China, key social media as well as other internet directing portals.
 
Sales and Marketing
 
For the year ended December 31, 2012, we derived 46% our revenues from our Internet advertising and provision of the related technical services and 44% from our TV advertising, compared to 70% and 22%, respectively, for the year ended December 31, 2011.
 
The following table sets forth a breakdown of our revenue from Internet advertising and the related technical services, by industry, for the year ended December 31, 2012:

Industry
  
Percentage of total revenue
  
Food and beverage
    
20
%
Women Accessories
    
7
%
Footwear, apparel and garments
    
14
%
Home Goods and Construction Materials
    
13
%
Environmental Protection Equipment
    
12
%
Cosmetic and Health Care
    
15
%
Education Network
    
12
%
Others
    
7
%
Total
    
100
%
 
 
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For the year ended December 31, 2012, our TV advertising revenues were primarily achieved from cosmetics and health care, women accessories and food and beverage industries.
 
We employ experienced advertising sales people. We provide in-house education and training to our sales people to ensure that they provide our current and prospective clients with comprehensive information about our services, the benefits of using our advertising and marketing services and relevant information regarding the advertising industry.  We also market our advertising services from time to time by placing advertisements on television and other well-known portals of China, participating in domestic and international franchise exhibitions in China and other countries and acting as a sponsor to third-party programming, as well as to our own shows.
 
We believe our advertising clients derive substantial value from our ability to provide advertising services targeted at specific segments of consumer markets. Market research is an important part of evaluating the effectiveness and value of our business to our customers. We conduct market research, consumer surveys, demographic analysis and other advertising industry research for internal use to evaluate new and existing advertising and marketing channels. We also purchase or commission studies containing relevant market data from reputable third-party market research firms when necessary. We typically consult such studies to assist us in evaluating the effectiveness of our network to our advertisers. A number of these studies contain research on the numbers and socio-economic and demographic profiles of the people who visit our network.
 
Suppliers
 
Our suppliers are major search engines, other internet gateways and regional television stations. Among these suppliers, for the year ended December 31, 2012, Baidu counted for approximately 52% of our internet resource cost.  For television, we have three regional television stations which supply us with television airtime.
 
Research and Development
 
We intend to continue to optimize our Standard Operating Environment (the “SOE”) technology in order to reduce costs and the time to deploy, configure, maintain, support and manage computer servers and systems. Whether to further deploy newer technology will depend upon cost and network security. We also continue to develop proprietary software and systems in connection with the operation of and provision of services through 28.com, Liansuo.com and Sooe.cn to enhance ease of use by both operators and customers. We focus on enhancing related software systems enabling us to track and monitor advertiser demands. With the introduction of cloud-computing based technology, we will continue to integrate this technology into our online management tools services through self-development and also by entering into alliances, partnerships, and/or mergers and acquisitions. In 2013, we intend to move our research and development efforts to mobile-based application system and tools more aggressively.
 
Intellectual Property
 
As of December 31, 2012, we had twenty-six software copyright certificates issued by the State Copyright Office of the PRC (“SCO”) as set forth below:

Name of Software
Registration Number
互联网用户监测及网民综合分析评价系统V1.0
Software V1.0 of Internet users Monitor and General Analysis and Assess System
2008SRBJ4071
 
 
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Name of Software Registration Number
互联网信息内容综合管理平台技术软件V1.0
Software V1.0 of General Management Platform on Internet Information Content
 
2008SRBJ4097
互联网广告效果监测数据分析系统软件V1.0
Software V1.0 of Internet Advertising Effect Monitor and Data Analysis System
 
2008SRBJ4083
基于互联网广告效果投放综合监测及管理平台软件 V1.0
Software V1.0 of General Monitoring and Management Platform on Internet Advertising Effect
 
2008SRBJ4073
基于效果的搜索引擎服务平台软件 V1.0
Software V1.0 of Effect-based Search Engine Service Platform
 
2008SRBJ4084
基于互联网广告留言综合分析及管理平台软件 V1.0
Software V1.0 of General Analysis and Management Platform on Internet Based Advertising Message
 
2008SRBJ4085
基于互联网广告留言综合分析及管理平台软件 V2.0
Software V2.0 of General Analysis and Management Platform on Internet Based Advertising Message
 
2010SR038775
基于广告管理和OA系统的综合运营技术平台软件V1.0
Software V1.0 of General Operation Technology Platform on Advertisement Management and OA System
 
2010SR039308
互联网用户监测及网民综合分析评价系统V3.0
Software V3.0 of Internet User Monitor and General Analysis System
 
2010SR039309
互联网信息内容综合管理平台软件 V2.0
Software V2.0 of General Management Platform on Internet information contents
 
2010SR039310
基于互联网广告效果投放综合监测及管理平台软件V2.0
Software V2.0 of General Analysis and Management Platform on Internet Advertising Effect
 
2010SR039311
基于留言效果的搜索引擎服务平台软件V2.0
Software V2.0 of Effect-based Search Engine Service Platform
 
2010SR039020
基于电视媒体广告效果投放效果综合监测及管理平台软件V2.0
Software V2.0 of General Analysis and Management Platform on Television Advertisement Effect
 
2010SR039548
基于用户中心的短信、邮件群发的管理平台软件V1.0
Software V1.0 of General Management Platform on Group Mailing and Group  SMS
2010SR039551
 
 
18
 
 
 Name of Software Registration Number 
基于日志分析的访问热区和浏览轨迹分析系统V1.0
Software V1.0 of Analysis System on Log-Based Visit Hotspot and Browsing Trail
 
2010SR039554
基于用户桌面客户端的广告效果管理平台软件V1.0
Software V1.0 of Management Platform on Client/Service-Based Advertisement Effect
 
2010SR039556
SOOE 互联网效果营销工具平台软件 V1.0
Software V1.0 of SOOE Internet Effect Marketing Tools Platform
 
2010SR017044
SOOE流量统计及网民行为分析软V1.0
Software V1.0 of SOOE Internet Traffic Statistic and Internet User Behavior Analysis System
 
2010SR017040
SOOE搜索引擎效果分析软件V1.0
Software V1.0 of SOOE Search Engine Effect Analysis System
 
2010SR017097
搜易基于互联网效果营销综合服务平台软件V1.0
Software V1.0 of Sou Yi General Service Platform on Internet Effect Marketing
 
2010SR017042
BMtoBM业务综合服务平台软件V1.0
Software V1.0  of General Service Platform on BMtoBM Business
 
2010SRBJ2389
连锁加盟店面管理软件V1.0
 Software V1.0 of Franchise Chain Store Management System
 
2010SRBJ2386
连锁加盟企业综合管理平台软件V1.0
Software V1.0 of General Management Platform on Franchise Chain Enterprise
 
2010SRBJ2388
中小企业渠道管理软件V1.0
Software V1.0 of Small to Medium Enterprise Sales Channel Management System
 
2010SRBJ2365
广告效果监测数据分析软件V1.0
Software V1.0 of Advertising Effect Monitor Data Analysis System
 
2010SRBJ7041
网络营销效果综合分析及投放管理平台软件V1.0
Software V1.0 of Management Platform on Internet Marketing Effect and Placement
2010SRBJ7043
 
With this intellectual property, we can continue providing value-added services that are in demand by our customers and can track end users to help our customers to assess and adjust their marketing strategies and enhance the
 
 
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effectiveness and efficiency of their advertisements placed through our multi-channel advertising and marketing service platform.
 
We increased, and plan to continue increasing, expenditures to enhance the safety of our hardware and server on which we dependent to support our network and manage and monitor programs on the network. We also increased, and plan to continue increasing, investment in research and development as we continue to expand, optimize and enhance the technologies of our portal websites, upgrade our advertising and internet management software and develop our cloud-computing based management tools.
 
Competition
 
We compete with other internet advertising companies in China, including companies that operate Internet advertising portals, such as u88.cn, 3158.com and 78.cn. We compete for clients primarily on the basis of network size and coverage, location, price, the range of services that we offer and our brand name. We also compete for overall advertising spending with other alternative advertising media companies, such as wireless telecommunications, street furniture, billboards, frame and public transport advertising companies, and with traditional advertising media, such as newspapers, magazines and radio.
 
Government Regulation
 
The PRC government imposes extensive controls and regulations over the media industry, including on television, radio, newspapers, magazines, advertising, media content production, and the market research industry. This section summarizes the principal PRC regulations that are relevant to our lines of business.
 
Regulations on the Advertising Industry in China
 
Foreign Investments in Advertising
 
Under the Administrative Provision on Foreign Investment in the Advertising Industry, jointly promulgated by the SAIC and MOFCOM on March 2, 2004, or the 2004 Provision, foreign investors can invest in PRC advertising companies either through wholly owned enterprises or joint ventures with Chinese parties. Since December 10, 2005, foreign investors have been allowed to own up to 100% equity interest in PRC advertising companies. However, the foreign investor must have at least three years of direct operations outside China in the advertising industry as its core business. This requirement is reduced to two years if foreign investment in the advertising company is in the form of a joint venture. Such requirement is also included in the newly promulgated regulation that replaced the 2004 Provision as of October 1, 2008, except that according to the new regulation, the establishment of wholly foreign-owned advertising companies must be approved by the SAIC or its authorized provincial counterparts and provincial MOFCOM, instead of the SAIC and MOFCOM only. Foreign-invested advertising companies can engage in advertising design, production, publishing and agency, provided that certain conditions are met and necessary approvals are obtained.
 
We have not engaged in direct operations outside China in the advertising industry as our core business. Therefore, our subsidiary in China, Rise King WFOE, is ineligible to apply for the required licenses for providing advertising services in China. Our advertising business is operated by Business Opportunity Online and Beijing CNET Online in China. We have been, and are expected to continue to be, dependent on these companies to operate our advertising business. We do not have any equity interest in our PRC Operating Entities, but Rise King WFOE, receives the economic benefits of the same through the Contractual Arrangements.
 
We have been advised by our PRC counsel, that each of the Contractual Agreements complies, and immediately after the completion of the transactions contemplated herein, will comply with all applicable PRC laws and regulations and does not violate, breach, contravene or otherwise conflict with any applicable PRC laws, rules or regulations. However, there exist substantial uncertainties regarding the application, interpretation and enforcement of current and future PRC laws and regulations and their potential effect on corporate structure and contractual arrangements. The interpretation of these laws and regulations are subject to the discretion of competent PRC
 
 
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authorities. There can be no assurance that the PRC regulatory authorities will not take a view different from the opinions of our PRC counsel and determine that its corporate structure and contractual arrangements violate PRC laws, rules and regulations. In the event that the PRC regulatory authorities determine in their discretion that our corporate structure and contractual arrangements violate applicable PRC laws, rules and regulations, including restrictions on foreign investment in the advertising industry in the future, we may be subject to severe penalties, including an order to cease its business operations.
 
Business License for Advertising Companies
 
On October 27, 1994, the Tenth Session of the Standing Committee of the Eighth National People’s Congress adopted the Advertising Law which became effective on February 1, 1995. According to the currently effective Advertising Law and its various implementing rules, companies engaging in advertising activities must obtain from the SAIC or its local branches a business license which specifically includes within its scope the operation of an advertising business. Companies conducting advertising activities without such a license may be subject to penalties, including fines, confiscation of advertising income and orders to cease advertising operations. The business license of an advertising company is valid for the duration of its existence, unless the license is suspended or revoked due to a violation of any relevant law or regulation. We have obtained such a business license from the local branches of the SAIC as required by existing PRC regulations. We do not expect to encounter any difficulties in maintaining the business license. However, if we seriously violate the relevant advertising laws and regulations, the SAIC or its local branches may revoke our business licenses.
 
Outdoors
 
The Advertising Law in China stipulates that the exhibition and display of outdoor advertisements must comply with certain requirements. It provides that the exhibition and display of outdoors advertisements must not:
 
·  
utilize traffic safety facilities and traffic signs;
 
·  
impede the use of public facilities, traffic safety facilities and traffic signs;
 
·  
obstruct commercial and public activities or create an unpleasant sight in urban areas;
 
·  
be placed in restrictive areas near government offices, cultural landmarks or historical or scenic sites; or
 
·  
be placed in areas prohibited by the local governments from having outdoor advertisements.
 
In addition to the Advertising Law, the SAIC promulgated the Outdoor Advertising Registration Administrative Regulations on December 8, 1995, as amended on December 3, 1998 and May 22, 2006, which also governs the outdoor advertising industry in China. Under these regulations, outdoor advertisements in China must be registered with the local SAIC before dissemination. The advertising distributors are required to submit a registration application form and other supporting documents for registration. After review and examination, if an application complies with the requirements, the local SAIC will issue an Outdoor Advertising Registration Certificate for such advertisement. The content, quantity, format, specifications, periods, distributors’ name, and locations of dissemination of the outdoor advertisement must be submitted for registration with the local SAIC. A change of registration with local SAICs must be effected in the event of a change in the distributor, the location of dissemination, the periods, the content, the format, or the specifications of the advertisements. It is unclear whether the SAIC, or any of its local branches in the municipalities and provinces covered by our network, will deem our business as an outdoor advertising business, and thus require us to obtain the Outdoor Advertising Registration Certificate. If the PRC government determines that we are obligated to complete outdoor advertisement registration as an outdoor advertising network operator, we may be subject to administrative sanctions, including discontinuation of its business for failure to complete such registration.”
 
In addition, on December 6, 2007, the State Administration of Radio, Film and Television (“SARFT”) promulgated the December 2007 Notice pursuant to which the broadcasting of audio and visual programs, including news, drama series, sports, technology, entertainment and other programs, through radio and television networks, the Internet and other information systems affixed to vehicles and buildings and in airports, bus and railway stations,
 
 
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shopping malls, banks, hospitals and other outdoor public media would be subject to approval by the SARFT. The December 2007 Notice required the local branches of SARFT to investigate and record any organization or company engaging in the activities described in the December 2007 Notice without permission, to send written notices to such organizations or companies demanding their compliance with the December 2007 Notice, and to report the results of such investigations to SARFT by January 15, 2008. We have not yet received any notice from the SARFT or any of its local branches demanding compliance with the December 2007 Notice.  We may, however, be required to obtain an approval from SARFT under the December 2007 Notice, or may be required to remove entertainment programs from its advertising network.
 
Advertising Content
 
PRC advertising laws, rules and regulations set forth certain content requirements for advertisements in China including, among other things, prohibitions on false or misleading content, superlative wording, socially destabilizing content or content involving obscenities, superstition, violence, discrimination or infringement of the public interest. Advertisements for anesthetic, psychotropic, toxic or radioactive drugs are prohibited. There are also specific restrictions and requirements regarding advertisements that relate to matters such as patented products or processes, pharmaceutical products, medical procedures, alcohol, tobacco, and cosmetics. In addition, all advertisements relating to pharmaceuticals, medical instruments, agrochemicals and veterinary pharmaceuticals, together with any other advertisements which are subject to censorship by administrative authorities according to relevant laws or regulations, must be submitted to relevant authorities for content approval prior to dissemination.
 
Advertisers, advertising operators, including advertising agencies, and advertising distributors are required by PRC advertising laws and regulations to ensure that the content of the advertisements they prepare or distribute is true and in full compliance with applicable laws. In providing advertising services, advertising operators and advertising distributors must review the supporting documents provided by advertisers for advertisements and verify that the content of the advertisements complies with applicable PRC laws, rules and regulations. Prior to distributing advertisements that are subject to government censorship and approval, advertising distributors are obligated to verify that such censorship has been performed and approval has been obtained. Violation of these regulations may result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders to publish an advertisement correcting the misleading information. In circumstances involving serious violations, the SAIC or its local branches may revoke violators’ licenses or permits for their advertising business operations. Furthermore, advertisers, advertising operators or advertising distributors may be subject to civil liability if they infringe on the legal rights and interests of third parties in the course of their advertising business.
 
We do not believe that advertisements containing content subject to restriction or censorship comprise a material portion of the advertisements displayed on our media network. However, there can be no assurance that each advertisement displayed on our network complies with relevant PRC advertising laws and regulations. Failure to comply with PRC laws and regulations relating to advertisement content restrictions governing the advertising industry in China may result in severe penalties.
 
Regulation on Intellectual Property
 
Regulation on Trademark
 
The Trademark Law of the PRC was adopted at the 24th meeting of the Standing Committee of the Fifth National People’s Congress on August 23, 1982 and amended on February 22, 1993 and October 27, 2001. The Trademark Law sets out the guidelines on administration of trademarks and protection of the exclusive rights of trademark owners. In order to enjoy an exclusive right to use a trademark, one must register the trademark with the Trademark Bureau of the SAIC and obtain a registration certificate.
 
Regulation on Patents
 
The Patent Law of the PRC was adopted at the 4th Meeting of the Standing Committee of the Sixth National People’s Congress on March 12, 1984 and subsequently amended in 1992 and 2000. The Patent Law extends
 
 
22
 
protection to three kinds of patents: invention patents, utility patents and design patents. According to the Implementing Regulations of the Patent Law, promulgated by the State Council of the PRC on December 28, 2002 and effective on February 1, 2003, an invention patent refers to a new technical solution relating to a product, a process or improvement. When compared to existing technology, an invention patent has prominent substantive features and represents notable progress. A utility patent refers to any new technical solution relating to the shape, the structure, or their combination, of a product. Utility patents are granted for products only, not processes. A design patent (or industrial design) refers to any new design of the shape, pattern or color of a product or their combinations, which creates an aesthetic feeling and are suitable for industrial application. Inventors or designers must register with the State Intellectual Property Office to obtain patent protection. The term of protection is twenty years for invention patents and ten years for utility patents and design patents. Unauthorized use of patent constitutes an infringement and the patent holders are entitled to claims of damages, including royalties, to the extent reasonable, and lost profits.
 
Regulation on Copyright
 
The Copyright Law of the PRC was adopted at the 15th Meeting of the Standing Committee of the Seventh National People’s Congress on September 7, 1990 and amended on October 27, 2001. Unlike patent and trademark protection, copyrighted works do not require registration for protection in China. However, copyright owners may wish to voluntarily register with China’s National Copyright Administration to establish evidence of ownership in the event enforcement actions become necessary. Consent from the copyright owners and payment of royalties are required for the use of copyrighted works. Copyrights of movies or other audio or video works usually expire fifty years after their first publication. We believe that we are in compliance with the PRC regulations on copyright.
 
Regulations on Foreign Currency Exchange
 
Foreign Currency Exchange
 
Pursuant to the Foreign Currency Administration Rules promulgated on August 25, 2008 and various regulations issued by SAFE and other relevant PRC government authorities, the Renminbi is freely convertible only to the extent of current account items, such as trade-related receipts and payments, interest and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment, require the prior approval from SAFE or its local branch for conversion of the Renminbi into a foreign currency, such as U.S. dollars, and remittance of the foreign currency outside the PRC. Payments for transactions that take place within the PRC must be made in Renminbi. Domestic companies or individuals can repatriate foreign currency payments received from abroad or deposit these payments abroad subject to applicable regulations that expressly require repatriation within certain period. Foreign-invested enterprises may retain foreign exchange in accounts with designated foreign exchange banks subject to a cap set by SAFE or its local branch. Foreign currencies received under current account items can be either retained or sold to financial institutions engaged in the foreign exchange settlement or sales business without prior approval from SAFE by complying with relevant regulations. Foreign exchange income under capital account can be retained or sold to financial institutions engaged in foreign exchange settlement and sales business, with prior approval from SAFE unless otherwise provided.
 
Our business operations, which are subject to the foreign currency exchange regulations, have all been implemented in accordance with these regulations. We will take steps to ensure that our future operations comply with these regulations.
 
Foreign Exchange Registration of Offshore Investment by PRC Residents
 
Pursuant to SAFE’s Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage in Financing and Inbound Investment via Overseas Special Purpose Vehicles, or Circular No. 75.
 
Dividend Distribution
 
The principal laws, rules and regulations governing dividends paid by PRC operating subsidiaries and VIEs include the Company Law of the PRC (1993), as amended in 2006, the Wholly Foreign Owned Enterprise Law (1986),
 
 
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as amended in 2000, and the Wholly Foreign Owned Enterprise Law Implementation Rules (1990), as amended in 2001. Under these laws and regulations, PRC subsidiaries and VIEs, including wholly owned foreign enterprises, or WFOEs, and domestic companies in China, may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, its PRC significant subsidiaries and VIEs, including WFOEs and domestic companies, are required to set aside at least 10% of their after-tax profit based on PRC accounting standards each year to their statutory capital reserve fund until the cumulative amount of such reserve reaches 50% of their respective registered capital. These reserves are not distributable as cash dividends.
 
Tax
 
On March 16, 2007, the Fifth Session of the Tenth National People’s Congress of PRC passed the Enterprise Income Tax Law of the People’s Republic of China, or EIT Law, which became effective on January 1, 2008. On November 28, 2007, the State Council at the 197th Executive Meeting passed the Regulation on the Implementation of the Income Tax Law of the People’s Republic of China, which became effective on January 1, 2008.  The EIT Law adopted a uniform tax rate of 25% for all enterprises (including foreign-invested enterprises) and revoked the existing tax exemption, reduction and preferential treatments applicable to foreign-invested enterprises. However, there is a transition period for enterprises, whether foreign-invested or domestic, that received preferential tax treatments granted by relevant tax authorities prior to the effectiveness of the EIT Law. Enterprises that were subject to an enterprise income tax rate lower than 25% may continue to enjoy the lower rate and gradually transit to the new tax rate within five years after the effective date of the EIT Law.
 
Under the EIT Law, enterprises are classified as either “resident enterprises” or “non-resident enterprises.” Pursuant to the EIT Law and the Implementation Rules, enterprises established under PRC laws, or enterprises established outside China whose “de facto management bodies” are located in China, are considered “resident enterprises” and subject to the uniform 25% enterprise income tax rate for their global income. According to the Implementation Rules, “de facto management body” refers to a managing body that in practice exercises overall management and control over the production and business, personnel, accounting and assets of an enterprise. Our management is currently based in China and is expected to remain in China in the future. In addition, although the EIT Law provides that “dividends, bonuses and other equity investment proceeds between qualified resident enterprises” is exempted income, and the Implementation Rules refer to “dividends, bonuses and other equity investment proceeds between qualified resident enterprises” as the investment proceeds obtained by a resident enterprise from its direct investment in another resident enterprise, however, it is unclear whether our circumstance is eligible for exemption.
 
Furthermore, the EIT Law and Implementation Rules provide that the “non-resident enterprises” are subject to the enterprise income tax rate of 10% on their income sourced from China, if such “non-resident enterprises” (i) do not have establishments or premises of business in China or (ii) have establishments or premises of business in China, but the relevant income does not have actual connection with their establishments or premises of business in China. Such income tax may be exempted or reduced by the State Council of the PRC or pursuant to a tax treaty between China and the jurisdictions in which its non-PRC shareholders reside. Under the Double Tax Avoidance Arrangement between Hong Kong and Mainland China, if the Hong Kong resident enterprise owns more than 25% of the equity interest in a company in China, the 10% withholding tax on the dividends the Hong Kong resident enterprise received from such company in China is reduced to 5%. If China Net HK is considered to be a Hong Kong resident enterprise under the Double Tax Avoidance Arrangement and is considered to be a “non-resident enterprise” under the EIT Law, the dividends paid to us by Rise King WFOE may be subject to the reduced income tax rate of 5% under the Double Tax Avoidance Arrangement. However, based on the Notice on Certain Issues with Respect to the Enforcement of Dividend Provisions in Tax Treaties, issued on February 20, 2009 by the State Administration of Taxation, if the relevant PRC tax authorities determine, in their discretion, that a company benefits from such reduced income tax rate due to a structure or arrangement that is primarily tax-driven, such PRC tax authorities may adjust the preferential tax treatment.
 
We are in the process of evaluating the impact of the EIT Law on our results of operations. Any significant income tax expenses may have a material adverse effect on our net income in 2008 and beyond. Reduction or elimination of the financial subsidies or preferential tax treatments we currently enjoy or imposition of additional
 
 
24
 
taxes on us or our subsidiary in China may significantly increase our income tax expense and materially reduce our net income.
 
Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors
 
On August 8, 2006, six PRC regulatory agencies, including CSRC, MOC, SAT, SASAC, SAIC and SAFE, jointly promulgated the M&A Rules, which became effective on September 8, 2006, to regulate foreign investment in PRC domestic enterprises. The M&A Rules provide that the MOC must be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise and any of the following situations exist: (i) the transaction involves an important industry in China; (ii) the transaction may affect national “economic security”; or (iii) the PRC domestic enterprise has a well-known trademark or historical Chinese trade name in China. The M&A Rules also contain a provision requiring offshore SPVs formed for the purpose of the overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC issued a clarification that sets forth the criteria and procedures for obtaining any required approval from the CSRC.
 
To date, the application of the M&A Rules is unclear. Our PRC counsel, has advised us that:
 
·  
the CSRC approval requirement applies to SPVs that acquire equity interests in PRC companies through share exchanges and cash, and seek overseas listings; and
 
·  
based on their understanding of the current PRC laws, rules and regulations and the M&A Rules, unless there are new PRC laws and regulations or clear requirements from the CSRC in any form that require the prior approval of the CSRC for the listing and trading of any overseas SPV’s securities on an overseas stock exchange, the M&A Rules do not require that we obtain prior CSRC approval because:  (i) the Share Exchange is a purely foreign related transaction governed by foreign laws, not subject to the jurisdiction of PRC laws and regulations; (ii) we are not a special purpose vehicle formed or controlled by PRC companies or PRC individuals; and (iii) we are owned or substantively controlled by foreigners.
 
However, the interpretation and application of the M&A Rules remain unclear, and the PRC government authorities have the sole discretion to determine whether the transaction is subject to the approval of the CSRC, especially when taking into consideration of the performance-based incentive option arrangement by way of the Share Transfer Agreements. If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval is required for the transaction, we cannot predict how long it would take to obtain the approval. In addition, we may need to apply for a remedial approval from the CSRC and may be subject to certain administrative or other sanctions from these regulatory agencies.
 
Further, new rules and regulations or relevant interpretations may be issued from time to time that may require us to obtain retroactive approval from the CSRC in connection with the business combination. If this were to occur, our failure to obtain or delay in obtaining the CSRC approval for the business combination would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies. These sanctions could include fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions that may materially and adversely affect our business, results of operations and financial condition.
 
If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval is required for the business combination, we may need to apply for a remedial approval from the CSRC and may be subject to certain administrative punishments or other sanctions from these regulatory agencies. New rules and regulations or relevant interpretations may require that we retroactively obtain approval from the CSRC in connection with the business combination. If this were to occur, our failure to obtain or delay in obtaining the CSRC approval for the transaction would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies. These sanctions could include fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions that may materially and adversely affect our business, results of operations and financial condition.
 
 
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The M&A Rules also established additional procedures and requirements expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex, including requirements in some instances that the MOC be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. These rules may also require the approval from the MOC where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. Complying with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes, including MOC approval, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business.
 
Employees
 
As of December 31, 2012, we had 462 full-time employees, 116 of whom are in sales and marketing, 145 of whom are in operations and support, 94 of whom are in management and administration and 107 of whom are in technology support and R&D.
 
We are compliant with local prevailing wage, contractor licensing and insurance regulations, and have good relations with our employees.
 
As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, medical and unemployment benefit plans. We are required under PRC laws to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date.
 
Generally we enter into a standard employment contract with our officers and managers for a set period of years and a standard employment contract with other employees for a set period of years.  According to these contracts, all of our employees are prohibited from engaging in any activities that compete with our business during the period of their employment with us.  Furthermore, the employment contracts with officers or managers include a covenant that prohibits officers or managers from engaging in any activities that compete with our business for two years after the period of employment.
 
Corporation Information
 
Our principal executive offices are located at No. 3 Min Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC.  Our telephone number at this address is (86 10) 51600828 and our fax number is (86 10) 88857816.  For more information, see www.chinanet-online.com.
 
ITEM 1A. RISK FACTORS
 
In addition to the other information in this Form 10-K, readers should carefully consider the following important factors. These factors, among others, in some cases have affected, and in the future could affect, our financial condition and results of operations and could cause our future results to differ materially from those expressed or implied in any forward-looking statements that appear in this on Form 10-K or that we have made or will make elsewhere .
 
Risks Related to Our Business
 
The decline of global and China’s economy has had, and may continue to have, a negative effect on our business, and could have a material adverse effect on our business, financial condition, results of operations and cash flow.
 
The China economy is in a slow recovery from the sharp decline incurred in mid 2011 with increasing housing price and inflation, which impact the overall consumer spending power. With the lower consumption will, small businesses
 
 
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or so-called small and medium enterprises have lower intention to spend more on their advertising and have intention to slow down their expansion. The global and China’s economy has recovered slower than the anticipation, which has caused, among other things, for example, tightening in the credit markets, lower levels of liquidity, higher default and bankruptcy rates in small businesses, lower consumer and business spending, and lower consumer net worth, in China and other parts of the world. These global economic uncertainties and the slow recovery of China’s economy have had, and may continue to have, a negative effect on the market price of our business, the volatility of which has increased as a result of the disruptions in the financial markets. It may also impair our ability to borrow funds or enter into other financial arrangements if and when additional founds become necessary for our operations. We believe many of our advertisers have also been affected by the current economic slowdowns in China. Current or potential advertisers may no longer be in business, may be unable to continue to purchase advertising or determine to reduce purchases. All of which would lead to reduced demand for our advertising services, reduced gross margins, and increased delays of payments of accounts receivable or defaults of payments. We are also limited in our ability to reduce costs to offset the results of a prolonged or severe economic downturn given our fixed costs associated with our operations. Therefore, the global uncertainties and the downward trend of China’s economy from 2011 could have a material adverse effect on our business, financial condition, results of operations and cash flow. In addition, the timing and nature of any recovery in the credit and financial markets remains uncertain, and there can be no assurance that market conditions will improve in the near future or that our results will not continue to be materially and adversely affected.
 
We have a limited operating history, which may make it difficult to evaluate our business and prospects.
 
We began our Internet advertising service via 28.com in 2003, and entered into the TV production and advertising with China Net TV in May 2008. Both the Internet and TV advertising platforms are targeting SME customers. The SME market in China is still in its early stages. Accordingly, our limited operating history and the early stage of development of the markets in which we operate makes it difficult to evaluate the viability and sustainability of our business and its acceptance by advertisers and consumers. Although we generated profits every year since our incorporation, we cannot assure you that we will maintain our profitability or that we will not incur net losses in the future. We expect that our operating expenses will increase as we expand. Any significant failure to realize anticipated revenue growth could result in operating losses.
 
We may be subject to, and may expend significant resources in defending against, government actions and civil suits based on the content and services we provide through our Internet, TV and bank kiosk advertising platforms.
 
PRC advertising laws and regulations require advertisers, advertising operators and advertising distributors, including businesses such as ours, to ensure that the content of the advertisements they prepare or distribute is fair, accurate and in full compliance with applicable laws, rules and regulations. Although we comply with the requirements by reviewing the business licenses and the profiles of our clients, clients may post advertisements about business opportunities that are not legitimate and over which we have no control. Violation of these laws, rules or regulations may result in penalties, including fines, confiscation of advertising fees, orders to cease dissemination of the advertisements and orders to publish an advertisement correcting the misleading information. In circumstances involving serious violations, the PRC government may revoke a violator’s license for its advertising business operations.
 
In April 2009, CCTV reported a story that a franchised store advertised on 28.com turned out to be a fraud, and the fraud victim asserted she joined the store because she trusted the website.  Pursuant to the PRC advertising law, Business Opportunity Online, as the publisher of advertisement, has the obligation to check relevant documents and verify the content of the advertisement.  For commercial franchise business in China, a franchiser needs to file an application with the MOC or its local branches through the website http://txjy.syggs.mofcom.gov.cn/.  When a franchiser publishes an advertisement through Business Opportunity Online, Business Opportunity Online checks the business license, the franchiser’s registration form, the trade mark certificate and other relevant documents to verify the content of the advertisement.  The Internet information services regulations and the unfair competition regulations have similar requirements for Internet advertisement publishers.  Based on the laws and regulations above, it is our view that there is neither any mandatory requirement that Business Opportunity Online bear any responsibility for the
 
 
27
 
franchiser’s business activities, nor any valid action or investigation that can be brought by the consumer or the government against Business Opportunity Online based on the franchiser’s business activities. Nevertheless, the possibility remains that Business Opportunity Online may be required to assume civil and administrative responsibilities subject to further investigation or enforcement by competent authorities.
 
If advertisers or the viewing public do not accept, or lose interest in, our advertising platforms, our revenues may be negatively affected and our business may not expand or be successful.
 
The Internet and bank kiosk advertising platforms in China are relatively new and their potential is uncertain. We compete for advertising revenues with many forms of more established advertising media. Our success depends on the acceptance of our advertising platforms by advertisers and their continuing interest in this media as part of their advertising strategies. Our success also depends on the viewing public’s continued receptiveness towards our advertising models. Advertisers may elect not to use our services if they believe that viewers are not receptive to our platforms or that our platforms do not provide sufficient value as an effective advertising medium. If a substantial number of advertisers lose interest in advertising on our platforms, we will be unable to generate sufficient revenues and cash flows to operate our business, and our financial condition and results of operations would be materially and adversely affected.
 
We operate in the advertising industry, which is particularly sensitive to changes in economic conditions and advertising trends.
 
Advertising spending by our clients, is particularly sensitive to changes in general economic conditions. For example, advertising expenditures typically decrease during periods of economic downturn. Advertisers may reduce the amount of money they spend to advertise on our advertising platforms for a number of reasons, including:
 
·  
a general decline in economic conditions;
 
·  
a decline in economic conditions in the particular cities where we conduct business;
 
·  
a decision to shift advertising expenditures to other available less expensive advertising media; and
 
·  
a decline in advertising spending in general.
 
A decrease in the demand for advertising media in general, and for our advertising services in particular, would materially and adversely affect our ability to generate revenues, and have a material adverse effect on our financial condition and results of operations.
 
If the Internet and, in particular, Internet marketing are not broadly adopted in China, our ability to generate revenue and sustain profitability from our website portals could be materially and adversely affected.
 
Our future revenues and profits from our online advertising agency business that we operate through our website portals are dependent in part upon advertisers in China increasingly accepting the use of the Internet as a marketing channel, which is at an early stage in China. Penetration rates for personal computers, the Internet and broadband in China are all relatively low compared to those in more developed countries. Furthermore, many Chinese Internet users are not accustomed to using the Internet for e-commerce or as a medium for other transactions. Many of our current and potential SME clients have limited experience with the Internet as a marketing channel, and have not historically devoted a significant portion of their marketing budgets to Internet marketing and promotion. As a result, they may not consider the Internet as effective in promoting their products and services as traditional print and broadcast media.
 
We face significant competition, and if we do not compete successfully against new and existing competitors, we may lose our market share, and our profitability may be adversely affected.
 
Increased competition could reduce our profitability and result in a loss of market share. Some of our existing and potential competitors may have competitive advantages, such as significantly greater financial, marketing or other
 
 
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resources, and may successfully mimic and adopt our business models. Moreover, increased competition will provide advertisers with a wider range of media and advertising service alternatives, which could lead to lower prices and decreased revenues, gross margins and profits. We cannot assure you that we will be able to successfully compete against new or existing competitors.
 
Failure to manage our growth could strain our management, operational and other resources, which could materially and adversely affect our business and prospects.
 
We have been expanding our operations and plan to continue to expand in China. To meet the demand of advertisers for broader coverage, we must continue to expand our platforms by showing our TV productions and advertisements on more television stations, and expanding the capacity and enhancing the technology advantages of our internet advertising portals. The continued growth of our business has resulted in, and will continue to result in, substantial demand on our management, operational and other resources. In particular, the management of our growth will require, among other things:
 
·  
increased sales and sales support activities;
 
·  
improved administrative and operational systems;
 
·  
enhancements to our information technology system;
 
·  
stringent cost controls and sufficient working capital;
 
·  
strengthening of financial and management controls; and
 
·  
hiring and training of new personnel.
 
As we continue this effort, we may incur substantial costs and expend substantial resources. We may not be able to manage our current or future operations effectively and efficiently or compete effectively in new markets we enter. If we are not able to manage our growth successfully, our business and prospects would be materially and adversely affected.
 
Key employees are essential to growing our business.
 
Handong Cheng, our chief executive officer and president, Zhige Zhang, our chief financial officer and George K. Chu, our chief operating officer are essential to our ability to continue to grow our business. They have established relationships within the industries in which we operate. If they were to leave us, our growth strategy might be hindered, which could limit our ability to increase revenue.
 
In addition, we face competition for attracting skilled personnel with increasing labor cost. If we fail to attract and retain qualified personnel to meet current and future needs, this could slow our ability to grow our business, which could result in a decrease in market share.
 
We may need additional capital and we may not be able to obtain it at acceptable terms, or at all, which could adversely affect our liquidity and financial position.
 
We may need additional cash resources due to changed business conditions or other future developments. If these sources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations and liquidity.
 
Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:
 
·  
investors’ perception of, and demand for, securities of alternative advertising media companies;
 
 
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·  
conditions of the U.S. and other capital markets in which we may seek to raise funds;
 
·  
our future results of operations, financial condition and cash flow;
 
·  
PRC governmental regulation of foreign investment in advertising service companies in China;
 
·  
economic, political and other conditions in China; and
 
·  
PRC governmental policies relating to foreign currency borrowings.
 
Our failure to protect our intellectual property rights could have a negative impact on our business.
 
We believe our brand, trade name, copyrights, domain name and other intellectual property are critical to our success. The success of our business depends in part upon our continued ability to use our brand, trade names and copyrights to further develop and increase brand awareness. The infringement of our trade names and copyrights could diminish the value of our brand and its market acceptance, competitive advantages or goodwill. In addition, our information and operational systems, which have not been patented or otherwise registered as our property, are a key component of our competitive advantage and our growth strategy.
 
Monitoring and preventing the unauthorized use of our intellectual property is difficult. The measures we take to protect our brand, trade names, copyrights, domain name and other intellectual property rights may not be adequate to prevent their unauthorized use by third parties. Furthermore, application of laws governing intellectual property rights in China and abroad is uncertain and evolving, and could involve substantial risks to us. If we are unable to adequately protect our brand, trade names, copyrights, domain name and other intellectual property rights, we may lose these rights and our business may suffer materially. Further, unauthorized use of our brand, domain name or trade names could cause brand confusion among advertisers and harm our reputation. If our brand recognition decreases, we may lose advertisers and fail in our expansion strategies, and our business, results of operations, financial condition and prospects could be materially and adversely affected.
 
We rely on computer software and hardware systems in managing our operations, the failure of which could adversely affect our business, financial condition and results of operations.
 
We are dependent upon our computer software and hardware systems in supporting our network and managing and monitoring programs on the network. In addition, we rely on our computer hardware for the storage, delivery and transmission of the data on our network. Any system failure that interrupts the input, retrieval and transmission of data or increases the service time could disrupt our normal operation. Any failure in our computer software or hardware systems could decrease our revenues and harm our relationships with advertisers and consumers, which in turn could have a material adverse effect on our business, financial condition and results of operations.
 
We have limited insurance coverage.
 
The insurance industry in China is still in the early stages of development. Insurance companies in China offer limited insurance products. We have determined that the risks of disruption or liability from our business, the loss or damage to our property, including our facilities, equipment and office furniture, the cost of insuring for these risks, and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. As a result, we do not have any business liability, disruption, litigation or property insurance coverage for our operations in China except for insurance on some company owned vehicles. Any uninsured occurrence of loss or damage to property, or litigation or business disruption may result in the incurrence of substantial costs and the diversion of resources, which could have an adverse effect on our operating results.
 
If we are unable to maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our Common Stock.
 
 
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Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We maintain a system of internal control over financial reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer and principal financial officer, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
 
As a public company, we have significant additional requirements for enhanced financial reporting and internal controls. We are required to document and test our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal controls over financial reporting. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company.
 
We cannot assure you that we will not, in the future, identify areas requiring improvement in our internal control over financial reporting. We cannot assure you that the measures we will take to remediate any areas in need of improvement will be successful or that we will implement and maintain adequate controls over our financial processes and reporting in the future as we continue our growth.  If we are unable to maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our Common Stock.
 
Risks Relating to Regulation of Our Business and to Our Structure
 
If the PRC government finds that the agreements that establish the structure for operating our China business do not comply with PRC governmental restrictions on foreign investment in the advertising industry, we could be subject to severe penalties.
 
All of our operations are conducted through our PRC subsidiary and PRC Operating Entities, or VIEs, and through our contractual agreements with each of our PRC Operating Entities in China. PRC regulations require any foreign entities that invest in the advertising services industry to have at least two years of direct operations in the advertising industry outside of China. Since December 10, 2005, foreign investors have been allowed to own directly 100% of PRC companies operating an advertising business if the foreign entity has at least three years of direct operations in the advertising business outside of China or less than 100% if the foreign investor has at least two years of direct operations in the advertising industry outside of China. We do not currently directly operate an advertising business outside of China and cannot qualify under PRC regulations any earlier than two or three years after we commence any such operations outside of China or until we acquire a company that has directly operated an advertising business outside of China for the required period of time.  Our PRC Operating Entities hold the requisite licenses to provide advertising services in China. Our PRC Operating Entities directly operate our advertising network. We have been and are expected to continue to be dependent on these PRC Operating Entities to operate our advertising business for the foreseeable future. We have entered into Contractual Agreements with the PRC Operating Entities, pursuant to which we, through Rise King WFOE, provide technical support and consulting services to the PRC Operating Entities. In addition, we have entered into agreements with our PRC Operating Entities and each of their shareholders which provide us with the substantial ability to control these affiliates.
 
If we or our existing or future PRC Operating Entities are found to be in violation of any existing or future PRC laws or regulations or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities, including the State Administration for Industry and Commerce, or SAIC, which regulates advertising companies, would have broad discretion in dealing with such violations, including:
 
·  
revoking the business and operating licenses of Rise King WFOE and/or the PRC Operating Entities;
 
·  
discontinuing or restricting the operations of Rise King WFOE and/or the PRC Operating Entities;
 
 
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·  
imposing conditions or requirements with which we, Rise King WFOE and/or our PRC Operating Entities may not be able to comply;
 
·  
requiring us or Rise King WFOE and/or PRC Operating Entities to restructure the relevant ownership structure or operations; or
 
·  
restricting or prohibiting our use of the proceeds of this offering to finance our business and operations in China.
 
The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business.
 
We rely on contractual arrangements with the PRC Operating Entities and their shareholders for our China operations, which may not be as effective in providing operational control as direct ownership.
 
We rely on contractual arrangements with our PRC Operating Entities and their shareholders to operate our advertising business. These contractual arrangements may not be as effective in providing us with control over the PRC Operating Entities as direct ownership. If we had direct ownership of the PRC Operating Entities, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of those companies, which in turn could affect changes, subject to any applicable fiduciary obligations, at the management level. However, under the current contractual arrangements, as a legal matter, if the PRC Operating Entities or any of their subsidiaries and shareholders fail to perform its or their respective obligations under these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you to be effective. Accordingly, it may be difficult for us to change our corporate structure or to bring claims against the PRC Operating Entities if they do not perform their obligations under its contracts with us or if any of the PRC citizens who hold the equity interest in the PRC Operating Entities do not cooperate with any such actions.
 
Many of these contractual arrangements are governed by PRC laws and provide for the resolution of disputes through either arbitration or litigation in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, we may not be able to exert effective control over our operating entities, and our ability to conduct our business may be negatively affected.
 
Contractual arrangements we have entered into among the PRC Operating Entities may be subject to scrutiny by the PRC tax authorities and a finding that we owe additional taxes or are ineligible for our tax exemption, or both, could substantially increase our taxes owed, and reduce our net income and the value of your investment.
 
Under PRC law, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. If any of the transactions we have entered into among our subsidiary and affiliated entities are found not to be on an arm’s-length basis, or to result in an unreasonable reduction in tax under PRC law, the PRC tax authorities have the authority to disallow our tax savings, adjust the profits and losses of our respective PRC entities and assess late payment interest and penalties.
 
If any of our PRC Operating Entities incurs debt on its own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements with the PRC Operating Entities we currently have in place in a manner that would materially and adversely affect the PRC Operating Entities’ ability to pay dividends and other distributions to us. Furthermore, relevant PRC laws and regulations permit payments of dividends by the PRC Operating Entities only out of their retained earnings, if any, determined in accordance with PRC accounting standards and regulations. Under PRC laws and regulations, each of the PRC Operating Entities is
 
 
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also required to set aside a portion of its net income each year to fund specific reserve funds. These reserves are not distributable as cash dividends. In addition, subject to certain cumulative limits, the statutory general reserve fund requires annual appropriations of 10% of after-tax income to be set aside prior to payment of dividends. As a result of these PRC laws and regulations, the PRC Operating Entities are restricted in their ability to transfer a portion of their net assets to us whether in the form of dividends, loans or advances. Any limitation on the ability of the PRC Operating Entities to pay dividends to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.
 
Risks Associated With Doing Business In China
 
There are substantial risks associated with doing business in China, as set forth in the following risk factors.
 
Our operations and assets in China are subject to significant political and economic uncertainties.
 
Changes in PRC laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition. Under its current leadership, the Chinese government has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the Chinese government will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
 
We derive a substantial portion of ours sales from China.
 
Substantially all of our sales are generated in China. We anticipate that sales of our services in China will continue to represent a substantial proportion of our total sales in the near future. Any significant decline in the condition of the PRC economy could adversely affect consumer demand of our services, among other things, which in turn would have a material adverse effect on our business and financial condition.
 
Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert Chinese Renminbi into foreign currencies and, if Chinese Renminbi were to decline in value, reducing our revenue in U.S. dollar terms.
 
Our reporting currency is the U.S. dollar and our operations in China use the local currency as their functional currencies. Substantially all of our revenue and expenses are in Chinese Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. As a result of this policy change, Chinese Renminbi continually appreciated approximately 2.6% against the U.S. dollar in 2005, 3.2% in 2006, 6.4% in 2007, 6.3% in 2008, 0.2% in 2009, 3.3% in 2010, 3.7% in 2011 and 0.8% in 2012. It is possible that the Chinese government could adopt a more flexible currency policy, which could result in more significant fluctuation of Chinese Renminbi against the U.S. dollar. We can offer no assurance that Chinese Renminbi will be stable against the U.S. dollar or any other foreign currency.
 
The income statements of our operations are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial
 
 
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statements of our foreign operating subsidiary and VIEs into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiary and VIEs’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.
 
Although Chinese governmental policies were introduced in 1996 to 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 the State Administration of Foreign Exchange, or 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. We cannot be sure that we will be able to obtain all required conversion approvals for our operations or those Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Because a significant amount of our future revenue may be in the form of Chinese Renminbi, our inability to obtain the requisite approvals or any future restrictions on currency exchanges could limit our ability to utilize revenue generated in Chinese Renminbi to fund our business activities outside of China, or to repay foreign currency obligations, including our debt obligations, which would have a material adverse effect on our financial condition and results of operations.
 
We may have limited legal recourse under PRC laws if disputes arise under our contracts with third parties.
 
The Chinese government has enacted laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful, or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business operations of these acquired companies. The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an injunction under PRC law, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.
 
We must comply with the Foreign Corrupt Practices Act.
 
We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties.
 
Changes in foreign exchange regulations in the PRC may affect our ability to pay dividends in foreign currency or conduct other foreign exchange business.
 
The Renminbi is not a freely convertible currency, and the restrictions on currency exchanges may limit our ability to use revenues generated in Renminbi to fund our business activities outside the PRC or to make dividends or
 
 
34
 
other payments in United States dollars. The PRC government strictly regulates conversion of Renminbi into foreign currencies. Over the years, foreign exchange regulations in the PRC have significantly reduced the government’s control over routine foreign exchange transactions under current accounts.  In the PRC, the State Administration for Foreign Exchange, or the SAFE, regulates the conversion of the Renminbi into foreign currencies. Pursuant to applicable PRC laws and regulations, foreign invested enterprises incorporated in the PRC are required to apply for “Foreign Exchange Registration Certificates.”  Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, etc.) can be effected without requiring the approval of SAFE.  However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE.
 
Recent PRC regulations relating to mergers and acquisitions of domestic enterprises by foreign investors may increase the administrative burden we face and create regulatory uncertainties.
 
On August 8, 2006, the Ministry of Commerce (the “MOC”), joined by the China Securities Regulatory Commission (the “CSRC”), State-owned Assets Supervision and Administration Commission of the State Council (the “SASAC”), the State Administration of Taxation (the “SAT”), the State Administration of Industry and Commerce (the “SAIC”), and SAFE, jointly promulgated a rule entitled the Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “M&A Rules”), which took effect as of September 8, 2006.  This new regulation, among other things, has certain provisions that require special purpose vehicles, or SPVs, formed for the purpose of acquiring PRC domestic companies and controlled by PRC individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock market. However, the new regulation does not expressly provide that approval from the CSRC is required for the offshore listing of the SPV which acquires, directly or indirectly, equity interest or shares of domestic PRC entities held by domestic companies or individuals by cash payment, nor does it expressly provide that approval from CSRC is not required for the offshore listing of a SPV which has fully completed its acquisition of equity interest of domestic PRC equity prior to September 8, 2006. On September 21, 2006, the CSRC published on its official website a notice specifying the documents and materials that are required to be submitted for obtaining CSRC approval.
 
It is not clear whether the provisions in the new regulation regarding the offshore listing and trading of the securities of a SPV applies to an offshore company such as us which owns controlling contractual interest in the PRC Operating Entities. We believe that the M&A Rules and the CSRC approval are not required in the context of the share exchange under our transaction because (i) such share exchange is a purely foreign related transaction governed by foreign laws, not subject to the jurisdiction of PRC laws and regulations; (ii) we are not a SPV formed or controlled by PRC companies or PRC individuals; and (iii) we are owned or substantively controlled by foreigners.  However, we cannot be certain that the relevant PRC government agencies, including the CSRC, would reach the same conclusion, and we still cannot rule out the possibility that CSRC may deem that the transactions effected by the share exchange circumvented the new M&A rules, the PRC Securities Law and other rules and notices.
 
If the CSRC or another PRC regulatory agency subsequently determines that the CSRC’s approval is required for the transaction, we may face sanctions by the CSRC or another PRC regulatory agency. If this happens, these regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this offering into the PRC, restrict or prohibit payment or remittance of dividends to us or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our shares. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to delay or cancel the transaction.
 
The M&A Rules, along with foreign exchange regulations discussed in the above subsection, will be interpreted or implemented by the relevant government authorities in connection with our future offshore financings or acquisitions, and we cannot predict how they will affect our acquisition strategy. For example, our operating companies’ ability to remit dividends to us, or to engage in foreign-currency-denominated borrowings, may be conditioned upon compliance with the SAFE registration requirements by such Chinese domestic residents, over whom we may have no control. In addition, such Chinese domestic residents may be unable to complete the necessary
 
 
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approval and registration procedures required by the SAFE regulations. Such uncertainties may restrict our ability to implement our acquisition strategy and adversely affect our business and prospects.
 
The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
 
China only recently has permitted provincial and local economic autonomy and private economic activities, and, as a result, we are dependent on our relationship with the local government in the province in which we operate our business.  Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership.  Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, environmental regulations, land use rights, property and other matters.  We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements.  However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.  Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.
 
Future inflation in China may inhibit our activity to conduct business in China.
 
In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation.  These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation.  High inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our services.
 
We may have difficulty establishing adequate management, legal and financial controls in the PRC.
 
We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC.  As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. We may have difficulty establishing adequate management, legal and financial controls in the PRC.
 
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us and our management.
 
We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, some of our directors and executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon some of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. It would also be difficult for investors to bring an original lawsuit against us or our directors or executive officers before a Chinese court based on U.S. federal securities laws or otherwise. Moreover, China does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.
 
New PRC enterprise income tax law could adversely affect our business and our net income.
 
On March 16, 2007, the National People’s Congress of the PRC passed the new Enterprise Income Tax Law (or EIT Law), which took effect on of January 1, 2008. The new EIT Law imposes a unified income tax rate of 25% on all companies established in China. Under the EIT Law, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered as a resident enterprise and will normally be subject to the
 
 
36
 
enterprise income tax at the rate of 25.0% on its global income. The new EIT Law, however, does not define the term “de facto management bodies.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our global income will be subject to PRC income tax at a tax rate of 25%.
 
With the introduction of the EIT Law, China has resumed imposition of a withholding tax (10% in the absence of a bilateral tax treaty or new domestic regulation reducing such withholding tax rate to a lower rate).  Per the Double Tax Avoidance Arrangement between Hong Kong and Mainland China, a Hong Kong company as the investor, which is considered a “non-resident enterprise” under the EIT Law, may enjoy the reduced withholding tax rate of 5% if it holds more than 25% equity interest in its PRC subsidiary.  As China Net HK is the sole shareholder of Rise King WFOE, substantially all of our income will derive from dividends we receive from Rise King WFOE through China Net HK.  When we declare dividends from the income in the PRC, we cannot assure whether such dividends may be taxed at a reduced withholding tax rate of 5% per the Double Tax Avoidance Arrangement between Hong Kong and Mainland China as the PRC tax authorities may regard our China Net HK as a shell company formed only for tax purposes and still deem Rise King WFOE in the PRC as the subsidiary directly owned by us. Based on the Notice on Certain Issues with respect to the Enforcement of Dividend Provisions in Tax Treaties, issued on February 20, 2009 by the State Administration of Taxation, if the relevant PRC tax authorities determine, in their discretion, that a company benefits from such reduced income tax rate due to a structure or arrangement that is primarily tax-driven, such PRC tax authorities may adjust the preferential tax treatment.
 
Investors should note that the new EIT Law provides only a framework of the enterprise tax provisions, leaving many details on the definitions of numerous terms as well as the interpretation and specific applications of various provisions unclear and unspecified.  Any increase in our tax rate in the future could have a material adverse effect on our financial conditions and results of operations.
 
Under the new EIT Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and holders of our securities.
 
Under the new EIT Law, an enterprise established outside of China with its “de facto management body” in China is considered a “resident enterprise,” meaning that it can be treated the same as a Chinese enterprise for enterprise income tax purposes. The implementing rules of the new EIT Law defines “de facto management body” as an organization that exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of an enterprise. Currently no interpretation or application of the new EIT Law and its implementing rules is available, therefore it is unclear how tax authorities will determine tax residency based on the facts of each case.
 
If the PRC tax authorities determine that China Net is a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we will be subject to enterprise income tax at a rate of 25% on our worldwide income as well as PRC enterprise income tax reporting obligations. This would mean that income such as interest on offering proceeds and other non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the new EIT Law and its implementing rules dividends paid to us by our PRC subsidiary would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, a 10% withholding tax will be imposed on dividends we pay to our non-PRC shareholders.
 
Our Chinese operating companies are obligated to withhold and pay PRC individual income tax in respect of the salaries and other income received by their employees who are subject to PRC individual income tax. If they fail to withhold or pay such individual income tax in accordance with applicable PRC regulations, they may be subject to certain sanctions and other penalties, which could have a material adverse impact on our business.
 
Under PRC laws, Rise King WFOE and the PRC Operating Entities will be obligated to withhold and pay individual income tax in respect of the salaries and other income received by their employees who are subject to PRC
 
 
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individual income tax. Such companies may be subject to certain sanctions and other liabilities under PRC laws in case of failure to withhold and pay individual income taxes for its employees in accordance with the applicable laws.
 
In addition, the SAT has issued several circulars concerning employee stock options. Under these circulars, employees working in the PRC (which could include both PRC employees and expatriate employees subject to PRC individual income tax) are required to pay PRC individual income tax in respect of their income derived from exercising or otherwise disposing of their stock options. Our PRC entities will be obligated to file documents related to employee stock options with relevant tax authorities and withhold and pay individual income taxes for those employees who exercise their stock options. While tax authorities may advise us that our policy is compliant, they may change their policy, and we could be subject to sanctions.
 
Because Chinese laws will govern almost all of our business’ material agreements, we may not be able to enforce our rights within the PRC or elsewhere, which could result in a significant loss of business, business opportunities or capital.
 
The Chinese legal system is similar to a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. Although legislation in the PRC over the past 30 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in the PRC, these laws, regulations and legal requirements are relatively new. Due to the limited volume of published judicial decisions, their non-binding nature, the short history since their enactments, the discrete understanding of the judges or government agencies of the same legal provision, inconsistent professional abilities of the judicators, and the inclination to protect local interest in the court rooms, interpretation and enforcement of PRC laws and regulations involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you. The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital and could have a material adverse impact on our business, prospects, financial condition, and results of operations. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until a period of time after the violation. In addition, any litigation in the PRC, regardless of outcome, may be protracted and result in substantial costs and diversion of resources and management attention.
 
Risks Related to our Securities
 
Insiders have substantial control over us, and they could delay or prevent a change in our corporate control even if our other stockholders wanted it to occur.
 
Our executive officers, directors, and principal stockholders hold approximately 36% of our outstanding Common Stock. Accordingly, these stockholders are able to exert substantial influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This could delay or prevent an outside party from acquiring or merging with us even if our other stockholders wanted it to occur.
 
There may not be sufficient liquidity in the market for our securities in order for investors to sell their securities.
 
There is currently only a limited public market for our Common Stock and there can be no assurance that a trading market will develop further or be maintained in the future. As of April 12, 2013, the closing trade price of our Common Stock was $0.75 per share. As of April 12, 2013, we had approximately 635 shareholders of record of our Common Stock, not including shares held in street name. In addition, during the past two years our Common Stock has had a trading range with a low price of $0.37 per share and a high price of $4.65 per share.
 
The market price of our Common Stock may be volatile.
 
The market price of our Common Stock has been and will likely continue to be highly volatile, as is the stock market in general. Some of the factors that may materially affect the market price of our Common Stock are beyond
 
 
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our control, such as changes in financial estimates by industry and securities analysts, conditions or trends in the industry in which we operate or sales of our common stock. These factors may materially adversely affect the market price of our Common Stock, regardless of our performance. In addition, the public stock markets have experienced extreme price and trading volume volatility particularly for companies whose primary operations are located in the PRC. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our Common Stock.
 
Because the Company became public by means of a reverse merger, it may not be able to attract the attention of major brokerage firms.
 
Additional risks may exist since the Company became public through a “reverse merger.”  Securities analysts of major brokerage firms may not provide coverage of the Company since there is little incentive to brokerage firms to recommend the purchase of its Common Stock.  No assurance can be given that brokerage firms will want to conduct any secondary offerings on behalf of the Company in the future.
 
The outstanding warrants and options may adversely affect us in the future and cause dilution to existing stockholders.
 
We currently have warrants outstanding to purchase up to 2,363,456 shares of our Common Stock, which will expire on August 20, 2014. The exercise price of these warrants ranges from $2.50 to $3.75 per share, subject to adjustment in certain circumstances. We also have common stock options outstanding to purchase up to 54,000 shares of our Common Stock, issued to our independent directors, which will expire on November 30, 2014. The exercise price of these options is $5.00 per share. On November 30, 2011, we also issued common stock options to purchase up to 885,440 shares of our Common Stock in the aggregate to our management, executive directors and employees, subject to forfeiture upon an employee's cessation of employment at the discretion of the Company. The exercise price of these options is $1.20 per share and these options will expire on November 30, 2021. Exercise of these warrants and options may cause dilution in the interests of other stockholders as a result of the additional Common Stock that would be issued upon exercise. In addition, sales of the shares of our Common Stock issuable upon exercise of these warrants and options could have a depressive effect on the price of our stock, particularly if there is not a coinciding increase in demand by purchasers of our Common Stock. Further, the terms on which we may obtain additional financing during the period any of these warrants and options remain outstanding may be adversely affected by the existence of these warrants and options as well.
 
We may need additional capital and may sell additional securities or other equity securities or incur indebtedness, which could result in additional dilution to our shareholders or increase our debt service obligations.
 
We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our cash resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities or equity-linked debt securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.
 
We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our stock.
 
We have never paid any cash dividends on our Common Stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future and any return on investment may be limited to the value of our stock. We plan to retain any future earning to finance growth.
 
 
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Techniques employed by manipulative short sellers in Chinese small cap stocks may drive down the market price of our common stock.
 
Short selling is the practice of selling securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale.  As it is therefore in the short seller’s best interests for the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short.  While traditionally these disclosed shorts were limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research reports that mimic the type of investment analysis performed by large Wall Street firm and independent research analysts.  These short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base.  Issuers with business operations based in China and who have limited trading volumes and are susceptible to higher volatility levels than U.S. domestic large-cap stocks, can be particularly vulnerable to such short attacks.
 
These short seller publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not subject to the certification requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst Certification) and, accordingly, the opinions they express may be based on distortions of actual facts or, in some cases, fabrications of facts.  In light of the limited risks involved in publishing such information, and the enormous profit that can be made from running just one successful short attack, unless the short sellers become subject to significant penalties, it is more likely than not that disclosed shorts will continue to issue such reports.
 
While we intend to strongly defend our public filings against any such short seller attacks, oftentimes we are constrained, either by principles of freedom of speech, applicable state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceed against the relevant short seller. You should be aware that in light of the relative freedom to operate that such persons enjoy – oftentimes blogging from outside the U.S. with little or no assets or identity requirements – should we be targeted for such an attack, our stock will likely suffer from a temporary, or possibly long term, decline in market price should the rumors created not be dismissed by market participants.
 
The NASDAQ may delist our securities from quotation on its exchange which could limit investors’ ability to make transactions in our securities and subject us to additional trading restrictions.
 
Our Common Stock is traded on the NASDAQ, a national securities exchange. We cannot assure you that our securities will meet the continued listing requirements be listed on the NASDAQ in the future.
 
On May 30, 2012, we received a letter from the Nasdaq Stock Market LLC (“Nasdaq”), which stated that, based upon the closing bid price for the last 30 consecutive business days, the Company no longer meets the requirement set forth in Nasdaq Rule 5550(a)(2), which requires listed securities to maintain a minimum bid price of $1 per share (the “Minimum Bid Price Rule”). In accordance with Nasdaq Rule 5810(c)(3)(A), we were provided with a period of 180 calendar days, or until November 26, 2012, to regain compliance with the Minimum Bid Price Rule. We would regain compliance with the Minimum Bid Price Rule if the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive business days at any time prior to November 26, 2012.
 
On November 30, 2012, we received a letter from the NASDAQ Stock Market LLC (the “NASDAQ”) notifying that we have regained compliance with the minimum bid price requirement for continued listing set forth in NASDAQ Listing Rule 5450(a)(1), as our common stock had achieved a closing bid price of $1.00 or more for 10 consecutive business days from November 15, 2012 to November 29, 2012.
 
 
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Although, we has regained compliance with NASDAQ Listing Rule 5450(a)(1), we cannot assure you our securities will meet the continued listing requirements be listed on the NASDAQ in the future. If the NASDAQ delists our Common Stock from trading on its exchange, we could face significant material adverse consequences including:
 
·  
a limited availability of market quotations for our securities;
 
·  
a determination that our Common Stock is a “penny stock” which will require brokers trading in our Common Stock to adhere to more stringent rules and possibly resulting in a reduced level of trading activity in the secondary trading market for our Common Stock;
 
·  
a limited amount of news and analyst coverage for our company; and
 
·  
a decreased ability to issue additional securities or obtain additional financing in the future.
 
Our Common Stock is considered “penny stock.”
 
The SEC has adopted regulations which generally define “penny stock” to be an equity security that has a market price of less than $5.00 per share, subject to specific exemptions.  The market price of our Common Stock is currently less than $5.00 per share and therefore may be a “penny stock.” Brokers and dealers effecting transactions in “penny stock” must disclose certain information concerning the transaction, obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability of brokers or dealers to sell the Common Stock and may affect your ability to sell shares.
 
ITEM 1B. UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2  PROPERTIES
 
The following table summarizes the location of real property we lease.  We do not own any real property.
 
Item
 
Address
 
Leased/Owned
 
1
 
No. 3 Min, Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC, 1st Floor
 
 
Leased
2
No. 3 Min, Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC, 2nd Floor
 
Leased
3
No. 3 Min, Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC, Basement
 
Leased
4
No. 15 Changzheng Road, Xiaogan City, Hubei Province, PRC, 2nd Floor
 
Leased
5
No. 15 Changzheng Road, Xiaogan City, Hubei Province, PRC, 3rd Floor
 
Leased
6
Quanzhou Hangdao Plaza, Baozhou Road, Fengze District, Quanzhou City, Fujian Province, PRC, 4th Floor, Room 401-402
 
Leased
7
Building 2, San Jiang Plaza, Puxi Road, Road, Fengze District, Quanzhou City, Fujian Province, PRC, Room 101
 
Leased
8
7A-02, Building 2, No.2 Shangdi Xinxi Road, Haidian District, Beijing, PRC
 
Leased
9
Roon 601, Hui Gu Shi Kong, East Lake Development Zone, Wuhan City, Hubei Province, PRC
Leased
 
 
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The properties listed in Items 1, 2 and 3 above are our principal executive offices and are used by all of our business segments. The properties listed in Items 4, 5 and 9 above are the offices for our operating VIEs in Hubei province, and are primarily used by our internet advertising and TV advertising business segments. The properties listed in Items 6 and 7 above are the offices for our operating VIEs in Quanzhou, Fujian province, and are primarily used by our brand management and sales channel building business segment. The property listed in Item 8 is used by one of our operating VIEs in Beijing, and is primarily used by our internet advertising business segment.
 
We believe that our existing facilities and equipment are well maintained and in good operating condition, and are sufficient to meet our needs for the foreseeable future.
 
ITEM 3  LEGAL PROCEEDINGS
 
We may be subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. We are not currently a party to any litigation or other legal proceedings brought against us. We are also not aware of any legal proceeding, investigation or claim, or other legal exposure that has a more than remote possibility of having a material adverse effect on our business, financial condition or results of operations.
 
ITEM 4  MINE SAFETY DISCLOSURES
 
Not applicable.
 
PART II.                      
 
ITEM 5  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock has been listed on the Nasdaq Global Stock Exchange under the symbol “CNET” since September 14, 2010. Prior to that time, from March 4, 2010 through September 13, 2010, our common stock was listed on the NYSE AMEX under the trading symbol “CNET.”  Prior to that, our common stock was quoted on the OTC Bulletin Board (“OTCBB “) under the trading symbol “EMZG”, until August 14, 2009, when our ticker symbol was change to “CHNT”. The last reported price for our common stock on the Nasdaq Global Market on April 12, 2013 was $0.75 per share.
 
The following table shows the high and low closing sale prices for our common stock reported by the Nasdaq Global Stock Exchange for the two years ended December 31, 2012 and subsequent periods.

Year
  
Period
  
High
    
Low
  
2011
  
First Quarter
   $ 4.65     $ 3.25  
                     
   
Second Quarter
   $ 3.80     $ 1.34  
                     
   
Third Quarter
   $ 2.60     $ 1.11  
                     
   
Fourth Quarter
   $ 1.32     $ 1.04  
                     
2012
  
First Quarter
   $ 1.17     $ 0.97  
                     
   
Second Quarter
   $ 1.06     $ 0.63  
                     
   
Third Quarter
   $ 0.69     $ 0.37  
                     
   
Fourth Quarter
   $ 1.22     $ 0.44  
                     
2013
  
First Quarter
   $ 1.02     $ 0.71  
                     
   
Second Quarter (through April 12, 2013)
   $ 0.80     $ 0.73  
 
 
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Holders
 
As of April 12, 2013, there were approximately 635 record holders of our common stock.
 
Dividends
 
We have never paid any dividends on our common stock and we plan to retain earnings, if any, for use in the development and growth of our business. Payment of future dividends, if any, will be at the discretion of the board of directors after taking into account various factors, including current financial condition, operating results and current and anticipated cash needs. If we ever determine to pay a dividend, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency from China for the payment of such dividends from the profits of our PRC subsidiary and VIEs.
 
Securities Authorized for Issuance Under Equity Compensation Plans
 
Additional information required under this item is incorporated herein by reference to Item 12 of this Annual Report on Form 10-K under the heading "Equity Compensation Plan Information."
 
Equity Repurchases
 
During the fourth quarter of our fiscal year ended December 31, 2012, neither we nor any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) purchased any shares of our common stock, the only class of our equity securities registered pursuant to Section 12 of the Exchange Act.
 
Recent Sales of Unregistered Securities
 
Any previous sales of unregistered securities by the Company have been previously disclosed in our reports on Form 10-Q or Form 8-K, as applicable, filed with the SEC.
 
ITEM 6  SELECTED FINANCIAL DATA
 
As a smaller reporting company, we are not required to include disclosure under this Item.
 
ITEM 7  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 audited consolidated financial statements and the related notes to the consolidated financial statements included elsewhere in this Form 10-K. Our audited consolidated financial statements have been prepared in accordance with U.S. GAAP. In addition, our audited consolidated financial statements and the financial data included in this Form 10-K reflect our reorganization and have been prepared as if our current corporate structure had been in place throughout the relevant periods. 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
 
 
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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” and elsewhere in this Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements.
 
Overview
 
Our company (formerly known as Emazing Interactive, Inc.) was incorporated in the State of Texas in April 2006 and re-domiciled to become a Nevada corporation in October 2006. From the date of our company’s incorporation until June 26, 2009, when our company consummated the Share Exchange (as defined below), our company’s activities were primarily concentrated in web server access and company branding in hosting web based e-games.
 
On June 26, 2009, our company entered into a Share Exchange Agreement (the “Exchange Agreement”), with (i) China Net Online Media Group Limited, a company organized under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s shareholders, Allglad Limited, a British Virgin Islands company (“Allglad”), Growgain Limited, a British Virgin Islands company (“Growgain”), Rise King Investments Limited, a British Virgin Islands company (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus Elegant Investment Limited, a British Virgin Islands company (“Surplus”), Clear Jolly Holdings Limited, a British Virgin Islands company (“Clear” and together with Allglad, Growgain, Rise King BVI, Star and Surplus, the “China Net BVI Shareholders”), who together owned shares constituting 100% of the issued and outstanding ordinary shares of China Net BVI (the “China Net BVI Shares”) and (iii) G. Edward Hancock, our principal stockholder at such time. Pursuant to the terms of the Exchange Agreement, the China Net BVI Shareholders transferred to us  all of the China Net BVI Shares in exchange for the issuance of 13,790,800 shares (the “Exchange Shares”) in the aggregate of our common stock (the “Share Exchange”). As a result of the Share Exchange, China Net BVI became our wholly owned subsidiary and we are now a holding company which, through certain contractual arrangements with operating companies in the People’s Republic of China (the “PRC”), is engaged in providing advertising, marketing, communication and brand management and sales channel building services to small and medium companies in China.
 
Our wholly owned subsidiary, China Net BVI, was incorporated in the British Virgin Islands on August 13, 2007.  On April 11, 2008, China Net BVI became the parent holding company of a group of companies comprised of CNET Online Technology Limited, a Hong Kong company (“China Net HK”), which established, and is the parent company of, Rise King Century Technology Development (Beijing) Co., Ltd., a wholly foreign-owned enterprise (“WFOE”) established in the PRC (“Rise King WFOE”). We refer to the transactions that resulted in China Net BVI becoming an indirect parent company of Rise King WFOE as the “Offshore Restructuring.”
 
PRC regulations prohibit direct foreign ownership of business entities providing internet content, or ICP services in the PRC, and restrict foreign ownership of business entities engaging in the advertising business. In October 2008, a series of contractual arrangements (the “Contractual Agreements” or the “VIE Agreements) were entered between Rise King WFOE and Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”), Beijing CNET Online Advertising Co., Ltd. (“Beijing CNET Online”) (collectively the “PRC Operating Entities”) and its common individual owners (the “PRC Shareholders” or the “Control Group”). The Contractual Agreements allowed China Net BVI through Rise King WFOE to, among other things, secure significant rights to influence the PRC Operating Entities’ business operations, policies and management, approve all matters requiring shareholder approval, and receive 100% of the income earned by the PRC Operating Entities.  In return, Rise King WFOE provides consulting services to the PRC Operating Entities.  In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform their obligations under the Contractual Arrangements, the PRC Shareholders have pledged all of their equity interests in the PRC Operating Entities to Rise King WFOE.  They have also entered into an option agreement with Rise King WFOE which provides that at such time as when the current restrictions under PRC law on foreign ownership of Chinese companies engaging in the Internet content, information services or advertising business in China are lifted, Rise King WFOE may exercise its option to purchase the equity interests in the PRC Operating Entities directly.
 
 
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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, Rise King WFOE’s ability to extract the profits from the operation of the VIEs and assume the residual benefits of the VIEs. Due to the fact that Rise King WFOE and its indirect parent are the sole interest holders of the VIEs, we included the assets, liabilities, revenues and expenses of the VIEs in our consolidated financial statements, which is consistent with the provisions of FASB Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” subtopic 10.
 
As of the date of the Share Exchange, through a series of contractual agreements, we operate our business in China primarily through Business Opportunity Online and Beijing CNET Online. Beijing CNET Online owns 51% of Shanghai Borongdingsi Computer Technology Co., Ltd. (“Shanghai Borongdingsi”). Business Opportunity Online, Beijing CNET Online 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 beginning in 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 net profit generated from the bank kiosk advertising business, if any, to the minority shareholders of Shanghai Borongdingsi.
 
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$2,374,883) 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. On December 19, 2012, as approved by the shareholders of Shenzhen Mingshan, Shenzhen Mingshan reduced its registered and paid-in capital from RMB25,000,000 (approximately US$3,958,139) to RMB22,000,000 (approximately US$3,483,162), resulted from a decrease of paid-in capital from three other noncontrolling shareholders, except Business Opportunity Online. As a result, our share of the equity interest in Shenzhen Mingshan increased from 20.4% to 23.18% and we continued to retain significant influence over Shenzhen Mingshan. Therefore, as of December 31, 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
 
 
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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% equity 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 in Quanzhou Tian Xi Shun He. Quanzhou Tian Xi Shun He became a wholly owned subsidiary of Beijing CNET Online.
 
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$1,583,255) 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 December 31, 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.
 
 
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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. In September 2012, the Company sold all of its equity interest in Business Opportunity Online Chongqing to two unaffiliated parties. Business Opportunity Online Chongqing was dormant from the time of its incorporation through the date the Company disposed of its equity interest to two unaffiliated parties. No gain or loss was incurred in connection with this transaction, as we recovered all of its net assets, which are all cash and cash equivalents from the buyers.
 
On December 20, 2011, Business Opportunity Online Hubei acquired a 51% equity interest in Sou Yi Lian Mei Network Technology (Beijing) Co. Ltd., (“Sou Yi Lian Mei”).  In September 2012, Business Opportunity Online Hubei acquired the remaining 49% equity interest in Sou Yi Lian Mei. Sou Yi Lian Mei became a wholly owned subsidiary of Business Opportunity Online Hubei accordingly. 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 primarily operate an one-stop services for our clients on four major service platforms, including social networking service information platform, multi-channel advertising and promotion platform, brand management and sales channel building platform and management tools platform. Our social networking service information platform primarily consists of www. chuangye.com, an information and service portal for entrepreneurs or any individual who plans to start their own business. Our multi-channel advertising and promotion platform primarily consists of internet advertising and marketing portals, including www.28.com (“28.com”), www.liansuo.com (“liansuo.com”) and www.sooe.cn (“sooe.cn”), ChinaNet TV as our TV production and advertising unit and the bank kiosk advertising unit. We provide varieties of marketing campaigns through this platform by the combination of the Internet, mobile, television, bank kiosks and printed-medias to maximize market exposure and effectiveness for our clients. Our band management and sales channel expansion platform consists of our brand consulting and management service and offline sales channel expansion service, which is to physically help small businesses to recruit dealers, wholesalers, partners or franchisees based on their business needs. Management tools platform consists of a mobile-based sales and administrative management tools specifically designed for small business in China to match their simplicity.
 
Basis of presentation, critical accounting policies and management estimates
 
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) 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. We consider the policies discussed below to be critical to an understanding of our financial statements.
 
Foreign currency translation
 
Our functional currency is United States dollars (“US$”), and the functional currency of China Net HK is Hong Kong dollars (“HK$”).  The functional currency of our PRC operating subsidiary and VIEs is Renminbi (“RMB’), and PRC is the primary economic environment in which we operate.
 
 
47
 
For financial reporting purposes, the financial statements of our PRC operating subsidiary and VIEs, which are prepared using the RMB, are translated into our 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 financial statements 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:

   
As of December 31,
  
   
2012
    
2011
  
Balance sheet items, except for equity accounts
     6.3161       6.3647  

   
Year ended December 31,
  
   
2012
    
2011
  
Items in the statements of income and comprehensive income, and statements cash flows
     6.3198       6.4735  
 
No representation is made that the RMB amounts could have been, or could be converted into US$ at the above rates.
 
Investment in equity investment affiliates
 
Investee companies that are not consolidated, but over which we exercise significant influence, are accounted for under the equity method of accounting in accordance with ASC Topic 323 “Equity Method and Joint Ventures”. Whether or not we exercise significant influence with respect to an Investee depends on an evaluation of several factors including, among others, representation on the investee companies’ board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee companies. Under the equity method of accounting, an investee company’s accounts are not reflected within our consolidated balance sheets and statements of income and comprehensive income; however, our share of the earnings or losses of the investee company is reflected in the caption “Share of earnings (losses) in equity investment affiliates” in the consolidated statements of income and comprehensive income. Our carrying value (including advance to the investees) in equity method investee companies is reflected in the caption “Investment in and advance to equity investment affiliates” in our consolidated balance sheets.
 
When our carrying value in an equity method investee company is reduced to zero, no further losses are recorded in our consolidated financial statements unless we guaranteed obligations of the investee company or have committed additional funding. When the investee company subsequently reports income, we will not record its share of such income until it equals the amount of its share of losses not previously recognized.
 
Goodwill
 
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of acquisitions of interests in our subsidiaries.
 
Goodwill is not depreciated or amortized but is tested for impairment at the reporting unit level at least on an annual basis, and between annual tests when an event occurs or circumstances change that could indicate that the asset might be impaired.  The test consists of two steps. First, identify potential impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired. Second, if there is impairment identified in the first step, an
 
 
48
 
impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with ASC Topic 805, “Business Combinations.”
 
Application of a goodwill impairment test requires significant management judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. The judgment in estimating the fair value of reporting units includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.
 
Deconsolidation
 
We accounted for deconsolidation of subsidiaries in accordance with ASC Topic 810 “Consolidation”.
 
 In accordance with ASC Topic 810-10-40-5, the parent shall account for the deconsolidation of a subsidiary by recognizing a gain or loss in net income attributable to the parent, measured as the difference between:
 
a. The aggregate of all of the following:
 
1. The fair value of any consideration received;
 
2. The fair value of any retained noncontrolling investment in the former subsidiary at the date the subsidiary is deconsolidated;
 
3. The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated.
 
b. The carrying amount of the former subsidiary’s assets and liabilities.
 
Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary
 
We accounted for changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary in accordance with ASC Topic 810 “Consolidation”, subtopic 10, which requires the transaction be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net income or comprehensive income. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equity attributable to the parent and reallocated the subsidiary’s accumulated comprehensive income, if any, among the parent and the noncontrolling interest through an adjustment to the parent’s equity.
 
Revenue recognition
 
Our revenue recognition policies are in compliance with ASC Topic 605. In accordance with ASC Topic 605, revenues are recognized when all four of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the service has been rendered, (iii) the fees are fixed or determinable, and (iv) collectability is reasonably assured.
 
Sales include revenues from reselling of advertising time purchased from TV stations, internet advertising and providing related value added technical services, reselling of internet advertising spaces and other advertisement related resources. No revenue from advertising-for-advertising barter transactions was recognized because the transactions did not meet the criteria for recognition in ASC Topic 605, subtopic 20. Advertising contracts establish the fixed price and advertising services to be provided.  Pursuant to advertising contracts, we provide advertisement
 
 
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placements in different formats, including but not limited to banners, links, logos, buttons, rich media and content integration. Revenue is recognized ratably over the period the advertising is provided and, as such, we consider the services to have been delivered. We treat all elements of advertising contracts as a single unit of accounting for revenue recognition purposes. Value added technical services are provided based on two types of contracts: (i) fixed price and (ii) fixed price with minimum performance threshold. For contracts with fixed price term, revenue is recognized on a pro-rata basis over the engaged service period. For fixed price contracts with minimum performance threshold, revenue is recognized when the specified performance criteria is met. Based upon our credit assessments of our customers prior to entering into contracts, we determine if collectability is reasonably assured.  In situations where collectability is not deemed to be reasonably assured, we recognize revenue upon receipt of cash from customers, only after services have been provided and all other criteria for revenue recognition have been met.
 
Taxation
 
1.  
Income tax
 
We adopt ASC Topic 740 “Income taxes” and use 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. We record 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 income statement in the period that includes the enactment date.
 
We adopt ASC Topic 740-10-25-5 through 740-10-25-7 and 740-10-25-13, which prescribes a more likely than not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. For the years ended December 31, 2012 and 2011, we did not have any interest and penalties associated with tax positions and did not have any significant unrecognized uncertain tax positions.
 
i). We were incorporated in the State of Nevada.  Under the current laws of Nevada we are not subject to state corporate income tax.  We became a holding company and do not conduct any substantial operations of our own after the Share Exchange. No provision for federal corporate income tax has been made in our financial statements as no assessable profits for the years ended December 31, 2012 and 2011, or any prior periods. We do not provide for U.S. taxes or foreign withholding taxes on undistributed earnings from non-U.S. subsidiaries and VIEs 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 laws of the BVI, we are not subject to tax on income or capital gains.  Additionally, upon payments of dividends by China Net BVI to us, 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 have been made in our financial statements as no assessable profits for the years ended December 31, 2012 and 2011, or any prior periods. Additionally, upon payments of dividends by China Net HK to its sole shareholder, China Net BVI, no Hong Kong withholding tax will be imposed.
 
iv). Our PRC operating subsidiary and VIEs, being incorporated in the PRC, are governed by the income tax law of the PRC and are subject to PRC enterprise income tax (“EIT”).  Effective from January 1, 2008, the EIT rate of PRC was changed from 33% of 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 us. 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 years ended December 31, 2012 and 2011, the applicable income tax rate for Rise King WFOE was both 12.5%. After fiscal year 2013, the applicable income tax rate of Rise King WFOE will be 25% under the current EIT law of PRC.
 
 
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·  
Business Opportunity Online was approved by the related PRC governmental authorities as a High and New Technology Enterprise under the New EIT law effective September 4, 2009, and was approved by the local tax authorities of Beijing, the PRC, to be entitled to a favorable statutory tax rate of 15%. Business Opportunity Online’s High and New Technology Enterprise certificate would expire on September 4, 2012. On July 9, 2012, Business Opportunity Online passed the administrative review conducted by the related PRC governmental authorities for obtaining the renewed certificate, which enabled it to continue to enjoy the 15% preferential income tax rate as a High and New Technology Enterprise. Therefore, for the years ended December 31, 2012 and 2011, the applicable income tax rate of Business Opportunity Online was both 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 year ended December 31, 2011, Business Opportunity Online Hubei calculated its income tax expenses based on 2.5% of the total revenue recognized for the reporting period. Starting from January 1, 2012, the local tax authorities cancelled the deemed income tax method for computation of income tax expenses for the entity. As such, 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 for fiscal years 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 year ended December 31, 2012, the applicable income tax rate of Business Opportunity Online Hubei is nil%.
 
·  
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 year ended December 31, 2011, Hubei CNET calculated its income tax expenses based on 2.5% of the total revenue recognized for the reporting period. Starting from January 1, 2012, the local tax authorities cancelled the 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 year ended December 31, 2012, the applicable income tax rate for Hubei CNET is 25%.
 
·  
The applicable income tax rate for the rest of our PRC operating entities was 25% for the years ended December 31, 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 owned by an intermediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to this intermediate holding company.
 
 
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For the years ended December 31, 2012 and 2011, all of the preferential income tax treatments enjoyed by our 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 our respective PRC subsidiary and VIEs operate. Rise King WFOE, Business Opportunity Online, Business Opportunity Online Hubei, Hubei CNET and were most affected by these preferential income tax treatments within the structure of us. 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.  
Turnover taxes and the relevant surcharges
 
For fiscal 2011, revenue from advertisement services is subject to 5.5% business tax (including surcharges) and 3% cultural industry development surcharge of the net service income after deducting amount paid to ending media promulgators. Revenue from internet technical services is subjected to 5.5% business tax (including surcharges).
 
Beginning on January 1, 2012, PRC tax authorities increased the local business tax rate by 0.1%-0.2%. Therefore, from January 1, 2012 through August 31, 2012 (for our PRC operating entities incorporated in Beijing) or October 31, 2012 (for our PRC operating entities incorporated in Fujian province) or November 30, 2012 (for our PRC operating entities incorporated in Hubei province), revenue from advertisement services was subject to 5.6%-5.7% business tax (including surcharges), depending on which tax jurisdiction our PRC operating subsidiary and VIE operate in, and 3% cultural industry development surcharge of the net service income after deducting amount pay to ending media promulgators. Revenue from internet technical services is subjected to 5.6%-5.7% business tax (including surcharges), depending on which tax jurisdiction our operating subsidiary and VIE operate in.
 
On July 31, 2012, the Ministry of Finance (the “MOF”) and the State Administration of Taxation (the “SAT”) of the PRC jointly promulgated a “Circular on Launching the Pilot Collection of Value Added Tax in lieu of Business Tax in Transportation and Certain Areas of Modern Services Industries in Eight Provinces and Municipalities Including Beijing” (“Circular Cai Shui [2012] No. 71”), pursuant to which a business tax to value added tax (the “VAT”) transformation pilot program was launched. The implementation date for Beijing is September 1, 2012, for Fujian province, November 1, 2012, and for Hubei province, December 1, 2012. Other circulars such as “Circular on Carrying out the Pilot Collection of Value Added Tax in Lieu of Business Tax to be imposed on Transportation Industry and Part of Modern Services Industry in Shanghai” (“Circular Cai Shui [2011] No. 111”) jointly promulgated by the MOF and the SAT on November 16, 2011 which contains detailed implementation measures for such VAT pilot program apply to the locations including Beijing, Fujian province and Hubei province. In accordance with the Circular Cai Shui [2011] No. 111, the VAT rate for provision of modern services (other than lease of corporeal movables) is 6% and for small scale taxpayer, 3%. Therefore, beginning on September 1, 2012, for our PRC operating subsidiary and VIEs incorporated in Beijing, November 1, 2012, for our PRC operating VIEs incorporated in Fujian province, December 1, 2012, for our PRC operating VIEs incorporated in Hubei province, 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 our PRC operating subsidiary and VIE operate in.
 
Business tax is a price including tax in the PRC turnover tax system, which is calculated based on the revenue inclusive of turnover tax. Therefore, revenues achieved by the Company which are subject to business tax are presented on a gross basis inclusive of business tax, and on the other hand, business tax was included in cost of revenues upon recognition of services revenues. Contrastively, VAT is a price excluding tax in the PRC
 
 
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turnover tax system, which is calculated based on the revenue exclusive of turnover tax. Therefore, revenues achieved by the Company which are subject to VAT is presented on a net basis exclusive of VAT.
 
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 our tax filings may not be finalized. It is therefore uncertain as to whether the PRC tax authority may take different views about our tax filings which may lead to additional tax liabilities.
 
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 or results of operations.
 
In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”, The ASU does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, this ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The guidance is effective prospectively for reporting periods beginning after December 15, 2012 for public entities. The adoption of this standard is not expected to have a material impact on our 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 our consolidated financial position and results of operations upon adoption.
 
A.           RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 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.
 
 
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Year ended December 31,
  
   
2012
    
2011
  
   
US$
    
US$
  
Sales
            
From unrelated parties
   $ 46,403     $ 28,105  
From related parties
     197       626  
      46,600       28,731  
Cost of sales
     31,558       12,027  
Gross margin
     15,042       16,704  
                 
Operating expenses
                
Selling expenses
     2,683       3,506  
General and administrative expenses
     6,030       7,904  
Research and development expenses
     1,819       2,132  
      10,532       13,542  
                 
Income from operations
     4,510       3,162  
                 
Other income (expenses)
                
Changes in fair value of contingent consideration receivables
     (160 )     (70 )
Interest income
     186       13  
Gain on deconsolidation of subsidiaries
     -       925  
Other (expenses) income
     (150 )     5  
      (124 )     873  
                 
Income before income tax expense, equity method investments and noncontrolling interests
     4,386       4,035  
Income tax expense
     529       1,035  
Income before equity method investments and noncontrolling interests
     3,857       3,000  
Share of losses in equity investment affiliates
     (449 )     (219 )
Net income
     3,408       2,781  
Net (income) loss attributable to noncontrolling interests
     (412 )     214  
Net income attributable to ChinaNet Online Holdings, Inc.
     2,996       2,995  
Dividend of Series A convertible preferred stock
     -       (407 )
Net income attributable to common stockholders of ChinaNet Online Holdings, Inc.
   $ 2,996     $ 2,588  
                 
Earnings per share
                
Earnings per common share
                
Basic
   $ 0.14     $ 0.14  
Diluted
   $ 0.14     $ 0.14  
                 
                 
Weighted average number of common shares outstanding:
                
Basic
     22,185,556       18,545,609  
Diluted
     22,185,556       18,759,240  
 
NON-GAAP MEASURES
 
To supplement the audited consolidated statement of income and comprehensive income presented in accordance with GAAP, we are also providing non-GAAP measures of income from operations, income before income tax expenses, net income, net income attributable to us, net income attributable to our common stockholders and basic and diluted earnings per share for the year ended December 31, 2012 and 2011, which are adjusted from results based on GAAP to exclude the non-cash gain and expenses recorded, which related to changes in fair value of contingent consideration receivables related to the “make-good” provisions upon acquisition of VIEs for the year ended December 31, 2012; the gain on deconsolidation of subsidiaries, the related deferred income tax expenses, changes in fair value of contingent consideration receivables related to the “make-good” provisions upon acquisition of VIEs, and non-cash share-based compensation expenses recognized for the restricted stock and common stock purchase options issued to our management, directors and employees for the year ended December 31, 2011.
 
The non-GAAP financial measures are provided to enhance the investors' overall understanding of our current performance in on-going core operations as well as prospects for the future. These measures should be considered in addition to results prepared and presented in accordance with GAAP, but should not be considered a substitute for or superior to GAAP results. We use both GAAP and non-GAAP information in evaluating our operating business results internally and therefore deemed it important to provide all of this information to investors.
 
 
54
 
The following table presents reconciliations of our non-GAAP financial measures to the audited consolidated statements of income and comprehensive income for the years ended December 31, 2012 and 2011 (all amounts, except number of shares and per share data, are presented in thousands of US dollars):
 

   
Year Ended December 31,
  
   
2012
    
2011
  
   
GAAP
    
NON GAAP
    
GAAP
    
NONGAAP
  
   
US$
    
US$
    
US$
    
US$
  
                         
Gross Profit
   $ 15,042     $ 15,042     $ 16,704     $ 16,704  
                                 
Operating expenses
                                
Selling expenses
     2,683       2,683       3,506       2,827  
General and administrative expenses
     6,030       6,030       7,904       6,647  
Research and development expenses
     1,819       1,819       2,132       1,461  
      10,532       10,532       13,542          
                              10,935  
                                 
Income from operations
     4,510       4,510     $ 3,162          
Adjusted income from operations
                           $ 5,769  
                                 
Other income (expenses):
                                
Changes in fair value of contingent consideration receivables
     (160 )     -       (70 )     -  
Interest income
     186       186       13       13  
Gain on deconsolidation of subsidiaries
     -       -       925       -  
Other (expenses) income
     (150 )     (150 )     5       5  
      (124 )             873          
              36               18  
Income before income tax expense, equity method investments and noncontrolling interests
     4,386               4,035          
Adjusted income before income tax expense, equity method investments and noncontrolling interests
             4,546               5,787  
Income tax expense
     529       529       1,035       827  
Income before equity method investments and noncontrolling interests
     3,857               3,000          
Adjusted income before equity method investments and noncontrolling interests
             4,017               4,960  
Share of losses in equity investment affiliates
     (449 )     (449 )     (219 )     (219 )
Net income
     3,408               2,781          
Adjusted net income
             3,568               4,741  
Net (income) loss attributable to noncontrolling interest
     (412 )     (412 )     214       214  
Net income attributable to ChinaNet Online Holdings, Inc.
     2,996               2,995          
Adjusted net income attributable to ChinaNet Online Holdings, Inc.
             3,156               4,955  
Dividend for series A convertible preferred stock
     -       -       (407 )     (407 )
Net income attributable to common shareholders of ChinaNet Online
   $ 2,996             $ 2,588          
Adjusted net income attributable to common shareholders of ChinaNet Online
           $ 3,156             $ 4,548  
                                 
                                 
Earnings per common share-Basic
   $ 0.14             $ 0.14          
Adjusted earnings per common share-Basic
           $ 0.14             $ 0.25  
                                 
Earnings per common share-Diluted
   $ 0.14             $ 0.14          
Adjusted earnings per common share-Diluted
           $ 0.14             $ 0.24  
                                 
Weighted average number of common shares   outstanding:
                                
Basic
     22,185,556       22,185,556       18,545,609       18,545,609  
Diluted
     22,185,556       22,185,556       18,759,240 (1)     20,384,766 (2)
 
(1)  
For the year ended December 31, 2011, the effect of the 1,625,526 incremental shares resulted from assumed conversion of the convertible preferred stock was not included, because its effect was anti-dilutive under GAAP measures.
 
(2)  
For the year ended December 31, 2011, the effect of the 1,625,526 incremental shares resulted from assumed conversion of the convertible preferred stock was included, because the effect was dilutive for not including the non-cash gain and expenses related to the non-recurring transactions incurred under NON-GAAP measures.
 
 
55
 
REVENUE
 
The following tables set forth a breakdown of our total revenue, divided into five segments for the periods indicated, with inter-segment transactions eliminated:

   
Year ended December 31,
  
   
2012
    
2011
  
 
Revenue type
  
(Amounts expressed
in thousands of US dollars, except percentages)
  
                         
Internet advertisement
   $ 21,121       45.3 %   $ 15,359       53.4 %
Technical services
     245       0.5 %     4,622       16.1 %
TV advertisement
     20,454       43.9 %     6,434       22.4 %
Bank kiosks
     282       0.6 %     487       1.7 %
Brand management and sales channel building
     4,498       9.7 %     1,829       6.4 %
Total
   $ 46,600       100 %   $ 28,731       100 %

 
Total Revenues: Our total revenues increased to US$46.6 million for the year ended December 31, 2012 from US$28.7 million for the year ended December 31, 2011, representing a 62% increase.
 
We derive the majority of our advertising service revenues from the sale of advertising space on our internet portals and from providing the related technical support and services, internet marketing service and content management services to unrelated third parties and to certain related parties. We also derive revenue from the sale of advertising time purchased from different TV programs. Our advertising services to related parties were provided in the ordinary course of business on the same terms as those provided to our unrelated advertising clients. For the year ended December 31, 2012 and 2011, our service revenue from related parties in the aggregate was less than 2.5% of the total revenue we achieved for each respective reporting period.
 
Our advertising service revenues are recorded net of any sales discounts. Sales discounts include volume discounts and other customary incentives offered to our small and medium-sized franchise and merchant clients, including providing them with additional advertising time for their advertisements if we have unused space available on our websites and represent the difference between our official list price and the amount we actually charge our clients. We typically sign service contracts with our small and medium-sized franchisor and other clients that require us to place the advertisements on our portal websites in specified locations on the sites and for agreed periods; and/or
 
 
56
 
place the advertisements onto our purchased advertisement time during specific TV programs for agreed periods. We recognize revenues as the advertisement airs over the contractual term based on the schedule agreed upon with our clients.
 
As a result of the research and development activities conducted and managed by Rise King WFOE, beginning in December 2009, our WFOE began providing a number of value added technical services and management systems to our internet advertisement customers, which services enhance the quality and performance of the internet advertising services provided by Business Opportunity Online. These value added technical services are primarily online technical management systems and platforms. Customers use these technical services to analyze, monitor and manage their advertisements on our key advertising portal, 28.com, their other traffic generating activities and their online marketing campaign activities. Revenues generated by Rise King WFOE are from the provision of technical and management systems including tools, databases and services developed and managed by Rise King WFOE to analyze, monitor and manage a customer’s advertisements on our key advertising portal, 28.com, their traffic generating activities, and their online marketing campaign activities. Most of these services are based on fixed price terms; revenues are then generated and recognized from the use of the online management system and tools on a periodic basis, together with the satisfaction of other applicable performance thresholds, if specified. Rise King WFOE’s customers are similar to our internet advertising customers, with over 70% of the WFOE’s customers also being customers of our internet advertisement services. The other 30% of Rise King WFOE’s customers do not directly advertise on our web portal but use Rise King WFOE’s management systems and the internet information collected from our key advertising web portal to monitor and manage their traffic generating activities and online marketing campaign activities. These value added technical services, operated and managed by Rise King WFOE, are primarily developed and offered as additions to the internet advertisement services provided by Business Opportunity Online. The revenue generating activities conducted by Rise King WFOE are not prohibited under the known and existing PRC laws and regulations, as our WFOE is providing value-added technical services to our clients, and is not engaged in the internet advertising business or any other business that is subject to obtaining an Internet Content Provider License. For the internet advertisement services conducted by our VIE, Business Opportunity Online, customers use our internet advertising portal, www. 28.com, to place internet advertisements in different formats, such as: banners, links, logos, buttons, as well as mini-sites. Customers get internet visits and messages from their advertisements placed on our portal. For the value added technical services provided by our WFOE, customers primarily use the technical and management systems offered by it to analyze, monitor and manage their advertisements and traffic generating activities on our advertising portal. For example, Rise King WFOE’s customers can use our management tools to obtain analysis of messages and sales leads received from their internet advertising.
 
The tables below summarize the revenues, cost of sales, gross margin and net income generated from each of our VIEs and subsidiaries for the year ended December 31, 2012 and 2011, respectively.
 
For the year ended December 31, 2012:
  
 
 
 
Name of subsidiary or VIE
  
Revenue
from
unrelated
parties
    
Revenue
 from
related
parties
    
 
Revenue from
inter-company
    
 
 
Total
  
    $ (’000 )   $ (’000 )   $ (’000 )   $ (’000 )
                                 
Rise King WFOE
     156       89       40       285  
Business Opportunity Online and subsidiaries
     37,961       108       -       38,069  
Beijing CNET Online and subsidiaries
     8,286       -       228       8,514  
Shanghai Jing Yang
     -       -       -       -  
Inter-co., elimination
     -       -       (268 )     (268 )
Total revenue
     46,403       197       -       46,600  
 
 
57
 
For the year ended December 31, 2012:
  
             
Name of subsidiary or VIE
  
Cost of Sales
    
Gross Margin
  
    $ (’000 )   $ (’000 )
                 
Rise King WFOE
     9       276  
Business Opportunity Online and subsidiaries
     26,643       11,426  
Beijing CNET Online and subsidiaries
     5,134       3,380  
Shanghai Jing Yang
     -       -  
Inter-co., elimination
     (228 )     (40 )
Total
     31,558       15,042  
 

For the year ended December 31, 2012:
      
       
Name of subsidiary or VIE
  
Net Income
  
    $ (’000 )
         
Rise King WFOE
     (1,520 )
Business Opportunity Online and subsidiaries
     4,503  
Beijing CNET Online and subsidiaries
     1,418  
Shanghai Jing Yang
     (11 )
ChinaNet Online Holdings, Inc.
     (982 )
Total net income before allocation to the noncontrolling interest
     3,408  
 

For the year ended December 31, 2011:
  
 
 
 
Name of subsidiary or VIE
  
Revenue
from
unrelated
parties
    
Revenue
from
related
parties
    
Revenue from
inter-company
    
 
Total
  
    $ (’000 )   $ (’000 )   $ (’000 )   $ (’000 )
                                 
Rise King WFOE
     4,451       171       -       4,622  
Business Opportunity Online and subsidiaries
     20,191       455       -       20,646  
Beijing CNET Online and subsidiaries
     3,460       -       14       3,474  
Shanghai Jing Yang
     3       -       -       3  
Inter-co., elimination
     -       -       (14 )     (14 )
Total revenue
     28,105       626       -       28,731  
 

For the year ended December 31, 2011:
  
             
Name of subsidiary or VIE
  
Cost of Sales
    
Gross Margin
  
    $ (’000 )   $ (’000 )
                 
Rise King WFOE
     254       4,368  
Business Opportunity Online and subsidiaries
     9,980       10,666  
Beijing CNET Online and subsidiaries
     1,807       1,667  
Shanghai Jing Yang
     -       3  
Inter-co., elimination
     (14 )     -  
Total
     12,027       16,704  
 
 
58
 
For the year ended December 31, 2011:
      
       
Name of subsidiary or VIE
  
Net Income
  
    $ (’000 )
         
Rise King WFOE
     594  
Business Opportunity Online and subsidiaries
     5,935  
Beijing CNET Online and subsidiaries
     (113 )
Shanghai Jing Yang
     27  
ChinaNet Online Holdings, Inc.
     (3,662 )
Total net income before allocation to the noncontrolling interest
     2,781  
 
Management considers revenues generated from internet advertising and the related technical services as one aggregate business operation and relies upon the consolidated results of all the operations in this business unit, when making decisions about allocating resources and assessing performance.
 
·  
Internet advertising revenues for the year ended December 31, 2012 were approximately US$21.1 million as compared to US$15.4 million for the same period in 2011, representing an increase of 37%. The increase in internet advertising revenue for the year ended December 31, 2012 was due to the addition of the internet advertising revenue generated by Sou Yi Lian Mei of approximately US$7.0 million, resulting from the 51% and 49% equity interest acquisition in Sou Yi Lian Mei in December 2011 and September 2012, respectively. The internet advertising revenue generated by the other operating VIEs of approximately US$14.1 million for the year ended December 31, 2012 decreased by approximately 8.4% as compared to US$15.4 million in internet advertising revenue generated in the same period of 2011. This decrease was primarily due to a decrease in the average internet advertising spending per customer caused by the general decline of China’s economy beginning in the second quarter of 2011, continued into fiscal 2012.
 
·  
Revenues generated from technical services offered by Rise King WFOE were US$0.25 million for the year ended December 31, 2012, as compared to US$4.6 million for the same period in 2011. Due to the Chinese government’s monetary policy of increasing interest rates and tightening the money supply, economic difficulties began in the second quarter of 2011, which only recovered slightly in fiscal 2012 with no significant improvement in the overall economy. In response to the overall economic downturn in China, and from the second half of 2011, the majority of our clients cancelled the subscription of these services and only continued their basic internet advertising service, which was recorded in as our internet advertising revenue discussed above and reduced their advertising spending significantly.
 
·  
Our TV advertising revenue increased significantly to US$20.5 million for the year ended December 31, 2012 from US$6.4 million for the same period in 2011. We generated this US$20.5 million of TV advertising revenue for the year ended December 31, 2012 by selling approximately 18,510 minutes of advertising time purchased from different provincial TV stations as compared with approximately 6,040 minutes of advertising time that we sold in the same period of 2011. This increase in TV advertising time selling was due to enhanced cooperation with the TV station responsible for launching the entrepreneurial reality show, which is based on the same concept and premise as the hit TV game show “Shark Tank” in the U.S. This show is intended to get the general public to visit our website, Chuanye.com and create additional traffic on our two advertising portals, 28.com and Liansuo.com, and in return to monetize more branded larger size small and medium enterprises to subscribe our services while securing our competitive advantage in the TV business segment against our competitors with more time purchased in 2012 as compared with 2011. The TV show is considered to be an alternative economic resource to obtain internet traffic to our web portals as the costs associated with our internet resources are increasing year over year and TV cost has a relatively lower rate of increase. However, due to the regular Chinese New Year holiday which takes place in the first quarter of each fiscal year and is always considered to the slowest time of the year, and the economic downturn happened from the second half of 2011, which continued to 2012, we had to combine the time slots of the first quarter of the year at cost with other quarter’s available time slots sales in order to counter off the deficiency in sales margin incurred during this time of the year. As a result of such combination, we achieved only 0.2% gross profit rate for this segment in the first quarter of 2012, this situation was improved in the following quarters of 2012 with our gross profit rate of this business segment improved to 1% for the year ended December 31, 2012.
 
 
59
 
·  
For the year ended December 31, 2012, we earned approximately US$0.28 million of revenue from the bank kiosk business segment as compared to approximately US$0.49 million for the same period in 2011. The decrease in advertising revenue from the bank kiosk business was a result of the decline of the general economy in China, which caused a significant reduction in our customers’ overall advertising spending as discussed above. The bank kiosk advertising business is not intended to expand at the moment as management’s main focus is on expanding internet business. Therefore, it was not a significant contributor to revenue for either year ended December 31, 2012 or 2011. Management currently maintains this business without any expansion plans and some of the technology used in this business unit will be fully integrated into the overall advertising and marketing platform.
 
·  
For the year ended December 31, 2012, we achieved approximately US$4.5 million service revenue from our brand management and sales channel building segment as compared to US$1.8 million service revenue generated in the same period of 2011. The increase in the revenue from this business segment was primarily due to the increase in the average brand advertising and marketing spending per customer from larger-sized and ex-exporting customers acquired for the year ended December 31 2012, as a result of our further expansion of our client base for this business segment in 2012.
 
Cost of revenues
 
Our cost of revenue consisted of costs directly related to the offering of our advertising services, technical services, marketing services and brand management and sales channel building services. The following table sets forth our cost of revenues, divided into five segments, by amount and gross profit ratio for the periods indicated, with inter-segment transactions eliminated:

   
Year ended December 31,
  
   
2012
    
2011
  
   
(Amounts expressed in thousands of US dollars, except percentages)
  
   
Revenue
    
Cost
    
GP ratio
    
Revenue
    
Cost
    
GP ratio
  
                                     
Internet advertisement
   $ 21,121       9,781       54 %   $ 15,359       6,033       61 %
Technical service
     245       9       96 %     4,622       254       95 %
TV advertisement
     20,454       20,222       1 %     6,434       5,233       19 %
Bank kiosk
     282       18       94 %     487       42       91 %
Brand management and sales channel building
     4,498       1,528       66 %     1,829       465       75 %
Total
   $ 46,600     $ 31,558       32 %   $ 28,731     $ 12,027       58 %
 
Cost of revenues: Our total cost of revenues increased to US$31.6 million for the year ended December 31, 2012 from US$12.0 million for the same period in 2011. The increase in total cost of revenues for the year ended December 31, 2012 was primarily due to the significant increase in costs associated with our TV advertisement business segment, which was in line with the increase in our TV advertisement revenue for the year ended December 31, 2012, as discussed above. Our cost of revenues related to the offering of our advertising and marketing services primarily consists of internet resources purchased from other portal websites and technical services providers related to lead generation, sponsored search, TV advertisement time costs purchased from TV stations, direct labor cost associated with providing services and business taxes and surcharges.
 
 
60
 
·  
Cost associated with obtaining internet resources was the largest component of our cost of revenue for internet advertisement, accounting for approximately 80%-90% of our total internet advertisement cost of sales. We purchased these internet resources from other well-known portal websites in China, for example, Baidu, Sohu and Tecent (QQ). Our purchasing of these internet resources in large volumes allowed us to negotiate discounts with our suppliers. The majority of the resources purchased were used by the internet advertising unit to attract more internet traffic to our advertising portals, assist our internet advertisement clients to obtain more diversified exposure and to generate more visits to their advertisements and mini-sites placed on our portal websites, which result in potential sales leads. For the year ended December 31, 2012 and 2011, our total cost of sales for internet advertising revenue was US$9.8 million and US$6.0 million, respectively. The increase in our cost of sales for internet advertising revenue was primarily due to the increase in the purchase price of these resources and the addition of the internet advertising cost of sales recorded by Sou Yi Lian Mei for the year ended December 31, 2012, which was approximately US$2.5 million. The internet cost of revenue incurred by the other operating VIEs of approximately US$7.3 million for the year ended December 31, 2012, increased by approximately 22%, as compared to US$6.0 million in internet advertising cost of revenue incurred in the same period of 2011. This increase was primarily due to the increase in the purchase price of such resources in 2012 as compared to 2011 and the increased demand of these resources to improve customer satisfaction. Given the foregoing, gross profit rate of internet advertising business segment furnished approximately 54% for the year ended December 31, 2012, as compared to 61% achieved in the same period in 2011.
 
·  
Beginning in December 2009, our WFOE began providing a number of value added technical services to our internet advertisement customers. The direct cost of sales for the WFOE’s technical services revenue recognized by our WFOE was primarily the PRC business tax expenses, which was approximately 5% of the total technical service revenue recognized by Rise King WFOE. The decrease in the business tax expenses incurred by our WFOE in 2012 was in line with the decrease in the technical services revenue earned by our WFOE in 2012 as compared to that in 2011.
 
·  
TV advertisement time cost is the largest component of cost of revenue for TV advertisement revenue. We purchase TV advertisement time from different provincial TV stations and resell it to our TV advertisement clients.  Our TV advertisement time cost was approximately US$20.2 million and US$5.2 million for the years ended December 31, 2012 and 2011, respectively. The significant increase in our total TV advertisement time cost was in line with the significant increase of TV advertising revenue for the year ended December 31, 2012 as compared to that in the same periods of 2011, as discussed above.
 
·  
Cost recognized for brand management and sales channel building business segment primarily consisted of director labor cost for providing these services to our customers and the related business tax and business tax surcharges. The increase in cost of service in this segment was in line with the increase of revenue achieved by this segment for the year ended December 31, 2012 as compared to that in the same periods of 2011.
 
Gross Profit
 
As a result of the foregoing, our gross profit was US$15.0 million for the year ended December 31, 2012 as compared to US$16.7 million for the same period in 2011. Our overall gross profit rate decreased to 32% for the year ended December 31, 2012, as compared to 58% for the same period in 2011. For the year ended December 31, 2012, the decrease in the overall gross profit rate was a direct result of (1) the significant increase of the low margin TV advertising revenue, which accounted for approximately 44% of the total revenue we achieved for the year ended December 31, 2012, as compared to 22% in the same period of 2011; and (2) lower gross profit rate achieved from the two major segment of our business, internet advertising segment and TV advertising segment, which achieved 54% and 1% gross profit rate for the year ended December 31, 2012, respectively, as compared to 61% and 19% gross profit rate achieved for the year ended December 31, 2011, respectively.
 
Operating Expenses and Net Income
 
Our operating expenses consist of selling expenses, general and administrative expenses and research and development expenses.  The following tables set forth our operating expenses, divided into their major categories by amount and as a percentage of our total revenues for the periods indicated.
 
 
61
 

   
Years ended December 31,
  
   
2012
    
2011
  
   
(Amounts expressed in thousands of US dollars, except percentages)
  
   
Amount
    
% of total revenue
    
Amount
    
% of total revenue
  
                         
Total Revenue
   $ 46,600       100 %   $ 28,731       100 %
Gross Profit
     15,042       32 %     16,704       58 %
Selling expenses
     2,683       6 %     3,506       12 %
General and administrative expenses
     6,030       13 %     7,904       28 %
Research and development expenses
     1,819       4 %     2,132       7 %
Total operating expenses
     10,532       23 %     13,542       47 %
 
Operating Expenses:   Our operating expenses decreased to US$10.5 million for the year ended December 31, 2012 from US$13.5 million for the same period of 2011.
 
·  
Selling expenses: For the year ended December 31, 2012, our selling expenses decreased to US$2.68 million from US$3.51 million for the same period of 2011. Our selling expenses primarily consist of advertising expenses for brand development that we pay to TV stations and other media outlets for the promotion and marketing of our advertising web portals, other advertising and promotional expenses, website server hosting and broadband leasing expenses, staff salaries, staff benefits, performance bonuses, travelling expenses, communication expenses and other general office expenses of our sales department.  For the year ended December 31, 2012, the change in our selling expenses was primarily due to the following reasons: (1) the increase in staff salary, bonus, employee related benefit expenses and other general selling expenses, such as travelling expenses, business and entertainment expenses and communication expenses of approximately US$1.02 million, primarily due to the expansion of our sales department and inclusion of the selling expenses incurred by Sou Yi Lian Mei, the new VIE we acquired in December 2011; (2) increase in website server hosting and broadband leasing expense of approximately US$0.13 million due to the same reason as discussed above; (3) decrease in selling expenses of approximately US$0.23 million due to deconsolidation Zhao Shang Ke Hubei incurred in December 2011; (4) decreased of share-based compensation expenses of approximately US$0.68 million, which is a non-recurring selling expense in 2011, due to insurance of restricted stock and common stock options to management, directors and employee in November 2011,; and (5) our brand development advertising expenses for our advertising web portals decreased by approximately US$1.07 million. Due to the current economic downturn, increase of TV advertising cost and overall cost reduction plan, we decided to slow down the brand-building activities until the recovery of the economy based on the factor that, our key advertising web portal, 28.com, has been already recognized as one of the most popular Chinese internet portals providing internet advertising and marketing services with sales leads, and other value-added services to SMEs, particularly for small and medium-sized franchisors, in the PRC, by the investment we made in brand building over the last three years. In 2012, we actively participated in both domestic and international franchise exhibitions, which is considered as a more cost-effective way for our continue brand building efforts.
 
·  
General and administrative expenses: General and administrative expenses decreased to US$6.03 million for the year ended December 31, 2012 as compared to US$7.90 million for the same period in 2011. Our general and administrative expenses primarily consist of salaries and benefits for management, accounting and administrative personnel, office rentals, depreciation of office equipment, professional service fees, maintenance, utilities and other office expenses. For the year ended December 31, 2012, the change in our general and administrative expenses was primarily due to the following reasons: (1) the increase in amortization expenses related to the intangible assets identified in the acquisition transactions consummated in 2011 of approximately US$0.51 million, which was primarily due to the acquisition of Sou Yi Lian Mei consummated in late December 2011 and the related amortization expenses was only included for the year ended December 31, 2012; (2) the increase in staff salary, bonus, employee related benefit expenses and other general expenses, such as entertainment expenses, travelling expenses and communication expenses of approximately US$0.51 million, primarily due to inclusion of the general and administrative expenses incurred by Sou Yi Lian Mei, the new VIE we acquired in late December 2011;  (3) the decrease in G&A expenses of approximately US$0.19 million due to deconsolidation Zhao Shang Ke Hubei incurred in December 2011; (4) the decrease in allowance for doubtful accounts we provided for the year ended December 31, 2012 of approximately US$1.44 million; and (5) the decrease in share-based compensation expense in relation to restricted stock and common stock purchase options issued to management, directors and employee in November 2011 of approximately US$1.26 million, which is a non-recurring general and administrative expense in 2011.
 
 
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·  
Research and development expenses: Research and development expenses decreased to US$1.82 million for the year ended December 31, 2012 from US$2.13 million for the same period of 2011. Our research and development expenses primarily consist of salaries and benefits for the research and development staff, equipment depreciation expenses, and office utilities and supplies allocated to our research and development department. For the year ended December 31, 2012, the change in our research and development expenses was primarily due to the following reasons: (1) the decrease in share-based compensation expense in relation to restricted stock and common stock purchase options issued to members of our research and development department in November 2011 of approximately US$0.67 million, which is a non-recurring research and development expense in 2011; (2) the increase in amortization expenses of cloud-computing based software technologies we acquired in July 2011 of approximately US$0.08 million; and (3) the increase of salary, staff benefit expenses and other R&D expenses of approximately US$0.28 million due to expansion of our research and development department in 2012. We expect that our research and development expenses will increase in future periods as we continue to expand, optimize and enhance the technology of our portal websites, upgrade our advertising and internet management software and develop our cloud-computing based management tools. In the next three to five years, we expect our research and development expenses to be within the range of four percent to six percent of our total revenues.
 
Operating Profit: As a result of the foregoing, our operating profit increased to US$4.5 million for the year ended December 31, 2012 from US$3.2 million for the same period of 2011. Excluding the approximately US$2.6 million of non-recurring share-based compensation expenses related to the restricted stock and common stock purchase options issued to management, directors and employees in November 2011, the adjusted NON-GAAP operating profit for the year ended December 31, 2011 was US$5.8 million.
 
Changes in Fair Value of Contingent Consideration Receivables: Contingent consideration receivables arose from certain “make good” provisions entered into by and between the Company and the former stockholders of Quanzhou Zhi Yuan, Quanzhou Tian Xi Shun He and Sou Yi Lian Mei, upon acquisition of these  operating 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 and 2011 increases by less than a 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. We assessed the fair value of these contingent consideration receivables at the respective acquisition date of these acquired VIEs and reassessed these fair values as of each of the reporting periods. The changes in the fair value of these contingent consideration receivables of approximately US$0.16 million and US$0.07 million for the year ended December 31, 2012 and 2011, respectively, was included in our consolidated statement of income and comprehensive income.
 
Gain on deconsolidation of subsidiaries: The deconsolidation of Shenzhen Mingshan and Zhao Shang Ke Hubei that occurred on January 6, 2011 and December 29, 2011, respectively, were accounted for in accordance with ASC Topic 810 “Consolidation”.  We recognized a gain of approximately US$0.23 million upon deconsolidation of Shenzhen Mingshan and a gain of approximately US$0.69 million upon deconsolidation of Zhao Shang Ke Hubei in our consolidated statements of income and comprehensive income for the year ended December 31, 2011, with a corresponding increase to the carrying value of the investment in Shenzhen Mingshan and Zhao Shang Ke Hubei, respectively, in our consolidated balance sheet. These deconsolidation gains represented the excess of the fair value of our retained equity interest in Shenzhen Mingshan and Zhao Shang Ke Hubei over its respective carrying value as of the respective date of deconsolidation.
 
Income before income tax expense, equity method investments and noncontrolling interests: As a result of the foregoing, our income before income tax expenses, equity method investment and noncontrolling interest increased to US$4.4 million for the year ended December 31, 2012 from US$4.0 million for the same period in 2011. Adjusted Non-GAAP income before income tax expenses, equity method investments and noncontrolling interest, which
 
 
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excludes the previously discussed non-cash gains or expenses recognized for non-recurring transactions for the year ended December 31, 2012 and 2011, was approximately US$4.5 million and US$5.8 million for the year ended December 31, 2012 and 2011, respectively.
 
Income tax expenses: We recognized an income tax expense of approximately US$0.53 million and US$1.04 million for the year ended December 31, 2012 and 2011, respectively. For the year ended December 31, 2012 and 2011, income tax expenses included: (1) current income tax expenses of approximately US$1.36 million and US$1.01 million, respectively; and (2) deferred income tax benefit of approximately US$0.83 million for the year ended December 31, 2012 and net deferred income tax expenses of approximately US$ 0.03 million for the year ended December 31, 2011. For the year ended December 31, 2012, the increase in current income tax expenses was primarily due to the increase in the overall effective income tax rate of our profitable PRC operating VIEs. For the year ended December 31, 2012 deferred income tax benefit recognized in relation to the amortization of the intangible assets identified in the acquisition transactions consummated in 2011 was approximately US$0.22 million. For the year ended December 31, 2012, deferred income tax benefit recognized also include an approximately US$0.61 million deferred income tax benefit in relation to the net operating losses incurred by our PRC operating VIEs for the year ended December 31, 2012, which we consider likely to be able to be utilized with respect to future earnings of the entities to which the operating losses relate. For the year ended December 31, 2011, our net deferred income tax expenses included an approximately US$0.21 million deferred income tax expenses in relation to the gain on deconsolidation of subsidiaries recognized for the year ended December 31, 2011, an approximately US$0.09 million deferred income tax benefit in relation to the amortization expenses of the intangible assets identified upon acquisition of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He for the year ended December 31, 2011 and an approximately US$0.09 million deferred income tax benefit in relation to the net operating loss carry forward incurred by our PRC operating VIEs, which we consider likely to be able to be utilized with respect to future earnings of the entities to which the operating losses relate.
 
Income before equity method investments and noncontrolling interests: As a result of the foregoing, our income before equity method investment and noncontrolling interest increased to US$3.9 million for the year ended December 31, 2012 from US$3.0 million for the same period of 2011. Adjusted Non-GAAP income before equity method investments and noncontrolling interest, which excludes the previously discussed non-cash gains or expenses recognized for non-recurring transactions for the year ended December 31, 2012 and 2011, was approximately US$4.0 million and US$5.0 million for the year ended December 31, 2012 and 2011, respectively.
 
Share of losses in equity investment affiliates: We acquired a 49% equity interest in Beijing Yang Guang in December 2010. In August 2011, we transferred our 49% equity interest in Beijing Yang Guang back to its majority shareholder. For the year ended December 31, 2011, our pro-rata share of earnings recognized in Beijing Yang Guang was approximately US$0.03 million. Shenzhen Mingshan used to be 51% owned by one of our operating VIEs and was consolidated by us from its date of incorporation through January 6, 2011. On January 6, 2011, an unaffiliated third party invested RMB15,000,000 (approximately US$2,374,883) to Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan, and our percentage of equity interest in Shenzhen Mingshan decreased from 51% to 20.4% accordingly. Shenzhen Mingshan became an equity investment affiliate of ours. In December 2012, as approved by the shareholders of Shenzhen Mingshan, Shenzhen Mingshan reduced its registered and paid-in capital from RMB25,000,000 (approximately US$3,958,139) to RMB22,000,000 (approximately US$3,483,162), resulted from a decrease of paid-in capital from three other noncontrolling shareholders, except Business Opportunity Online. As a result, our share of the equity interest in Shenzhen Mingshan increased from 20.4% to 23.18% and we continued to retain significant influence over Shenzhen Mingshan. Accordingly, we recognized our pro-rata share of losses in Shenzhen Mingshan immediately after the deconsolidation based on our percentage of equity interest in Shenzhen Mingshan for each period, which was approximately US$0.11 million and US$0.25 million for the year ended December 31, 2012 and 2011, respectively. Zhao Shang Ke Hubei used to be 51% owned by one of our operating VIEs and was consolidated by us from its date of incorporation through December 29, 2011. On December 29, 2011, two unaffiliated third party investors invested RMB10,000,000 (approximately US$1,583,255) to Zhao Shang Ke Hubei in exchange for a 50% equity interest in Zhao Shang Ke Hubei, and our percentage of equity interest in Zhao Shang Ke Hubei decreased from 51% to 25.5% accordingly. Zhao Shang Ke Hubei then became an equity investment affiliate of ours.  Accordingly, we recognized our pro-rata share of losses in Zhao Shang Ke Hubei immediately after the deconsolidation, which was approximately US$0.34 million for the year ended December 31, 2012. Given the
 
 
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foregoing, net amount recognized as share of losses in equity investment affiliates was approximately US$0.45 million and US$0.22 million for the year ended December 31, 2012 and 2011, respectively.
 
Net income: As a result of the foregoing, our net income increased to US$3.4 million for the year ended December 31, 2012 from US$2.8 million for the same period of 2011. Excluding the non-cash gain recognized for deconsolidation of subsidiaries of approximately US$0.93 million, the related deferred income tax expenses of approximately US$0.21 million, the non-cash expenses of share-based compensation recognized for the restricted stock and common stock purchase options issued in November 2011 of approximately US$2.6 million and the non-cash charge of the changes in fair value of the contingent consideration receivables of approximately US$0.07 million for the year ended December 31, 2011; and the non-cash charge of the changes in fair value of the contingent consideration receivables of approximately US$0.16 million for the year ended December 31, 2012, we achieved adjusted Non-GAAP net income amounting to US$3.6 million and US$4.7 million for the years ended December 31, 2012 and 2011, respectively.
 
Income / loss attributable to noncontrolling interest: Shenzhen Mingshan was 51% owned by Business Opportunity Online upon incorporation until it was deconsolidated from us in January 2011. Quanzhou Tian Xi Shun He was 51% owned by Beijing CNET Online upon acquisition before it became a wholly-owned subsidiary of Beijing CNET Online in June 2011. Zhao Shang Ke Hubei was 51% owned by Business Opportunity Online Hubei upon incorporation until it was deconsolidated from us in December 2011. Beijing Chuang Fu Tian Xia and Sheng Tian Hubei were 51% owned by Business Opportunity Online and Business Opportunity Online Hubei, respectively, upon incorporation. Sou Yi Lian Mei was 51% owned by Business Opportunity Online Hubei before it became a wholly-owned subsidiary of Business Opportunity Online Hubei in September 2012. Accordingly, net income/losses incurred by these entities during the period when they were majority-owned subsidiaries of our PRC VIEs were allocated between their respective shareholders based on their respective percentage of the ownership in these entities for the year ended December 31, 2012 and 2011. For the year ended December 31, 2012, the net income allocated to the noncontrolling interest of Sou Yi Lian Mei was approximately US$0.62 million, the aggregate net losses allocated to the noncontroliing interest of Beijing Chuang Fu Tian Xia and Sheng Tian Hubei was approximately US$0.21 million. Given the foregoing, net income attributable to noncontrolling interest in the aggregate was approximately US$0.41 million for the year ended December 31, 2012. For the year ended December 31, 2011, the aggregate net losses allocated to the noncontrolling interest of Quanzhou Tian Xi Shun He, Zhao Shang Ke Hubei, Beijing Chuang Fu Tian Xia and Sheng Tian Hubei were approximately US$0.21 million.
 
Net income attributable to ChinaNet Online Holdings, Inc.: Total net income as adjusted by the net income or loss attributable to the noncontrolling interest shareholders as discussed above yields the net income attributable to ChinaNet Online Holdings, Inc. Our net income attributable to ChinaNet Online Holdings, Inc. was US$3.0 million for both the year ended December 31, 2012 and 2011. Adjusted Non-GAAP net income attributable to ChinaNet Online Holdings, Inc. which excludes the previously discussed non-cash gains or expenses recognized for non-recurring transactions for the year ended December 31, 2012 and 2011 was approximately US$3.2 million and US$5.0 million for the year ended December 31, 2012 and 2011, respectively.
 
Dividend for Series A convertible preferred stock: Cash dividend to Series A convertible stock holders was calculated at the per annum rate of 10% of the liquidation preference amount of the Series A preferred stock which was US$2.5 per share and the actual number of days each share outstanding within each of the reporting period. As all of the outstanding Series A convertible preferred stock of us was automatically converted into our common stock on August 21, 2011, no preferred stock dividend was accrued for the year ended December 31, 2012. The cash dividends we accrued for the Series A convertible preferred stock were approximately US$0.41 million for the years ended December 31, 2011.
 
Net income attributable to ChinaNet’s common shareholders: Net income attributable to ChinaNet’s common shareholders represents the net income after allocation to noncontrolling interests minus the cash dividend accrued for Series A convertible preferred stock. Our net income attributable to ChinaNet’s common shareholders increased to US$3.0 million for the year ended December 31, 2012 from US$2.6 million for the same period of 2011. Adjusted Non-GAAP net income attributable to ChinaNet’s common shareholders, which excludes the previously discussed non-cash gains or expenses recognized for non-recurring transactions, was approximately US$3.2 million and US$4.5 million for the years ended December 31, 2012 and 2011, respectively.
 
 
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B.           LIQUIDITY AND CAPITAL RESOURCES
 
Cash and cash equivalents represent cash on hand and deposits held at call with banks. We consider all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents.  As of December 31, 2012, we had cash and cash equivalents of approximately US$5.5 million and we also have approximately US$3.4 million of term deposit placed in one of the major financial institutes in China which will expire in July 2013.
 
Our liquidity needs include (i) net cash used in operating activities that consists of (a) cash required to fund the initial build-out and continued expansion of our network and (b) our working capital needs, which include deposits and advance payment to TV advertising slots and internet resource providers, payment of our operating expenses and financing of our accounts receivable; and (ii) net cash used in investing activities that consist of the payment for acquisitions to further expand our business and client base, investment in software technologies to enhance the functionality of the management tools provided by our advertising portals and investment in other general office equipment. To date, we have financed our liquidity need primarily through proceeds from operating activities we generated in prior years. Our existing cash is adequate to fund operations for the next 12 months.
 
The following table provides detailed information about our net cash flow for the periods indicated:

   
Year ended December 31,
  
   
2012
    
2011
  
   
Amounts in thousands of US dollars
  
             
Net cash provided by/(used in) operating activities
   $ 5,028     $ (603 )
Net cash used in investing activities
     (9,919 )     (6,084 )
Net cash (used in)/provided by financing activities
     (385 )     1,482  
Effect of foreign currency exchange rate changes on cash
     64       310  
Net decrease in cash and cash equivalents
   $ (5,212 )   $ (4,895 )
 
Net cash provided by / (used in) operating activities:
 
For the year ended December 31, 2012, our net cash provided by operating activities of approximately US$5.03 million were primarily attributable to:
 
(1)  
net income excluding approximately US$1.69 million of non-cash expenses of depreciation, amortizations, share-based compensation; approximately US$1.14 million of non-cash charge of bad debts provisions; approximately US$0.45 million of share of losses in equity investment affiliates and approximately US$0.16 million of change in fair value of contingent consideration receivable, and net of approximately US$0.83 million of deferred income tax benefit, of approximately US$6.02 million;
 
(2)  
the receipt of cash from operations from changes in operating assets and liabilities such as:
 
-  
other receivables decreased by approximately US$1.4 million, which was primarily due to the collection of the overdue contract execution guarantee deposits and the partial collection of the loan made for the production of the TV series “Xiao Zhan Feng Yun”;
 
-  
prepayments and deposits to suppliers decreased by approximately US$0.88 million, primarily due to the decrease in prepayments and deposits paid for the TV advertisement time purchased for reselling in 2013;
 
-  
advance from customers and due to related parties for advertising services to be provided increased by approximately US$0.33 million;
 
-  
taxes payable increased by approximately US$1.60 million; and
 
 
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-  
other payables and accrued payroll and other accruals increased by approximately US$0.36 million.
 
(3)  
offset by the use from operations from changes in operating assets and liabilities such as:
 
-  
accounts receivable and due from related parties for the advertising services provided increased by approximately US$5.40 million; and
 
-  
accounts payable decreased by approximately US$0.16 million.
 
For the year ended December 31, 2011, our net cash used in operating activities of approximately US$0.6 million were primarily attributable to:
 
(1)  
net income excluding approximately US$0.9 million non-cash gain recognized upon deconsolidation of subsidiaries, US$2.58 million of non-cash charge of bad debts provisions, US$2.9 million of non-cash share-based compensation expenses, which primarily resulted from the 2,000,000 shares of restricted stock and 885,440 shares of common stock purchase options issued to our management and employees on November 30, 2011 and US$1.3 million of other non-cash expenses of depreciation, amortizations and our share of losses in equity investment affiliates of approximately US$8.7 million;
 
(2)  
the receipt of cash from operations from changes in operating assets and liabilities such as:
 
-  
Other receivables decreased by approximately US$5.3 million, which was primarily due to the collection of the third party loans and the partial collection of the loan made for the production of the TV series “Xiao Zhan Feng Yun”;
 
-  
accounts payable, other payables and accrued payroll and other accruals increased by approximately U$S0.7 million; and
 
-  
taxes payable increased by approximately US$0.8 million.
 
(3)  
offset by the use from operations from changes in operating assets and liabilities such as:
 
-  
accounts receivable and due from related parties for the advertising services provided increased by approximately US$2.2 million;
 
-  
prepayments and deposits to suppliers increased by approximately US$11.2 million, primarily due to the prepayments and deposits paid for the TV advertisement time purchased for fiscal 2012;
 
-  
advance from customers and due to related parties for advertising services to be provided decreased by approximately US$1.7 million;
 
-  
due to director and due to Control Group decreased by approximately US$0.7 million, as in year 2011, we settled the balances due to them for the cost and operating expenses paid by them on behalf of our company in previous years; and
 
-  
payments of approximately US$0.2 million for other current assets.
 
Net cash used in investing activities:
 
For the year ended December 31, 2012, our net cash used in investing activities included the following transactions: (1) we paid an aggregate of approximately US$5.78 million in connection with the acquisition of equity interest in Sou Yi Lian Mei; (2) we placed approximately US$3.36 million cash as term deposit in one of the major financial institutions in China, which will expire in July 2013 and this amount was recorded as a decrease in cash and cash equivalents, i.e. cash outflow in investing activity for the year ended December 31, 2012; (3) during the year ended December 31, 2012, we made an approximately US$2.45 million project development deposit to a third party
 
 
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project development and management company for the participation in the development and management of the Xiaogan TMT Zone, which had been fully refunded before December 31, 2012 due to our withdrawing from this project after evaluation; (4) we made an approximately US$0.48 million temporary loan to unrelated entities; and (5) we spent approximately US$0.31 million in general office equipment during the year ended December 31, 2012. In the aggregate, these transactions resulted in a net cash outflow from investing activities of approximately US$9.92 million for the year ended December 31, 2012.
 
For the year ended December 31, 2011, our net cash used in investing activities included the following transactions: (1) we paid approximately US$9.7 million in connection with the acquisitions incurred during the year, including the acquisitions of a 100% equity interest of Quanzhou Zhi Yuan and a 51% equity interest of Quanzhou Tian Xi Shun He in January 2011, the acquisition of the remaining 49% equity interest in Quanzhou Tian Xi Shun He in June 2011 and the acquisition of a 51% equity interest in Sou Yi Lian Mei in December 2011; (2) total cash acquired from the above acquisitions recorded as cash inflow from investing activities during the year was approximately US$0.3 million, (3) we paid approximately US$1.7 million to our equity investment affiliates during the year, including an additional US$1.5 million working capital loan to Beijing Yang Guang in the first quarter of 2011 and an approximately US$0.2 million additional cash investment to ShenZhen Mingshan in the third quarter of 2011; (4) from August to December 2011, after we disposed our investment in Beijing Yang Guang, we collected approximately US$8.9  million in the aggregate for (i) the cash consideration of the disposal of the 49% equity interest in Beijing Yang Guang; (ii) our pro-rata share of earnings generated from Beijing Yang Guang during the period when we held the 49% equity interest in it; and (iii) all of the outstanding working capital loans lent to Beijing Yang Guang in 2010 and 2011; (5) cash effect of deconsolidation of Shenzhen Mingshan and Zhao Shang Ke Hubei recorded as cash outflow from investing activities during the year was approximately US$1.7 million, which represented the cash balance of the deconsolidated subsidiaries as of their respective deconsolidation dates; and (6) we also invested approximately US$0.7 million in fixed assets and approximately US$1.4 million in intangible assets, which investments were primarily related to the cloud-computing based software technologies purchased during the year. In the aggregate, these transactions resulted in a net cash outflow from investing activities of approximately US$6.1 million for the year ended December 31, 2011.
 
Net cash (used in) / provided by financing activities:
 
For the year ended December 31, 2012, our net cash used in financing activities was approximately US$0.39 million which primarily consisted of the following transactions: (1) cash dividends paid to our preferred stockholders of approximately US$0.01 million; (2) one of our VIEs borrowed an approximately US$0.32 million working capital loan from Zhao Shang Ke Hubei, our equity investment affiliate during the three months ended March 31, 2012; and (3) our VIEs repaid all previously borrowed outstanding working capital loan of approximately US$0.54 million to Zhao Shang Ke Hubei during the three months ended June 30, 2012; (4) we also repaid approximately US$0.16 million to the legal (nominal) shareholders of Shanghai Jing Yang, with whom we entered into the VIE contractual arrangements in December 2010, for the initial paid-in capital they contributed upon incorporation of Shanghai Jing Yang.
 
For the year ended December 31, 2011, our net cash provided by financing activities was approximately US$1.5 million which primarily consisted of the following transactions: (1) cash dividends paid to our preferred stockholders of approximately US$0.7 million; (2) cash contributed by the noncontrolling interest shareholders of our newly formed VIEs of approximately US$0.4 million in connection with the establishment of these VIEs in 2011; (3) we received approximately US$1.5 million from the two new investors of Zhao Shang Ke Hubei in advance before it was deconsolidated from us, which was recorded as cash inflow from financing activities during the year; and (4) we, through one of our VIEs borrowed approximately US$0.2 million working capital loan from Zhao Shang Ke Hubei, which was also recorded as cash inflow from financing activities during the year.
 
Restricted Net Assets
 
As most of our operations are conducted through our PRC subsidiary and VIEs, our ability to pay dividends is primarily dependent on receiving distributions of funds from our PRC subsidiary and VIEs. Relevant PRC statutory laws and regulations permit payments of dividends by our PRC subsidiary and VIEs only out of their retained
 
 
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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 our consolidated net assets are also not 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 our PRC VIEs are subject to the above mandated restrictions on distributable profits.
 
As a result of these PRC laws and regulations, our PRC subsidiary and VIEs are restricted in their ability to transfer a portion of their net assets to us.  As of December 31, 2012 and 2011, net assets restricted in the aggregate, which includes paid-in capital and statutory reserve funds of our PRC subsidiary and VIEs that are included in our consolidated net assets, was approximately US$5.5 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 our PRC subsidiaries to make dividends and other payments to us 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 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.
 
 
69
 
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. We cannot be sure that it will be able to obtain all required conversion approvals for our operations or the Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Currently, most of our retained earnings are generated in Renminbi. Any future restrictions on currency exchanges may limit our ability to use retained earnings generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible business activities outside China.
 
As of December 31, 2012 and 2011, there were approximately US$38.1 million and US$34.0 million retained earnings in the aggregate, respectively, which were generated by our PRC subsidiary and VIEs in Renminbi included in our consolidated net assets, aside from US$2.4 million and US$2.2 million statutory reserve funds as of December 31, 2012 and 2011, respectively, that may be affected by increased restrictions on currency exchanges in the future and accordingly may further limit our PRC subsidiary’ or VIEs’ ability to make dividends or other payments in U.S. dollars to us, in addition to the approximately US$5.5 million and US$4.7 million restricted net assets as of December 31, 2012 and 2011, respectively, as discussed above.
 
C.           Off-Balance Sheet Arrangements
 
None.
 
D.           Tabular Disclosure of Contractual Obligations
 
The following table sets forth our company’s contractual obligations as of December 31, 2012:
 

   
Office Rental
    
Server hosting
and board-band Leasing
    
Total
  
   
US$(’000)
    
US$(’000)
    
US$(’000)
  
Year ending December 31,
                  
-2013
     367       69       436  
-2014
     293       -       293  
-2015
     293       -       293  
-2016
     73       -       73  
      1,026       69       1,095  
 
ITEM 7B. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
As a smaller reporting company, we are not required to include disclosure under this Item.
 
ITEM 8  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
Consolidated Financial Statements
 
Our consolidated financial statements and the notes thereto begin on page F-1 of this Annual Report.
 
ITEM 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

 
70
 
The practice of Bernstein & Pinchuk LLP (“B&P”), our company’s independent registered public accounting firm, entered into a joint venture agreement with Marcum LLP and formed Marcum Bernstein & Pinchuk LLP (“MarcumBP”) in a transaction pursuant to which B&P merged its China operations into MarcumBP and certain of the professional staff of B&P joined MarcumBP as employees of MarcumBP (“the “Merger”). Accordingly, and solely as a result of the Merger, effective April 14, 2011, B&P effectively resigned as our company’s independent registered public accounting firm and MarcumBP became our company's independent registered public accounting firm. This change in our company’s independent registered public accounting firm was approved by the Audit Committee of our company’s Board of Directors.

The principal accountant's reports of B&P on the financial statements of our company as of and for the years ended December 31, 2010 and 2009 did not contain any adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.
 
There were no disagreements with Marcum BP and BP on accounting and financial disclosures during the period that they serviced as our company’s independent registered public accounting firm, respectively.
 
ITEM 9A. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
Disclosure Controls and Procedures
 
Under the supervision and with the participation of management, including our chief executive officer and the chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of December 31, 2012. Based on this evaluation, our chief executive officer and chief financial officer concluded as of December 31, 2012 that our disclosure controls and procedures were effective such that the material information required to be included in our SEC reports is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms relating to our company, including our consolidating subsidiaries and VIEs, and was made known to them by others within those entities, particularly during the period when this report was being prepared.
 
Management’s Report on Internal Control over Financial Reporting
 
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2012. The framework on which such evaluation was based is contained in the report entitled “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”). Based on that evaluation and the criteria set forth in the COSO Report, management concluded that its internal control over financial reporting was effective as of December 31, 2012.
 
Changes in Internal Controls over Financial Reporting
 
 
71
 
There were no significant changes in our internal controls over financial reporting identified in connection with this evaluation that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
 
Management Process to Assess the Effectiveness of Internal Control over Financial Reporting
 
To comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the Company followed a comprehensive compliance process across our major operations to evaluate our internal control over financial reporting, engaging employees at all levels of the organization. Our internal control environment includes a corporate-wide attitude of integrity and control consciousness. This is exemplified by our ethics education program that includes long-standing principles and policies on ethical business conduct that require employees to maintain the highest ethical and legal standards in the conduct of our business. We have distributed the Board of Directors approved policy on ethics and code of business conduct to all employees and required them to study and abide by the policy. We encourage any employee may report suspected violations of law or our policy. The internal control system further includes careful selection and training of supervisory and management personnel, appropriate delegation of authority and division of responsibility, dissemination of accounting and business policies throughout the Company, and an extensive program of internal audits with management follow-up. Our Board of Directors, assisted by the Audit Committee, monitors the integrity of our financial statements and financial reporting procedures, the performance of our internal audit function and independent auditors, and other matters set forth in its charter. The Committee, which currently consists of three independent directors, meets regularly with representatives of management, and with the independent auditors and the Internal Auditor, with and without management representatives in attendance, to review their activities.
 
Attestation Report of the Registered Public Accounting Firm
 
This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. As a smaller reporting company, management’s report is not subject to attestation by our registered public accounting firm.
 
ITEM 9B. OTHER INFORMATION
 
There is no information required to be disclosed in a report on Form 8-K during the fourth quarter of the year covered by this Form 10-K but not reported.
 
PART III.
 
Certain information required by Part III is omitted from this Annual Report on Form 10-K since we intend to file our definitive Proxy Statement for our next Annual Meeting of Stockholders, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the “Proxy Statement”), within 120 days of the end of the fiscal year covered by this report, and certain information to be included in the Proxy Statement is incorporated herein by reference.
 
ITEM 10  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
The information set forth in the Proxy Statement under the captions Election of Directors—Nominees of the Board of Directors; Election of Directors—Section 16(a) Beneficial Ownership Compliance; Election of Directors—Board Operations, last paragraph; and Election of Directors—Board Committees—Audit Committee—first sentence of first paragraph and second sentence of second paragraph and Election of Directors—Board Committees—Nominating and Corporate Governance Committee—last paragraph is incorporated herein by reference.
 
ITEM 11  EXECUTIVE COMPENSATION
 
 
72
 
The information set forth in the Proxy Statement under the captions Election of Directors—Executive Compensation is incorporated herein by reference.
 
ITEM 12  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The information set forth in the Proxy Statement under the caption Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference.
 
ITEM 13  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
The information set forth in the Proxy Statement under the caption Election of Directors—Nominees of the Board of Directors identifying the directors and in the last paragraph under that caption, and the information under the caption Election of Directors—Certain Relationships and Related Transactions is incorporated herein by reference.
 
ITEM 14  PRINCIPAL ACCOUNTANT FEE AND SERVICES
 
The information set forth in the Proxy Statement under the captions Ratification of the Appointment of Independent Accountants—Services and Fees of Independent Accountants and Ratification of the Appointment of Independent Accountants—Pre-Approval of Services is incorporated herein by reference.
 
PART IV.                                
 
ITEM 15  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
a)       The following are filed with this report:
 
(1)
 
The financial statements listed on the Financial Statement’s Table of Contents
(2)
 
Not applicable
(3)
 
The exhibits referred to below, which include the following managerial contracts or compensatory plans or arrangements:
2.1
Share Exchange Agreement, dated as of June 26, 2009, by and among Emazing Interactive, Inc., G. Edward Hancock, China Net Online Media Group Limited, and the shareholders of China Net Online Media Group Limited.(1)
 
2.2
Escrow Agreement, dated as of June 8, 2009, by and between Emazing Interactive, Inc., China Net Online Media Group Limited, Edward Hancock and Leser, Hunter, Taubman & Taubman. (1)
 
2.3
Agreement and Plan of Merger (2)
 
3.1
Articles of Incorporation of Emazing Interactive, Inc., as amended (1)
 
3.2
Articles of Merger. (2)
 
3.3
By-laws. (4)
 
4.1
Registration Rights Agreement, dated as of June 26, 2009, by and among Emazing Interactive, Inc. and certain stockholders listed therein. (1)
 
 
73
 
4.2
Form of Series A-1 Warrant. (3)
 
4.3
Form of Series A-2 Warrant. (3)
 
4.4
Registration Rights Agreement, dated as of August 21, 2009. (3)
 
4.5*
2011 Omnibus Securities and Incentive Plan (9)
 
10.1
Exclusive Business Cooperation Agreement, dated October 8, 2008, by and between Rise King Century Technology Development (Beijing) Co., Ltd. and Beijing CNET Online Advertising Co., Ltd. (1)
 
10.2
Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Beijing CNET Online Advertising Co., Ltd. and Handong Cheng with respect to Mr. Cheng’s equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.3
Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Beijing CNET Online Advertising Co., Ltd. and Xuanfu Liu with respect to Mr. Liu’s equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.4
Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Beijing CNET Online Advertising Co., Ltd. and Li Sun with respect to Ms. Sun’s equity interest in Beijing CNET Online Advertising Co., Ltd.(1)
 
10.5
Equity Interest Pledge Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Beijing CNET Online Advertising Co., Ltd. and Handong Cheng with respect to Mr. Cheng’s equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.6
Equity Interest Pledge Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Beijing CNET Online Advertising Co., Ltd. and Xuanfu Liu with respect to Mr. Liu’s equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.7
Equity Interest Pledge Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Beijing CNET Online Advertising Co., Ltd. and Li Sun with respect to Ms. Sun’s equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.8
Power of Attorney of Handong Cheng, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as his agent and attorney in connection with his equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.9
Power of Attorney of Xuanfu Liu, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as his agent and attorney in connection with his equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.10
Power of Attorney of Li Sun, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as her agent and attorney in connection with her equity interest in Beijing CNET Online Advertising Co., Ltd. (1)
 
10.11
Exclusive Business Cooperation Agreement, dated October 8, 2008, by and between Rise King Century Technology Development (Beijing) Co., Ltd. and Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
 
74
 
10.12
Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Business Opportunity Online (Beijing) Network Technology Co., Ltd. and Handong Cheng with respect to Mr. Cheng’s equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.13
Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Business Opportunity Online (Beijing) Network Technology Co., Ltd. and Xuanfu Liu with respect to Mr. Liu’s equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.14
Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Business Opportunity Online (Beijing) Network Technology Co., Ltd. and Li Sun with respect to Ms. Sun’s equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.15
Equity Interest Pledge Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Business Opportunity Online (Beijing) Network Technology Co., Ltd. and Handong Cheng with respect to Mr. Cheng’s equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.16
Equity Interest Pledge Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Business Opportunity Online (Beijing) Network Technology Co., Ltd. and Xuanfu Liu with respect to Mr. Liu’s equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.17
Equity Interest Pledge Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Business Opportunity Online (Beijing) Network Technology Co., Ltd. and Li Sun with respect to Ms. Sun’s equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.18
Power of Attorney of Handong Cheng, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as his agent and attorney in connection with his equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.19
Power of Attorney of Xuanfu Liu, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as his agent and attorney in connection with his equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.20
Power of Attorney of Li Sun, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as her agent and attorney in connection with her equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1)
 
10.21
Entrustment Agreement, dated June 5, 2009, by and between Rise King Investments Limited and Handong Cheng, Xuanfu Liu and Li Sun. (1)
 
10.22
Share Transfer Agreement, dated April 28, 2009, by and between Yang Li and Handong Cheng (1)
 
10.23
Share Transfer Agreement, dated April 28, 2009, by and between Yang Li and Xuanfu Liu (1)
 
10.24
Share Transfer Agreement, dated April 28, 2009, by and between Yang Li and Li Sun (1)
 
10.25
Internet Banking Experiencing All-in-One Engine Strategic Cooperation Agreement, dated August 7, 2008, by and between Henan Branch of China Construction Bank and Shanghai Borongdingsi Computer Technology Co., Ltd. (1)
 
 
75
 
10.26
Cooperation Agreement, dated July 8, 2008, by and between Beijing CNET Online Advertising Co., Ltd. and Shanghai Borongdingsi Computer Technology Co., Ltd. (1)
 
10.27
Supplemental Agreement to the Cooperation Agreement, dated December 10, 2008, by and between Beijing CNET Online Advertising Co., Ltd. and Shanghai Borongdingsi Computer Technology Co., Ltd. (1)
 
10.28
Office Lease Agreement, dated January 1, 2009, by and between Beijing YuQuanHuiGu  Realty Management Ltd. Co. and Business Opportunity Online (Beijing) Network Technology Ltd. Co. (1)
 
10.29
Office Lease Agreement, dated January 1, 2009, by and between Beijing YuQuanHuiGu  Realty Management Ltd. Co. and Beijing CNET Online Advertising Co., Ltd. (1)
 
10.30
Office Lease Agreement, dated January 1, 2009, by and between Beijing YuQuanHuiGu  Realty Management Ltd. Co. and Rise King Century Technology Development (Beijing) Co., Ltd. (1)
 
10.31
Securities Purchase Agreement, dated as of August 21, 2009. (3)
 
10.32
Securities Escrow Agreement, dated as of August 21, 2009. (3)
 
10.33*
Independent Director Agreement effective as of November 30, 2009 by and between the Company and Douglas MacLellan. (5)
 
10.34*
Independent Director Agreement effective as of November 30, 2009 by and between the Company and Mototaka Watanabe. (5)
 
10.35*
Independent Director Agreement effective as of November 30, 2009 by and between the Company and Zhiqing Chen. (5)
 
10.36
Warrant Amendment Agreement (7)
 
10.37
Exclusive Business Cooperation Agreement, dated as of December 6, 2010, by and between Rise King Century Technology Development (Beijing) Co., Ltd. and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
10.38
Exclusive Option Agreement, dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Wei Yanmin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
10.39
Exclusive Option Agreement, dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Wu Huamin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
10.40
Equity Interest Pledge Agreement dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Wei Yanmin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
10.41
Equity Interest Pledge Agreement dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., Wu Huamin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
 
76
 
10.42
Power of Attorney of Wei Yanmin, dated as of December 6, 2010, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as his exclusive agent and attorney in connection with his equity interest in Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
10.43
Power of Attorney of Wu Huamin, dated as of December 6, 2010, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as his exclusive agent and attorney in connection with his equity interest in Rise King (Shanghai) Advertisement & Media Co., Ltd. (8)
 
10.44
Equity Transfer Agreement, dated as of December 15, 2011, Among Business Opportunity Online (Hubei) Network Technology Co., Ltd., Liu Yihang, Wei Yanmin and Soo Yi Lian Mei Network Technology (Beijing) Co. Ltd. (10)
 
10.45
English Translation of the Equity Transfer Agreement by and among Business Opportunity Online (Hubei) Network Technology Co., Ltd., Liu Yihong and Sou Yi Lian Mei Network Technology (Beijing) Co., Ltd., dated September 10, 2012. (11)
 
14
Code of Ethics (6)
 
21.1
Subsidiaries of the Registrant +
 
23.1
Consent of Marcum Bernstein & Pinchuk LLP +
 
31.1
Certification pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +
 
31.2
Certification pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +
 
32.1
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +
 
 
+
Filed herewith
 
*
Denotes managerial contracts or compensatory plans or arrangements:
 
(1)
Incorporated by reference herein to the Report on Form 8-K filed on July 2, 2009.
 
(2)
Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 24, 2009.
 
(3)
Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 27, 2009.
 
(4)
Incorporated by reference herein to the Company’s  Registration Statement  on Form SB-1 filed with the Securities and Exchange Commission on October 20, 2006.
 
(5)
Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 2, 2009.
 
(6)
Incorporated by reference herein to the Company’s Current Report on Form 8-K filed on December 21, 2009
 
 
77
 
(7)
Incorporated by reference herein to the Company’s Annual Report on Form 10-K filed on March 31, 2010.
 
(8)
Incorporated by reference herein to the Company’s Annual Report on Form 10-K filed on March 31, 2011.
 
(9)
Incorporated by reference herein to the Company’s Registration Statement on Form S-1 filed on May 11, 2011.
 
(10)
Incorporated by reference herein to the Company’s Current Report on Form 8-K filed on December 16, 2011.
 
(11)
Incorporated by reference herein to the Company’s Current Report on Form 8-K filed on September 11, 2012.
 
(b)
The exhibits listed on the Exhibit Index are filed as part of this report.
 
(c)
Not applicable.
 
 
 
78
 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 
ChinaNet Online Holdings, Inc.
     
Dated: April 15, 2013
By:
/s/ Handong Cheng
 
Name:
Handong Cheng
 
Title:
Chairman and Chief Executive Officer
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Dated: April 15, 2013
By:
/s/ Handong Cheng
 
Name:
Handong Cheng
 
Title:
Chairman and Chief Executive Officer
(Principal Executive Officer)

Dated: April 15, 2013
By:
/s/ Zhige Zhang
 
Name:
Zhige Zhang
 
Title:
Chief Financial Officer
(Principal Financial Officer) and Director

Dated: April 15, 2013
By:
/s/ Zhiqing Chen
 
Name:
Zhiqing Chen
 
Title:
Director

Dated: April 15, 2013
By:
/s/ Mototaka Watanabe
 
Name:
Mototaka Watanabe
 
Title:
Director

Dated: April 15, 2013
By:
/s/ Douglas MacLellan
 
Name:
Douglas MacLellan
 
Title:
Director
 
 
79
 
CHINANET ONLINE HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011

   
 
Pages
   
   
   
   
   
   



 
 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Audit Committee of the Board of Directors and Stockholders of
ChinaNet Online Holdings, Inc.
 
We have audited the accompanying consolidated balance sheets of ChinaNet Online Holdings, Inc. and Subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of income and comprehensive income, changes in equity and cash flows for each of the years in the two-year period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company, as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
 
 
/s/ Marcum Bernstein & Pinchuk LLP
 
Marcum Bernstein & Pinchuk LLP
New York, New York
April 15, 2013
 
 
F-1
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
As of December 31,
  
   
2012
    
2011
  
   
(US $)
    
(US $)
  
Assets
            
Current assets:
            
Cash and cash equivalents
   $ 5,483     $ 10,695  
Term deposit
     3,357       -  
Accounts receivable, net
     8,486       4,444  
Other receivables, net
     3,103       3,631  
Prepayment and deposit to suppliers
     14,596       15,360  
Due from related parties
     210       324  
Contingent consideration receivables
     -       159  
Other current assets
     136       129  
Deferred tax assets-current
     50       -  
Total current assets
     35,421       34,742  
                 
Investment in and advance to equity investment affiliates
     959       1,396  
Property and equipment, net
     1,636       1,902  
Intangible assets, net
     7,167       8,151  
Goodwill
     11,083       10,999  
Deferred tax assets-non current
     652       92  
Total Assets
   $ 56,918     $ 57,282  
                 
Liabilities and Equity
                
Current liabilities:
                
Accounts payable *
   $ 110     $ 268  
Advances from customers *
     1,065       724  
Accrued payroll and other accruals *
     904       616  
Due to equity investment affiliate *
     -       220  
Due to related parties *
     -       161  
Payable for acquisition *
     1,266       550  
Taxes payable *
     6,683       5,040  
Other payables *
     217       114  
Dividend payable
     -       5  
Total current liabilities
     10,245       7,698  
 
 
F-2
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands, except for number of shares)
   
As of December 31,
  
   
2012
    
2011
  
   
(US $)
    
(US $)
  
Long-term liabilities:
            
Deferred tax liability-non current *
     1,689       1,893  
Long-term borrowing from director
     139       137  
Total Liabilities
     12,073       9,728  
                 
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 22,186,540 shares and 22,146,540 shares at December 31, 2012 and 2011, respectively
     22       22  
Additional paid-in capital
     20,008       20,747  
Statutory reserves
     2,296       2,117  
Retained earnings
     19,505       16,688  
Accumulated other comprehensive income
     2,393       2,132  
Total ChinaNet Online Holdings, Inc.’s stockholders’ equity
     44,224       41,706  
                 
Noncontrolling interests
     621       5,848  
Total equity
     44,845       47,554  
                 
Total Liabilities and Equity
   $ 56,918     $ 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-3
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands)
 
   
Year Ended December 31,
  
   
2012
    
2011
  
   
(US $)
    
(US $)
  
             
Sales
            
From unrelated parties
   $ 46,403     $ 28,105  
From related parties
     197       626  
      46,600       28,731  
                 
Cost of sales
     31,558       12,027  
                 
Gross margin
     15,042       16,704  
                 
Operating expenses
                
Selling expenses
     2,683       3,506  
General and administrative expenses
     6,030       7,904  
Research and development expenses
     1,819       2,132  
      10,532       13,542  
                 
Income from operations
     4,510       3,162  
                 
Other income (expenses)
                
Changes in fair value of contingent consideration receivables
     (160 )     (70 )
Interest income
     186       13  
Gain on deconsolidation of subsidiaries
     -       925  
Other (expenses)/income
     (150 )     5  
      (124 )     873  
                 
Income before income tax expense, equity method investments and noncontrolling interests
     4,386       4,035  
Income tax expense
     529       1,035  
Income before equity method investments and noncontrolling interests
     3,857       3,000  
Share of losses in equity investment affiliates
     (449 )     (219 )
Net income
     3,408       2,781  
Net (income) / losses attributable to noncontrolling interests
     (412 )     214  
Net income attributable to ChinaNet Online Holdings, Inc.
     2,996       2,995  
 
 
F-4
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (CONTINUED)
(In thousands, except for number of shares and per share data)
   
Year Ended December 31,
  
   
2012
    
2011
  
   
(US $)
    
(US $)
  
             
Net income attributable to ChinaNet Online Holdings, Inc.
   $ 2,996     $ 2,995  
Dividend of Series A convertible preferred stock
     -       (407 )
Net income attributable to common stockholders of ChinaNet Online Holdings, Inc.
   $ 2,996     $ 2,588  
                 
                 
Net income
     3,408       2,781  
Foreign currency translation gain
     267       1,254  
Comprehensive Income
   $ 3,675     $ 4,035  
Comprehensive (income) / losses attributable to noncontrolling interests
     (418 )     162  
Comprehensive income attributable to ChinaNet Online Holdings, Inc.
   $ 3,257     $ 4,197  
 
                
Earnings per share
                
Earnings per common share
                
Basic
   $ 0.14     $ 0.14  
Diluted
   $ 0.14     $ 0.14  
                 
Weighted average number of common shares outstanding:
                
Basic
     22,185,556       18,545,609  
Diluted
     22,185,556       18,759,240  
 
See notes to consolidated financial statements
 
 
F-5
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
   
Year Ended December 31,
  
   
2012
    
2011
  
   
(US $)
    
(US $)
  
             
Cash flows from operating activities
            
Net income
   $ 3,408     $ 2,781  
Adjustments to reconcile net income to net cash provided by operating activities
                
Depreciation and amortization
     1,637       1,012  
Share-based compensation expenses
     48       2,900  
Changes in fair value of contingent consideration receivables
     160       70  
Allowances for doubtful debts
     1,141       2,583  
Share of losses in equity investment affiliates
     449       219  
Gain on deconsolidation of subsidiaries
     -       (925 )
Loss / (gain) on disposal of property and equipment
     2       (3 )
Deferred taxes
     (828 )     27  
Changes in operating assets and liabilities
                
Accounts receivable
     (5,516 )     (2,100 )
Other receivables
     1,400       5,276  
Prepayment and deposit to suppliers
     882       (11,247 )
Due from related parties
     117       (130 )
Other current assets
     (5 )     (197 )
Accounts payable
     (158 )     27  
Advances from customers
     335       (1,575 )
Accrued payroll and other accruals
     285       166  
Due to director
     -       (559 )
Due to Control Group
     -       (82 )
Due to related parties
     (4 )     (139 )
Other payables
     72       490  
Taxes payable
     1,603       803  
Net cash provided by (used in) operating activities
     5,028       (603 )
                 
Cash flows from investing activities
                
Purchases of vehicles and office equipment
     (314 )     (741 )
Purchase of intangible assets
     -       (1,445 )
Short-term loan to unrelated entities
     (475 )     -  
Project development deposit to a third party
     (2,453 )     -  
Refund of project development deposit from a third party
     2,453       -  
Cash from acquisition of VIEs
     -       330  
Cash effect on deconsolidation of VIEs
     -       (1,670 )
Long-term investment in and advance to equity investment affiliates
     -       (1,712 )
Disposal of investment in and loan repayment from equity investment affiliate
     -       8,885  
Payment for acquisition of VIEs
     (5,775 )     (9,731 )
Placement of term deposit
     (3,355 )     -  
Net cash used in investing activities
     (9,919 )     (6,084 )
 
 
F-6
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
 
   
Year Ended December 31,
  
   
2012
    
2011
  
   
(US $)
    
(US $)
  
             
Cash flows from financing activities
            
Cash investment contributed by noncontrolling interests
     -       378  
Dividend paid to convertible preferred stockholders
     (5 )     (657 )
Short-term loan borrowed from an equity investment affiliate
     316       216  
Short-term loan repaid to an equity investment affiliate
     (538 )     -  
Repayment to legal (nominal) shareholders of Shanghai Jing Yang
     (158 )     -  
Capital contributions received in advance from new shareholders of Zhao Shang Ke Hubei before deconsolidation
     -       1,545  
Net cash (used in) provided by financing activities
     (385 )     1,482  
                 
Effect of exchange rate fluctuation on cash and cash equivalents
     64       310  
                 
Net decrease in cash and cash equivalents
     (5,212 )     (4,895 )
                 
Cash and cash equivalents at beginning of the year
     10,695       15,590  
Cash and cash equivalents at end of the year
   $ 5,483     $ 10,695  
                 
Supplemental disclosure of cash flow information
                
                 
Income taxes paid
   $ 75     $ 319  
                 
Non-cash transactions:
                
                 
Restricted stock and options granted for future service
   $ 42     $ 6  
Payment for acquisition of Sou Yi Lian Mei (1)
   $ 1,266     $ 550  
 
(1) Refer to Note 4
 
See notes to consolidated financial statements
 
 
F-7
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for number of shares)
 
   
Total equity
              
   
Series A convertible
preferred stock
    
Common Stock
    
Additional
paid-in
capital
    
Statutory
reserves
    
Retained
earnings
    
Accumulated
other
comprehensive
income
    
Non-
Controlling
Interests
    
Total
Equity
  
   
Number of
shares
    
Amount
    
Number of
shares
    
Amount
                                      
         
(US $)
          
(US $)
    
(US $)
    
(US $)
    
(US $)
    
(US $)
    
(US $)
    
(US $)
  
Balance, January 1, 2011
     2,877,600       3       17,102,320       17       18,614       1,587       14,630       930       (70 )     35,711  
Preferred stock converted into common stock
     (2,877,600 )     (3 )     2,877,600       3       -       -       -       -       -       -  
Share based compensation related to services
     -       -       -       -       141       -       -       -       -       141  
Restricted shares issued for services
     -       -       60,000       -       152       -       -       -       -       152  
Restricted stock and options issued to management, employees and directors on November 30, 2011
     -       -       2,000,000       2       2,605       -       -       -       -       2,607  
Share issued under the Warrant Tender Offer on December 30, 2011
     -       -       106,620       -       -       -       -       -       -       -  
Noncontrolling equity interests in acquired VIEs
     -       -       -       -       -       -       -       -       6,054       6,054  
Noncontrolling equity interests in newly formed VIEs
     -       -       -       -       (703 )     -       -       -       1,079       376  
Deconsolidation of VIEs
     -       -       -       -       -       -       -       -       (20 )     (20 )
Purchased of noncontrolling interests in a VIE
     -       -       -       -       (62 )     -       -       -       (1,033 )     (1,095 )
Net income for the year
     -       -       -       -       -       -       2,995       -       (214 )     2,781  
Appropriation of statutory reserves
     -       -       -       -       -       530       (530 )     -       -       -  
Preferred stock dividend
     -       -       -       -       -       -       (407 )     -       -       (407 )
Foreign currency translation adjustment
     -       -       -       -       -       -       -       1,202       52       1,254  
Balance, December 31, 2011
     -       -       22,146,540       22       20,747       2,117       16,688       2,132       5,848       47,554  
 
 
F-8
 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (CONTINUED)
(In thousands, except for number of shares)

 
   
Total equity (Continued)
              
   
Series A convertible
preferred stock
    
Common Stock
    
Additional
paid-in
capital
    
Statutory
reserves
    
Retained
earnings
    
Accumulated
other
comprehensive
income
    
Non-
Controlling
Interests
    
Total
Equity
  
   
Number of
shares
    
Amount
    
Number of
shares
    
Amount
                                      
         
(US $)
          
(US $)
    
(US $)
    
(US $)
    
(US $)
    
(US $)
          
(US $)
  
Restricted shares issued for services
     -       -       40,000       -       42       -       -       -       -       42  
Share based compensation related to services
     -       -       -       -       6       -       -       -       -       6  
Purchased of noncontrolling interests in a VIE
     -       -       -       -       (787 )     -       -       -       (5,645 )     (6,432 )
Appropriation of statutory reserves
     -       -       -       -       -       179       (179 )     -       -       -  
Net income for the year
     -       -       -       -       -       -       2,996       -       412       3,408  
Foreign currency translation adjustment
     -       -       -       -       -       -       -       261       6       267  
      -       -       22,186,540       22       20,008       2,296       19,505       2,393       621       44,845  
 

 
See notes to consolidated financial statements

 
F-9
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 (See Note 2 for significant terms of these Contractual Arrangements).

Pursuant to the Contractual Agreements, all of the equity owners' rights and obligations of the VIEs were assigned to Rise King WFOE, which resulted in the equity owners lacking the ability to make decisions that have a significant effect on the VIEs, Rise King WFOE's ability to extract the profits from the operation of the VIEs and assume the residual benefits of the VIEs. Due to the fact that 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-10
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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 beginning in 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 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$2,374,883) 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 19, 2012, as approved by the shareholders of Shenzhen Mingshan, Shenzhen Mingshan reduced its registered and paid-in capital from RMB25,000,000 (approximately US$3,958,139) to RMB22,000,000 (approximately US$3,483,162), resulted from a decrease in paid-in capital from three other noncontrolling shareholders, except Business Opportunity Online. As a result, the Company’s share of the equity interest in Shenzhen Mingshan increased from 20.4% to 23.18% and the Company continued to retain 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 did not have the resources necessary to conduct 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 its 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% equity 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-11
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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$1,583,255) into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interest in Zhao Shang Ke Hubei. 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. In September 2012, the Company sold all of its equity interest in Business Opportunity Online Chongqing to two unaffiliated parties. Business Opportunity Online Chongqing was dormant from the time of its incorporation through the date the Company disposed of its equity interest to two unaffiliated parties. No gain or loss was incurred in connection with this transaction, as the Company recovered all of its net assets, which are all cash and cash equivalents from the buyers.

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”).  In September 2012, Business Opportunity Online Hubei acquired the remaining 49% equity interest in Sou Yi Lian Mei. Sou Yi Lian Mei became a wholly owned subsidiary of Business Opportunity Online Hubei accordingly. 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”).

 
F-12
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
As of December 31, 2012, the Company operated its business primarily in China through its PRC subsidiary and PRC operating entities, or VIEs as described above.
 
2.  
Variable Interest Entities

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

The significant terms of the VIE Agreements are summarized below:

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

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

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

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

 
F-13
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
As a result of these VIE Agreements, the Company through its wholly-owned subsidiary, Rise King WFOE, was granted with unconstrained decision making rights and power over key strategic and operational functions that would significantly impact the PRC Operating Entities or the VIEs’ economic performance, which includes, but is not limited to, the development and execution of the overall business strategy; important and material decision making; decision making for merger and acquisition targets and execution of merger and acquisition plans; business partnership strategy development and execution; government liaison; operation management and review; and human resources recruitment and compensation and incentive strategy development and execution. Rise King WFOE also provides comprehensive services to the VIEs for their daily operations, such as operational technical support, OA technical support, accounting support, general administration support and technical support for products and services. As a result of the Exclusive Business Cooperation Agreements, the Equity Pledge Agreements and the Exclusive Option Agreements, the Company will bear all of the VIEs’ operating costs in exchange for 100% of the net income of the VIEs. Under these agreements, the Company has the absolute and exclusive right to enjoy economic benefits similar to equity ownership through the VIE Agreements with our PRC Operating Entities and their shareholders.

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

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

Summarized below is the information related to the consolidated VIEs’ assets and liabilities as of December 31, 2012 and 2011, respectively:

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
Assets
            
Current assets:
            
Cash and cash equivalents
   $ 4,275     $ 8,322  
Term deposit
     3,357       -  
Accounts receivable, net
     8,392       3,705  
Other receivables, net
     2,921       3,619  
Prepayment and deposit to suppliers
     14,587       15,360  
Due from related parties
     49       192  
Contingent consideration receivables
     -       159  
Other current assets
     35       23  
Deferred tax assets-current
     50       -  
Total current assets
     33,666       31,380  
                 
Investment in and advance to equity investment affiliates
     916       1,354  
Property and equipment, net
     1,389       1,507  
Intangible assets, net
     7,152       8,111  
Goodwill
     11,083       10,999  
Deferred tax assets-non current
     511       92  
Total Assets
   $ 54,717     $ 53,443  
                 
Liabilities
                
Current liabilities:
                
Accounts payable
   $ 110     $ 268  
Advances from customers
     1,065       724  
Accrued payroll and other accruals
     455       251  
Due to equity investment affiliate
     -       220  
Due to related parties
     -       161  
Due to Control Group
     11       11  
Payable for acquisition
     1,266       550  
Taxes payable
     6,136       4,409  
Other payables
     196       107  
Total current liabilities
     9,239       6,701  
                 
Deferred tax Liabilities-non current
     1,689       1,893  
Total Liabilities
   $ 10,928     $ 8,594  

 
F-14
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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 year ended December 31, 2012, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$46,355,000, cost of sales of approximately US$31,550,000, operating expenses of approximately US$7,655,000 and net income before allocation to noncontrolling interests of approximately US$5,910,000.

For the year ended December 31, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$24,109,000, cost of sales of approximately US$11,772,000, operating expenses of approximately US$6,424,000 and net income before allocation to noncontrolling interests of approximately US$5,849,000.
 
3.  
Summary of significant accounting policies
 
a)  
Basis of presentation
 
The consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
 
b)  
Principles of consolidation
 
The 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.
 
 
F-15
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
d)  
Foreign currency translation and transactions
 
The functional currency of the Company is United States dollars (“US$”), and the functional currency of China Net HK is Hong Kong dollars (“HK$”). The functional currency of the Company’s PRC operating subsidiary and VIEs is Renminbi (“RMB”), and PRC is the primary economic environment in which the Company operates.
 
For financial reporting purposes, the financial statements of the Company’s PRC operating subsidiary and VIEs, which are prepared using the RMB, are translated into the Company’s reporting currency, the United States Dollar (“U.S. dollar”). Assets and liabilities are translated using the exchange rate at each balance sheet date. Revenue and expenses are translated using average rates prevailing during each reporting period, and stockholders’ equity is translated at historical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulated other comprehensive income in stockholders’ equity.
 
Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. The resulting exchange differences are included in the determination of net income of the consolidated statements of income and comprehensive income for the respective periods.
 
The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows:
 
   
As of December 31,
  
   
2012
    
2011
  
             
Balance sheet items, except for equity accounts
     6.3161       6.3647  
 
   
Year ended December 31,
  
   
2012
    
2011
  
Items in the statements of income and comprehensive income, and statements of cash flows
     6.3198       6.4735  
 
No representation is made that the RMB amounts could have been, or could be converted into US$ at the above rates.
 
e)  
Cash and cash equivalents
 
Cash and cash equivalents consist of cash on hand and bank deposits, which are unrestricted as to withdrawal and use. The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents.
 
f)  
Term deposits
 
Term deposits consist of bank deposits with an original maturity of between three to twelve months.
 
g)  
Accounts receivable, net
 
Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts as needed. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on aging data, historical collection experience, customer specific facts and economic conditions. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company did not have any off-balance-sheet credit exposure relating to its customers, suppliers or others.
 
 
F-16
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
h)  
Investment in equity method affiliates
 
Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting in accordance to ASC Topic 323 “Equity Method and Joint Ventures”. Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee companies’ board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee companies. Under the equity method of accounting, an investee company’s accounts are not reflected within the Company’s consolidated balance sheets and statements of income and comprehensive income; however, the Company’s share of the earnings or losses of the investee company is reflected in the caption “Share of earnings (losses) in equity investment affiliates” in the consolidated statements of income and comprehensive income. The Company’s carrying value (including advance to the investee) in equity method investee companies is reflected in the caption “Investment in and advance to equity investment affiliates” in the Company’s consolidated balance sheets.
 
When the Company’s carrying value in an equity method investee company is reduced to zero, no further losses are recorded in the Company’s consolidated financial statements unless the Company guaranteed obligations of the investee company or has committed additional funding. When the investee company subsequently reports income, the Company will not record its share of such income until it equals the amount of its share of losses not previously recognized.
 
i)  
Property and equipment, net
 
Property and equipment are recorded at cost less accumulated depreciation. Depreciation is calculated on the straight-line method after taking into account their respective estimated residual values over the following estimated useful lives:

Vehicles
5 years
Office equipment
3-5 years
Electronic devices
5 years
 
Depreciation expenses are included in selling expenses, general and administrative expenses and research and development expenses.
 
When property and equipment are retired or otherwise disposed of, resulting gain or loss is included in net income or loss in the year of disposition for the difference between the net book value and proceeds received thereon. Maintenance and repairs which do not improve or extend the expected useful lives of the assets are charged to expenses as incurred.
 
j)  
Intangible assets, net
 
Purchased software and software platform is initially recorded at cost and amortized on a straight-line basis over the estimated useful economic life.
 
Intangible assets other than goodwill acquired through various acquisitions are amortized on a straight-line basis over their expected useful economic lives.
 
If an acquired intangible asset is determined to have an indefinite useful life, it should not be amortized until its useful life is determined to be no longer indefinite. The Company reviews intangible assets' remaining useful lives in each reporting period. If such an asset is later determined to have a finite useful life, the asset will be tested for impairment. That asset will then be amortized prospectively over its estimated remaining useful life and accounted for in the same way as intangible assets subject to amortization.
 
The Company accounted for website development costs in accordance with ASC Topic 350-50, which requires that certain costs related to the development or purchase of internal-use software and systems as well as the costs incurred in the application development stage related to its website be capitalized and amortized over the estimated useful life of the software or system. ASC Topic 350-50 also require that costs related to the preliminary project stage, data conversion and post implementation/operation stage of an internal-use software development project be expensed as incurred.
 
In accordance with ASC Topic 350-50, the Company analyzed its website development cost which is subject to capitalization, incurred during the years ended December 31, 2012 and 2011 for the development of www.liansuo.com and www.chuangye.com, the Company did not capitalize such cost, as the amount was considered immaterial, which was primarily the labor cost of its staff in the research and development department.
 
 
F-17
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
k)  
Impairment of long-lived assets
 
Long-lived assets, which include tangible long-lived assets and intangible long-lived assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recognized for the difference between the carrying amount of the asset and its fair value.
 
For the years ended December 31, 2012 and 2011, the Company did not record any impairment losses associated with long-lived assets.
 
l)  
Goodwill
 
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of the Company's acquisitions of interests in its consolidated VIEs.
 
Goodwill is not depreciated or amortized but is tested for impairment at the reporting unit level at least on an annual basis, and between annual tests when an event occurs or circumstances change that could indicate that the asset might be impaired. The test consists of two steps. First, identify potential impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired. Second, if there is impairment identified in the first step, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with Topic 805 “Business Combinations.”
 
Application of a goodwill impairment test requires significant management judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. The judgment in estimating the fair value of reporting units includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.
 
For the years ended December 31, 2012 and 2011, the Company did not record any impairment losses associated with Goodwill.
 
m)  
Deconsolidation
 
The Company accounts for deconsolidation of subsidiaries in accordance with ASC Topic 810 “Consolidation”.
 
In accordance with ASC Topic 810-10-40-5, the parent shall account for the deconsolidation of a subsidiary by recognizing a gain or loss in net income attributable to the parent, measured as the difference between:
 
a. The aggregate of all of the following:
 
1. The fair value of any consideration received;
 
2. The fair value of any retained noncontrolling investment in the former subsidiary at the date the subsidiary is deconsolidated;
 
3. The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated.
 
b. The carrying amount of the former subsidiary’s assets and liabilities.
 
 
F-18
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
n)  
Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary
 
The Company accounted for changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary in accordance with ASC Topic 810 “Consolidation”, subtopic 10, which requires the transaction be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net income or comprehensive income. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equity attributable to the parent and reallocated the subsidiary’s accumulated comprehensive income, if any, among the parent and the noncontrolling interest through an adjustment to the parent’s equity.
 
o)  
Fair Value
 
The Company’s financial instruments primarily consist of cash and cash equivalents, accounts receivable, other receivables, prepayment and deposits, accounts payable, advances from customers, accruals and other payables. The carrying values of these financial instruments approximate fair values due to their short maturities.
 
ASC Topic 820 "Fair Value Measurement and Disclosures," defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
 
Level 1 - Quoted prices in active markets for identical assets or liabilities.
 
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.
 
p)  
Revenue recognition
 
The Company's revenue recognition policies are in compliance with ASC Topic 605 “Revenue Recognition”. In accordance with ASC Topic 605, revenues are recognized when the four of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the service has been rendered, (iii) the fees are fixed or determinable, and (iv) collectability is reasonably assured.
 
Sales include revenues from reselling of advertising time purchased from TV stations and, internet advertising and providing related value added technical services, reselling of internet advertising spaces and other advertisement related resources. No revenue from advertising-for-advertising barter transactions was recognized because the transactions did not meet the criteria for recognition in ASC Topic 605, subtopic 20. Advertising contracts establish the fixed price and advertising services to be provided. Pursuant to advertising contracts, the Company provides advertisement placements in different formats, including but not limited to banners, links, logos, buttons, rich media and content integration. Revenue is recognized ratably over the period the advertising is provided and, as such, the Company considers the services to have been delivered. The Company treats all elements of advertising contracts as a single unit of accounting for revenue recognition purposes. Value added technical services are provided based on two types of contracts: (i) fixed price and (ii) fixed price with minimum performance threshold. For contracts with fixed price terms, revenue is recognized on a pro-rata basis over the engaged service period. For fixed price contracts with minimum performance threshold, revenue is recognized when the specified performance criteria is met. Based upon the Company’s credit assessments of its customers prior to entering into contracts, the Company determines if collectability is reasonably assured. In situations where collectability is not deemed to be reasonably assured, the Company recognizes revenue upon receipt of cash from customers, only after services have been provided and all other criteria for revenue recognition have been met.
 
 
F-19
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
q)  
Cost of sales
 
Cost of sales primarily includes the cost of media advertising time, internet advertisement related resources and other technical services purchased from third parties, direct labor cost and benefits and PRC business tax.
 
r)  
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 years ended December 31, 2012 and 2011, advertising expenses for the Company’s own brand building were approximately US$289,000 and US$1,357,000, respectively.
 
s)  
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 years ended December 31, 2012 and 2011 were approximately US$1,819,000 and US$2,132,000, respectively.
 
t)  
Income taxes
 
The Company adopts ASC Topic 740 “Income taxes” and uses liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets, if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in statement of income and comprehensive income in the period that includes the enactment date.
 
u)  
Uncertain tax positions
 
The Company follows the guidance of ASC Topic 740-10-25-5 through 740-10-25-7 and 740-10-25-13, which prescribes a more likely than not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures.
 
The Company recognizes interest on non-payment of income taxes under requirement by tax law and penalties associated with tax positions when a tax position does not meet the minimum statutory threshold to avoid payment of penalties. According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or the withholding agent. The statute of limitations is extended to five years under special circumstances, where the underpayment of taxes is more than RMB100,000. In the case of transfer pricing issues, the statute of limitation is ten years. There is no statute of limitation in the case of tax evasion. The tax returns of the Company’s PRC VIEs and subsidiaries are subject to examination by the relevant tax authorities. The Company did not have any material interest or penalties associated with tax positions and did not have any significant unrecognized uncertain tax positions as of December 31, 2012 and 2011, respectively.
 
v)  
Share-based Compensation
 
The Company accounted for share-based compensation to employees in accordance with ASC Topic 718 “Compensation-Stock Compensation” which requires that share-based payment transactions be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period, or vesting period.
 
 
F-20
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
w)  
Noncontrolling interest
 
The Company accounts for noncontrolling interest in accordance with ASC Topic 810-10-45, which requires the Company to present noncontrolling interests (previously referred to as minority interests) as a separate component of total shareholders’ equity on the consolidated balance sheet and the consolidated net income attributable to the parent and the noncontrolling interest be clearly identified and presented on the face of the consolidated income and comprehensive income statement. ASC Topic 810-10-45 also requires that losses attributable to the parent and the noncontrolling interest in a subsidiary be attributed to those interests even if it results in a deficit noncontrolling interest balance.
 
x)  
Comprehensive income
 
The Company accounts for comprehensive income in accordance with ASC Topic 220 “Comprehensive Income”, which establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Accumulated other comprehensive income, as presented in the Company’s consolidated balance sheets are the cumulative foreign currency translation adjustments.
 
y)  
Earnings per share
 
Earnings per share are calculated in accordance with ASC Topic 260, “Earnings Per Share”. Basic earnings per share is computed by dividing income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Common shares issuable upon the conversion of the convertible preferred shares are included in the computation of diluted earnings per share on an “if-converted” basis when the impact is dilutive. The dilutive effect of outstanding common stock warrants and options are reflected in the diluted earnings per share by application of the treasury stock method when the impact is dilutive.
 
z)  
Commitments and contingencies
 
The Company has adopted ASC 450 “Contingencies” subtopic 20, in determining its accruals and disclosures with respect to loss contingencies. Accordingly, estimated losses from loss contingencies are accrued by a charge to income when information available prior to issuance of the financial statements indicates that it is probable that a liability have been incurred and the amount of the loss can be reasonably estimated. Legal expenses associated with the contingency are expensed as incurred. If a loss contingency is not probable or reasonably estimable, disclosure of the loss contingency is made in the financial statements when it is at least reasonably possible that a material loss could be incurred.
 
aa)  
Recent accounting standards
 
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 or results of operations.
 
In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”, The ASU does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, this ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The guidance is effective prospectively for reporting periods beginning after December 15, 2012 for public entities. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
 
 
F-21
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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.  
Acquisitions

For the year ended December 31, 2011, in order to further diversify the channels of the Company’s advertising and marketing campaign services, achieve an entry into Fujian province, a base of fast growing small to medium enterprises, and expand the Company’s market opportunities from these enterprises, which are looking to domestically expand their businesses through franchises, dealerships and merchants in China, the Company acquired a 100% equity interest and a 51% equity interest in Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He, respectively. In order to establish the distinct brands in each of the Company’s targeted customer segment and achieved more diversified operational synergies of the Company’s internet advertising and marketing business, the Company acquired a 51% equity interest in Sou Yi Lian Mei, an established internet advertising and marketing services provider for merchant and franchise enterprises and organizations primarily involved in small office/home office ("SOHO") and emerging business, through its web portal, www.sooe.cn.

Each acquisition was accounted for using the acquisition method of accounting in accordance with ASC Topic 805 “Business Combinations”, and accordingly the acquired assets and liabilities were recorded at their fair values on the dates of acquisitions and the results of their operations have been included in the Company’s results of operations since the dates of their acquisitions.

The income approach is applied for identifiable intangible assets (except software technologies) and noncontrolling interests’ valuation, based on a five-year financial projection and using the discounted cash flow method to calculate the present value of the future economic benefits. Key inputs used for such valuation include: weighted average cost of capital (“WPCC”), discount rate, and terminal growth rate. The income approach explicitly recognizes that the current value of an asset is premised upon the expected receipt of future economic benefits focusing on the income producing capability of a business or an asset. It measures the current value of a business or asset by calculating the present value of its future economic benefits such as earnings, cost savings, tax deduction, and proceeds from disposition. Indications of value are developed by discounting these benefits to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risk associated with the particular investment which reflects both current return requirements of the market and specific investment. The discount rate selected is generally based on rates of return available from alternative investments of similar type and quality as of each assessment date. The Cost approach is applied for software technologies valuation based on the estimated replacement cost of the software technologies. The Monte Carlo simulation is applied for the valuation of contingent consideration receivables. Contingent consideration receivables arose from certain “make good” provisions stipulated in the acquisition agreements with the sellers, which were that if audited pretax profit or after tax profit for the required further years increases by less than certain amount or percentage while compared to audited pretax profit or after tax profit of the prior year, the sellers need to compensate the Company in cash for the difference between target pretax profit or after tax profit and actual result achieved then.

Goodwill recognized from these transactions mainly represented the expected operational synergies upon acquisition of these subsidiaries and intangibles not qualifying for separate recognition. Goodwill is nondeductible for income tax purpose in the tax jurisdiction of these acquisition transactions incurred.

Acquisition of Quanzhou Zhi Yuan

The following table summarizes the assignment of fair value to identifiable assets and liabilities assumed as of January 4, 2011 (the acquisition date of Quanzhou Zhi Yuan):
 
 
F-22
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
Fair Value
  
Amortization
Period
   
US$(’000)
  
(Years)
         
Cash and cash equivalents
   $ 11    
Accounts receivables
     17    
Property and equipment, net
     57    
Other current liabilities
     (13 )  
Deferred tax liabilities
     (196 )  
Acquired intangible assets:
          
Trade Name
     113  
Indefinite
Contract Backlog
     18   0.7
Customer Relationship
     547   8
Non-Compete Agreement
     106   5
Goodwill:
          
Assembled Workforce
     20    
Other unidentifiable intangibles
     708    
      728    
           
Total Value
   $ 1,388    
           
Purchase price
   $ 1,440    
Contingent consideration receivable
     (52 )  
Total amount to be allocated
   $ 1,388    

Acquisition of Quanzhou Tian Xi Shun He

The following table summarized the assignment of fair value to identifiable assets and liabilities assumed as of February 23, 2011 (the acquisition date of Quanzhou Tian Xi Shun He):
 
   
Fair Value
  
Amortization
Period
   
US$(’000)
  
(Years)
         
Cash and cash equivalents
   $ 12    
Accounts receivables
     55    
Property and equipment, net
     41    
Other current liabilities
     (34 )  
Deferred tax liabilities
     (289 )  
Acquired intangible assets:
          
Trade Name
     182  
Indefinite
Contract Backlog
     170   0.6
Customer Relationship
     722   9
Non-Compete Agreement
     83   5
Goodwill:
          
Assembled Workforce
     23    
Other unidentifiable intangibles
     1,143    
      1,166    
           
Total Value
   $ 2,108    
           
Purchase price
     1,138    
Fair value of noncontrolling interest
     1,034    
Contingent consideration receivable
     (64 )  
Total amount to be allocated
   $ 2,108    

Acquisition of Sou Yi Lian Mei

The following table summarized the assignment of fair value to identifiable assets and liabilities assumed as of December 20, 2011 (the acquisition date of Sou Yi Lian Mei):
 
 
F-23
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
Fair Value
  
Amortization
Period
   
US$(’000)
  
(Years)
         
Cash and cash equivalents
   $ 310    
Accounts receivables
     1,957    
Property and equipment, net
     23    
Other current liabilities
     33    
Deferred tax liabilities
     (2,140 )  
Acquired intangible assets:
     (1,266 )  
Domain Name
     1,512  
Indefinite
Customer Relationship
     2,085   5
Non-Compete Agreement
     1,148   6
Software technologies
     321   5
Goodwill:
          
Assembled Workforce
     42    
Other unidentifiable intangibles
     8,963    
      9,005    
           
Total Value
   $ 12,988    
           
Purchase price
     8,078    
Fair value of noncontrolling interest
     5,021    
Contingent consideration receivable
     (111 )  
Total amount to be allocated
   $ 12,988    

The operating results of these acquirees are only included from the date of their respective acquisition dates. For the year ended December 31, 2011, the financial performance of the acquirees reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$1,474,000 and net income before allocation to noncontrolling interests of approximately US$441,000.
 
The following unaudited pro-forma financial results for the year ended December 31, 2011, combines the historical operating results of the Company with those of Quanzhou Zhi Yuan, Quanzhou Tian Xi Shun He and Sou Yi Lian Mei in the aggregate, as if these acquisitions had been completed as of the beginning of the reporting periods, and also includes the adjustments for the business combination effect of the amortization charges from acquired intangible assets and the related tax effects. (Amounts in thousands, except for per share data):

   
Year ended
December 31, 2011
  
       
Revenue
   $ 35,659  
Net income before allocation to the noncontrolling interests
   $ 4,508  
Earnings per share-Basic
   $ 0.19  
Earnings per share-Diluted
   $ 0.19  


Subsequently, the Company acquired the remaining 49% equity interest in Quanzhou Tian Xi Shun He and Sou Yi Lian Mei in June 2011 and September 2012, respectively. The Company accounted for changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary in accordance with ASC Topic 810 “Consolidation”, which requires the transaction be accounted for as equity transactions with no gain or loss recognized in earnings for these transactions for the years ended December 31, 2012 and 2011.

The difference between the cash consideration paid and the amount by which the noncontrolling interest was adjusted to reflect the change in its ownership interest in the subsidiary was approximately US$787,000 for the 49% equity interest acquisition in Sou Yi Lian Mei and approximately US$62,000 for the 49% equity interest acquisition in Quanzhou Tian Xi Shun He was recognized in equity attributable to the Company for the years ended December 31, 2012 and 2011, respectively.
 
 
F-24
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
5.  
Cash and cash equivalent

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Cash
     893       181  
Bank deposit
     4,590       10,514  
      5,483       10,695  
 
6.  
Term deposit
 
Term deposit as of December 31, 2012 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 3.5% per annual and the term deposit will mature on July 5, 2013.
 
7.  
Accounts receivable, net

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Accounts receivable
     12,116       6,546  
Allowance for doubtful debts
     (3,630 )     (2,102 )
Accounts receivable, net
     8,486       4,444  

All of the accounts receivable are non-interest bearing. Based on the assessment of the collectability of the accounts receivable, the Company provided approximately US$3,630,000 and US$2,102,000 allowance for doubtful debts for the years ended December 31, 2012 and 2011, respectively, 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 year ended December 31, 2012, approximately US$1,510,000 allowance for doubtful debts was provided.
 
8.  
Other receivables, net
 
   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Short-term loan for marketing campaign
     2,375       2,985  
Short-term loans to unrelated entities
     475       -  
Term deposit interest receivable
     59       -  
Staff advances for normal business purpose
     194       279  
Overdue contract guarantee deposits
     158       891  
Allowance for doubtful debts
     (158 )     (524 )
Other receivables, net
     3,103       3,631  
 
 
F-25
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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$3,958,139) 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. For the years ended December 31, 2012 and 2011, the Company has collected an aggregate of RMB10,000,000 (approximately US$1,583,255) 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, 2012 to December 31, 2013, as this TV series is still selling broadcasting rights to TV stations and other media and the Company has agreed a repayment schedule with the borrower, which is within one year. 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.
 
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 December 31, 2012 and 2011, the Company provided approximately US$158,000 and US$524,000 allowance for doubtful debts, respectively, which was related to the contract guarantee deposits of its TV advertising business segment. For the year ended December 31, 2012, approximately US$370,000 allowance for doubtful debts was reversed due to subsequent collection of these overdue deposits in 2012.
 
9.  
Prepayments and deposit to suppliers

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Contract execution guarantees to TV advertisement and internet resources providers
     9,463       10,050  
Prepayments to TV advertisement and internet resources providers
     5,069       5,285  
Other deposits and prepayments
     64       25  
      14,596       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 needed 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.
 
10.  
Due from related parties

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Beijing Fengshangyinli Technology Co., Ltd.
     53       113  
Beijing Saimeiwei Food Equipment Technology Co., Ltd.
     87       74  
Beijing Telijie Century Environmental Technology Co., Ltd.
     70       137  
      210       324  
 
 
F-26
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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 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 of the reporting date.
 
11.  
Contingent consideration receivables

   
Amount
  
   
US$(’000)
  
       
Balance as of December 31, 2011
     159  
Changes in fair value of contingent consideration receivables recognized
     (160 )
Exchange translation adjustment
     1  
Balance as of December 31, 2012
     -  
 
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 a 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.
 
The related VIEs acquired in 2011 which subject to the “make good” provisions discussed above have all achieved its respective target pre-tax or after tax profit for the year ended December 31, 2012 and the former stockholders of these VIEs will not compensate the Company any cash in accordance with the acquisition agreement. Therefore, any remaining balance of contingent consideration receivables was charged against earnings as charge in fair value of contingent consideration receivables in the Company’s consolidated statements of income and comprehensive income for the year ended December 31, 2012.
 
12.  
Investment in and advance to equity investment affiliates

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Investment in equity investment affiliates
     916       1,354  
Advance to equity investment affiliates
     43       42  
      959       1,396  
 
The following table summarizes the movement of the investment in and advance to equity investment affiliates for the year ended December 31, 2012:
 
   
Shenzhen
Mingshan
    
Zhao Shang
Ke Hubei
    
Total
  
   
US$(’000)
    
US$(’000)
    
US$(’000)
  
                   
Balance as of December 31, 2011
     595       801       1,396  
Share of losses in equity investment affiliates
     (109 )     (340 )     (449 )
Exchange translation adjustment
     6       6       12  
Balance as of December 31, 2012
     492       467       959  

 
F-27
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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$2,374,883) 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. On December 19, 2012, as approved by the shareholders of Shenzhen Mingshan, Shenzhen Mingshan reduced its registered and paid-in capital from RMB25,000,000 (approximately US$3,958,139) to RMB22,000,000 (approximately US$3,483,162), resulted from a decrease of paid-in capital from three other noncontrolling shareholders, except Business Opportunity Online. As a result, the Company’s share of the equity interest in Shenzhen Mingshan increased from 20.4% to 23.18% and the Company continued to retain significant influence over Shenzhen Mingshan.

The deconsolidation of Shenzhen Mingshan occurred in January 2011 was accounted for in accordance with ASC Topic 810 “Consolidation”. For the year ended December 31, 2011, the Company recognized a gain of approximately US$232,000 upon deconsolidation of Shenzhen Mingshan, which has been recorded as a gain on deconsolidation of subsidiaries in the Company’s consolidated statements of income and comprehensive income with a corresponding increase in the carrying value of the investment in Shenzhen Mingshan in the Company’s consolidated balance sheet. This gain represents the excess of the fair value of the Company’s retained equity interest over its carrying value as of the date of deconsolidation.

For the years ended December 31, 2012 and 2011, the Company recognized its pro-rata shares of losses in Shenzhen Mingshan of approximately US$109,000 and US$249,000, 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$1,583,255) 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 deconsolidation of Zhao Shang Ke Hubei occurred in December 2011 was accounted for in accordance with ASC Topic 810 “Consolidation”. For the year ended December 31, 2011, the Company recognized a gain of approximately US$693,000 upon deconsolidation of Zhao Shang Ke Hubei, which has been recorded as a gain on deconsolidation of subsidiaries in the Company’s consolidated statements of income and comprehensive income with a corresponding increase in the carrying value of the investment in Zhao Shang Ke Hubei in the Company’s consolidated balance sheet. This gain represents the excess of the fair value of the Company’s retained equity interest over its carrying value as of the date of deconsolidation.
 
The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the year ended December 31, 2012, the Company recognized its pro-rata share of losses in Zhao Shang Ke Hubei of approximately US$340,000, which was reflected in the caption of “Share of losses in equity investment affiliates” in the Company’s consolidated statements of income and comprehensive income with a corresponding decrease to the carrying value of the investment in Zhao Shang Ke Hubei in the Company’s consolidated balance sheet. For the year ended December 31, 2011, the Company did not recognize its pro-rata share of losses in Zhao Shang Ke Hubei as the amount is immaterial.
 
 
F-28
 
13.  
Property and equipment, net

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Vehicles
     925       683  
Office equipment
     1,481       1,399  
Electronic devices
     1,205       1,196  
Property and equipment, cost
     3,611       3,278  
Less: accumulated depreciation
     (1,975 )     (1,376 )
Property and equipment, net
     1,636       1,902  
 
Depreciation expenses in aggregate for the years ended December 31, 2012 and 2011 were approximately US$591,000 and US$551,000, respectively.
 
14.  
Intangible assets, net

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
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
     3,434       3,408  
Non-compete agreements
     1,358       1,348  
Software technologies
     325       322  
Cloud-computing based software platforms
     1,470       1,458  
Other computer software
     76       75  
Intangible assets, cost
     8,697       8,630  
Less: accumulated amortization
     (1,530 )     (479 )
Intangible assets, net
     7,167       8,151  
 
Amortization expenses in aggregate for the years ended December 31, 2012 and 2011 were approximately US$1,046,000 and US$461,000, respectively.
 
Based on the carrying value of the finite-lived intangible assets recorded as of December 31, 2012, and assuming no subsequent impairment of the underlying intangible assets, the estimated future amortization expenses is approximately US$1,022,000 per year through December 31, 2015, approximately US$982,000 for the year ended December 31, 2016 and approximately US$496,000 for the year ended December 31, 2017.
 
 
F-29
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
15.  
Goodwill

   
Amount
  
   
US$(’000)
  
       
Balance as of January 1, 2011
     -  
Acquisitions: (Note 4)
        
--Quanzhou Zhi Yuan
     728  
--Quanzhou Tian Xi Shun He
     1,166  
--Sou Yi Lian Mei
     9,005  
Exchange translation adjustment
     100  
Balance as of December 31, 2011
     10,999  
Exchange translation adjustment
     84  
Balance as of December 31, 2012
     11,083  
 
16.  
Accrued payroll and other accruals

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Accrued payroll and staff welfare
     538       344  
Accrued operating expenses
     366       272  
      904       616  
 
17.  
Due to equity investment affiliate

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
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 year ended December 31, 2012.
 
18.  
Due to related parties

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
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 year ended December 31, 2012.
 
 
F-30
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
19.  
Payable for acquisition

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Sou Yi Lian Mei
     1,266       550  

Payable for acquisition as of December 31, 2012 and 2011 represented the outstanding payment of approximately RMB8.0 million and RMB3.5 million for the acquisition of the 49% equity interest and the 51% equity interest of Sou Yi Lian Mei consummated in September 2012 and December 2011, respectively.
 
20.  
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 years ended December 31, 2012 and 2011, 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 years ended December 31, 2012 and 2011, or any prior periods. Additionally, upon payments of dividends by China Net HK to its shareholders, no Hong Kong withholding tax will be imposed.
 
iv).  The Company’s PRC operating subsidiary and VIEs, being incorporated in the PRC, are governed by the income tax law of the PRC and is subject to PRC enterprise income tax (“EIT”).  Effective from January 1, 2008, the EIT rate of PRC was changed from 33% to 25%, and applies to both domestic and foreign invested enterprises.
 
l
Rise King WFOE is a software company qualified by the related PRC governmental authorities and was approved by the local tax authorities of Beijing, the PRC, to be entitled to a two-year EIT exemption from its first profitable year and a 50% reduction of its applicable EIT rate, which is 25% to 12.5% of its taxable income for the succeeding three years. Rise King WFOE had a net loss for the year ended December 31, 2008 and its first profitable year was fiscal year 2009 which has been verified by the local tax bureau by accepting the application filed by us. 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 years ended December 31, 2012 and 2011, the applicable income tax rate for Rise King WFOE was both 12.5%. After fiscal year 2013, the applicable income tax rate of Rise King WFOE will be 25% under the current EIT law of PRC.
 
l
Business Opportunity Online was approved by the related PRC governmental authorities as a High and New Technology Enterprise under the New EIT law effective September 4, 2009, and was approved by the local tax authorities of Beijing, the PRC, to be entitled to a favorable statutory tax rate of 15%. Business Opportunity Online’s High and New Technology Enterprise certificate would expire on September 4, 2012. On July 9, 2012, Business Opportunity Online passed the administrative review conducted by the related PRC governmental authorities for obtaining the renewed certificate, which enabled it to continue to enjoy the 15% preferential income tax rate as a High and New Technology Enterprise. Therefore, for the years ended December 31, 2012 and 2011, the applicable income tax rate of Business Opportunity Online was both 15%.
 
 
F-31
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
l
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 year ended December 31, 2011, Business Opportunity Online Hubei calculated its income tax expenses based on 2.5% of the total revenue recognized for the reporting period. Starting from January 1, 2012, the local tax authorities cancelled the deemed income tax method for computation of income tax expenses for the entity. As such, 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 for fiscal years 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 year ended December 31, 2012, the applicable income tax rate of Business Opportunity Online Hubei is nil%.
 
l
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 year ended December 31, 2011, Hubei CNET calculated its income tax expenses based on 2.5% of the total revenue recognized for the reporting period. Starting from January 1, 2012, the local tax authorities cancelled the 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 year ended December 31, 2012, the applicable income tax rate for Hubei CNET is 25%.
 
l
The applicable income tax rate for other PRC operating entities of the Company is 25% for the years ended December 31, 2012 and 2011.
 
l
The New EIT also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous enterprise income tax law and rules.  A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate.  Rise King WFOE is invested by immediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company.
 
For the years ended December 31, 2012 and 2011, 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. 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) Turnover taxes and the relevant surcharges
 
For fiscal 2011, revenue from advertisement services is subject to 5.5% business tax (including surcharges) and 3% cultural industry development surcharge of the net service income after deducting amount paid to ending media promulgators. Revenue from internet technical services is subjected to 5.5% business tax (including surcharges).
 
Beginning on January 1, 2012, PRC tax authorities increased the local business tax rate by 0.1%-0.2%. Therefore, from January 1, 2012 through August 31, 2012 (for the Company’s PRC operating entities incorporated in Beijing) or  October 31, 2012 (for the Company’s PRC operating entities incorporated in Fujian province) or November 30, 2012 (for the Company’s PRC operating entities incorporated in Hubei province), revenue from advertisement services is subject to 5.6%-5.7% business tax (including surcharges), depending on which tax jurisdiction the Company’s PRC operating subsidiary and VIE operate in, and 3% cultural industry development surcharge of the net service income after deducting amount paid to ending media promulgators. Revenue from internet technical services was subjected to 5.6%-5.7% business tax (including surcharges), depending on which tax jurisdiction the Company’s PRC operating subsidiary and VIE operate in.
 
 
F-32
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
On July 31, 2012, the Ministry of Finance (the “MOF”) and the State Administration of Taxation (the “SAT”) of the PRC jointly promulgated a “Circular on Launching the Pilot Collection of Value Added Tax in lieu of Business Tax in Transportation and Certain Areas of Modern Services Industries in Eight Provinces and Municipalities Including Beijing” (“Circular Cai Shui [2012] No. 71”), pursuant to which a business tax to value added tax (the “VAT”) transformation pilot program was launched. The implementation date for Beijing is September 1, 2012, for Fujian province, November 1, 2012, and for Hubei province, December 1, 2012. Other circulars such as “Circular on Carrying out the Pilot Collection of Value Added Tax in Lieu of Business Tax to be imposed on Transportation Industry and Part of Modern Services Industry in Shanghai” (“Circular Cai Shui [2011] No. 111”) jointly promulgated by the MOF and the SAT on November 16, 2011 which contains detailed implementation measures for such VAT pilot program apply to the locations including Beijing, Fujian province and Hubei province. In accordance with the Circular Cai Shui [2011] No. 111, the VAT rate for provision of modern services (other than lease of corporeal movables) is 6% and for small scale taxpayer, 3%. Therefore, beginning on September 1, 2012, for the Company’s PRC operating subsidiary and VIEs incorporated in Beijing, November 1, 2012, for the Company’s PRC operating VIEs incorporated in Fujian province, December 1, 2012, for the Company’s PRC operating VIEs incorporated in Hubei province, 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.  
 
Business tax is a price including tax in the PRC turnover tax system, which is calculated based on the revenue inclusive of turnover tax. Therefore, revenues achieved by the Company which are subject to business tax are presented on a gross basis inclusive of business tax, and on the other hand, business tax was included in cost of revenues upon recognition of services revenues. Contrastively, VAT is a price excluding tax in the PRC turnover tax system, which is calculated based on the revenue exclusive of turnover tax. Therefore, revenues achieved by the Company which are subject to VAT is presented on a net basis exclusive of VAT.
 
As of December 31, 2012 and 2011, taxes payable consists of:
 
   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Turnover tax and surcharge payable
     2,609       2,212  
Enterprise income tax payable
     4,074       2,770  
Individual income tax payable
     -       58  
      6,683       5,040  
 
A reconciliation of the provision for income taxes determined at the US federal corporate income tax rate to the Company’s effective income tax rate is as follows:
 
 
F-33
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
Year ended December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Pre-tax income
     4,386       4,035  
US federal rate
     35 %     35 %
                 
Income tax expense computed at U.S. federal rate
     1,535       1,412  
Reconciling items:
                
Rate differential for domestic earnings
     (537 )     (770 )
Preferential tax treatments and tax holiday effects
     (1,039 )     (1,552 )
Valuation allowance on deferred tax assets
     512       1,921  
Loss not recognized as deferred tax assets
     3       -  
Non-deductible expenses and non-taxable income
     55       24  
Effective income tax expense
     529       1,035  
 
For the years ended December 31, 2012 and 2011, the Company’s income tax expense consisted of:
 
   
Year Ended December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Current-PRC
     1,357       1,008  
Deferred-PRC
     (828 )     27  
      529       1,035  
 
The Company’s deferred tax liabilities at December 31, 2012 and changes for the year then ended were as follows:
       
   
Amount
  
   
US$(’000)
  
       
Balance as of December 31, 2011
     1,893  
Reversal during the period
     (219 )
Exchange translation adjustment
     15  
Balance as of December 31, 2012
     1,689  

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 year ended December 31, 2012 of approximately US$219,000 was due to amortization of the acquired intangible assets.

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

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Tax effect of net operating losses carried forward
     2,929       1,975  
Bad debts provision
     824       651  
Valuation allowance
     (3,051 )     (2,534 )
      702       92  

 
F-34
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Deferred tax assets reclassified as current asset
     50       -  
Deferred tax assets reclassified as non-current asset
     652       92  
      702       92  
 
The net operating losses carried forward incurred by the Company (excluding its PRC operating subsidiary and VIEs) were approximately US$6,363,000 and US$5,381,000 at December 31, 2012 and 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 (excluding bad debts provision and non-deductible expenses) incurred by the Company’s PRC subsidiary and VIEs were approximately US$4,093,000 and US$361,000 at December 31, 2012 and 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.

As of December 31, 2012, the bad debts provision recorded by the Company’s PRC subsidiary and VIEs were approximately US$3,788,000. 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.
 
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.
 
21.  
Dividend payable

   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
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 years ended December 31, 2012 and 2011, the Company paid dividends of approximately US$5,000 and US$657,000 to its Series A convertible preferred stockholders, respectively.
 
 
F-35
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
22.  
Long-term borrowing from director
 
   
As of December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
Long-term borrowing from director
     139       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.
 
23.  
Warrants
 
In the Company’s August 2009 Financing, the Company issued to its investors (i) Series A-1 Warrant to purchase 2,060,800 shares of common stock at an exercise price of US$3.00 per share with a three-year term, and (ii) Series A-2 Warrants to purchase 2,060,800 shares of common stock at an exercise price of US$3.75 with a five-year term. The Company also issued to its placement agent warrants to purchase up to 329,728 shares of common stock at an exercise price of US$2.50, 164,864 shares at an exercise price of US$3.00 and 164,864 shares at an exercise price of US$3.75 respectively, with a five-year term (“Placement agent warrants” and together with the Series A-1 Warrant and Series A-2 Warrant, the “Warrants”).
 
On December 1, 2011, the Company initiated an exchange offer (the “Offer”) pursuant to which holders of certain of the Company’s outstanding warrants (the “Warrants”) to purchase an aggregate of 4,121,600 shares of the Company’s common stock had the opportunity to acquire shares of the Company’s common stock (the “Shares”) through a warrant for share exchange. The Company issued the Shares in exchange for the Warrants in accordance with the following exchange ratios: (A) with respect to any Series A-1 Warrant, one (1) Share in exchange for every twenty (20) Shares for which such Series A-1 Warrant was exercisable, and (B) with respect to any Series A-2 Warrant, one (1) Share in exchange for every ten (10) Shares for which such Series A-2 Warrant was exercisable; provided that each holder must have exchanged all its Series A-1 Warrants and/or all its Series A-2 Warrants pursuant to the terms and conditions thereof. The Offer continued for a period of twenty (20) business days from December 1, 2011 and expired on December 30, 2011, at 5:00 p.m., Eastern Time. Based on information provided by Empire Stock Transfer Inc., the Company’s stock transfer agent, and pursuant to the terms of the Offer, 1,418,800 Series A-1 Warrants were tendered in exchange for approximately 70,940 Shares and 356,800 Series A-2 Warrants were tendered in exchange for approximately 35,680 Shares, for a total of 1,775,600 Warrants exchanged for approximately 106,620 Shares. The Company had accepted for exchange all of the Warrants validly tendered and not withdrawn.
 
On August 20, 2012, Series A-1 warrants to purchase up to 642,000 share of the Company’s common stock issued on August 21, 2009 expired. The remaining Series A-2 warrants to purchase up to 1,704,000 shares of the Company’s common stock and placement agent warrants to purchase up to 659,456 shares of the Company’s common stock will expire on August 20, 2014.
 
Warrants issued and outstanding at December 31, 2012 and 2011, and changes during the two-year period ended December 31, 2012 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, January 1, 2011
     4,781,056       $3.31       2.77       4,781,056       $3.31       2.77  
Granted / Vested
     -                       -                  
Forfeited
     -                       -                  
Exercised
     -                       -                  
Exchanged in the Offer
     (1,775,600 )     $3.15               (1,775,600 )     $3.15          
Balance, December 31, 2011
     3,005,456       $3.41       2.21       3,005,456       $3.41       2.21  
Granted / Vested
     -                       -                  
Forfeited
     -                       -                  
Exercised
     -                       -                  
Expired
     (642,000 )     $3.00               (642,000 )     $3.00          
Balance, December 31, 2012
     2,363,456       $3.52       1.63       2,363,456       $3.52       1.63  
 
 
F-36
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
24.  
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 December 31, 2012 and 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$5.5 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:

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

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

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

 
F-37
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
As of December 31, 2012 and 2011, there was approximately US$38.1 million and US$34.0 million retained earnings in the aggregate, respectively, which was generated by the Company’s PRC subsidiary and VIEs in Renminbi included in the Company’s consolidated net assets, aside from US$2.4 million and US$2.2 million statutory reserve funds as of December 31, 2012 and 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$5.5 million and US$4.7 million restricted net assets as of December 31, 2012 and 2011, respectively, as discussed above.
 
25.  
Related party transactions
 
Revenue from related parties:
   
Year Ended December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
             
-Beijing Saimeiwei Food Equipment Technology Co., Ltd,
     123       85  
-Beijing Fengshangyinli Technology Co., Ltd.
     2       307  
-Beijing Telijie Century Environmental Technology Co., Ltd.
     72       234  
      197       626  
 
Sales of fixed assets to an equity investment affiliate:
 
For the year ended December 31, 2011, Rise King WFOE sold some spared computer servers to Shenzhen Mingshan, the Company’s equity investment affiliates for approximately US$36,000, the profit from this transaction which was included in the Company’s consolidated earnings was approximately US$3,000.
 
26.  
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$451,000 and US$381,000 for the years ended December 31, 2012 and 2011, respectively.
 
27.  
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 December 31, 2012 and 2011, 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.
 
 
F-38
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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 year ended December 31, 2011, one customer accounted for 12% 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 years ended December 31, 2012 and 2011, respectively.
 
As of December 31, 2012, one customer accounted for 10% 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 December 31, 2012 and 2011, respectively.
 
Concentration of suppliers
 
For the year ended December 31, 2012, three suppliers individually accounted for 52%, 15% and 11% of the Company’s cost of sales, respectively. For the year ended December 31, 2011, two suppliers individually accounted for 36% and 24% 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 years ended December 31, 2012 and 2011, respectively.
 
28.  
Commitments
 
The following table sets forth the Company’s contractual obligations as of December 31, 2012:

   
Office Rental
    
Server hosting
and board-band Leasing
    
Total
  
   
US$(’000)
    
US$(’000)
    
US$(’000)
  
                   
Year ending December 31,
                  
-2013
     367       69       436  
-2014
     293       -       293  
-2015
     293       -       293  
-2016
     73       -       73  
Total
     1,026       69       1,095  
 
29.  
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.
 
 
F-39
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Year Ended December 31, 2012

   
 
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
     21,366       20,682       282       4,498       40       (268 )     46,600  
Cost of sales
     9,790       20,450       18       1,528       -       (228 )     31,558  
Total operating expenses
     7,005       338       210       1,205       1,774 *     -       10,532  
Depreciation and amortization expense included in total operating expenses
       1,053         60         210         215         99         -         1,637  
Operating income (loss)
     4,571       (106 )     54       1,765       (1,734 )     (40 )     4,510  
                                                         
Changes in fair value of contingent consideration receivables
     (160 )     -       -       -       -       -       (160 )
Share of  losses  in equity investment affiliates
     -       -       -       (340 )     (109 )     -       (449 )
Expenditure for long-term assets
     306       8       -       -       -       -       314  
Net income (loss)
     4,181       (64 )     54       982       (1,705 )     (40 )     3,408  
Total assets – December 31, 2012
     38,215       16,628       596       8,965       15,338       (22,824 )     56,918  

*Including approximate US$48,000 share-based compensation expenses.
 
Year Ended December 31, 2011

   
 
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
     19,981       6,448       487       1,829       -       (14 )     28,731  
Cost of sales
     6,287       5,247       42       465               (14 )     12,027  
Total operating expenses
     6,834       1,002       226       889       4,591 *     -       13,542  
Depreciation and amortization expense included in total operating expenses
       263         76         191         387         95         -         1,012  
Operating income (loss)
     6,860       199       219       475       (4,591 )     -       3,162  
                                                         
Changes in fair value of contingent consideration receivables
     -       -       -       (70 )     -       -       (70 )
Gain on deconsolidation of subsidiaries
     -       -       -       693       232       -       925  
Share of earnings (losses) in equity investment affiliates
     -       26       -       -       (245 )     -       (219 )
Expenditure for long-term assets
     1,564       4       186       417       15       -       2,186  
Net income (loss)
     6,247       179       219       769       (4,633 )     -       2,781  
Total assets – December 31, 2011
     61,741       15,954       800       6,369       16,305       (43,887 )     57,282  

*Including approximate US$2,900,000 share-based compensation expenses.
 
 
F-40
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
30.  
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):
 
   
Year ended December 31,
  
   
2012
    
2011
  
   
US$(’000)
    
US$(’000)
  
   
(Amount in thousands except for the
number of shares and per share data)
  
             
Net income attributable to ChinaNet Online Holdings, Inc.
   $ 2,996     $ 2,995  
Less: Dividend for Series A convertible preferred stock
     -       407  
Net income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for basic earnings per share)
     2,996       2,588  
Add: Dividend for Series A convertible preferred stock
     -       -  
Net income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for diluted earnings per share)
   $ 2,996     $ 2,588  
                 
Weighted average number of common shares outstanding - Basic
     22,185,556       18,545,609  
Effect of diluted securities:
                
Series A Convertible preferred stock
     -       -  
Warrants
     -       213,631  
Weighted average number of common shares outstanding -Diluted
     22,185,556       18,759,240  
                 
Earnings per share-Basic
   $ 0.14     $ 0.14  
Earnings per share-Diluted
   $ 0.14     $ 0.14  
 
For the year ended December 31, 2012, the diluted earnings per share calculation did not include the warrants and options to purchase up to 2,772,161 and 939,440 shares of common stock, respectively, because their effect was anti-dilutive.
 
For the year ended December 31, 2011, the diluted earnings per share calculation did not include the effect of the 1,625,526 incremental shares resulted from assumed conversion of the convertible preferred stock, because their effect were anti-dilutive. For the year ended December 31, 2011, the diluted earnings per share calculation also did not include the warrants and options to purchase up to 3,072,411 and 129,202 shares of common stock, respectively, because their effect was anti-dilutive.
 
31.  
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 years ended December 31, 2012 and 2011 was U$$6,333 and US$152,000 respectively.

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 years ended December 31, 2012 and 2011 was US$42,000 and US$nil, respectively.

 
F-41
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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 year ended December 31, 2011 was US$141,480.

The Company estimated the fair value of these common stock options granted on November 30, 2009 using the Black-Scholes option pricing model based on the following assumptions:


Underlying stock price
   $ 5.00  
Expected term (years)
     3.00  
Risk-free interest rate
     1.10 %
Dividend yield
     -  
Expected Volatility
     150 %
Exercise price of the option
   $ 5.00  
Value per option
   $ 4.05  

Underlying stock price is the closing bid price of the Company’s common stock on the date of grant. As the three individuals receiving options are non-employee executive directors, the Company believes that forfeitures are highly unlikely, and termination is not applicable. As such, the Company developed a weighted-average expected term at 3 years based on analysis of the vesting schedule and exercise assumptions. The risk-free interest rate is based on the 3 year U.S. Treasury rate. The dividend yield is calculated based on management’s estimate of dividends to be paid on the underlying stock. The expected volatility is calculated using historical data obtained from an appropriate index due to lack of liquidity of the Company’s underlying stock. Exercise price of the option is the contractual exercise price of the option.

On November 30, 2011, under the Company’s 2011 Omnibus Securities and Incentive Plan, adopted by the stockholders of the Company at its annual meeting held on June 15, 2011, the Company issued its management, employees and directors in the aggregate of 2,000,000 restricted shares of the Company’s common stock for the services they provided to the Company. The restricted stock is subject to a strict lock-up for an initial six-month period. Following the initial six-month period, the restricted stock will continue to be locked up until the earlier of (i) the date upon which the closing price of the Company's common stock equals or exceeds $2.50 for five consecutive trading days, and (ii) November 30, 2013. In addition, the restricted stock is subject to forfeiture upon an employee's cessation of employment at the discretion of the Company. The restricted stock was fully vested upon issuance and was valued at $1.14 per share, the closing bid price of the Company’s common stock on the date of grant. Total compensation cost recognized for the year ended December 31, 2011 was US$2,280,000.

On November 30, 2011, under the Company’s 2011 Omnibus Securities and Incentive Plan, the Company also 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. Total compensation expenses recognized for these options for the year ended December 31, 2011 was US$328,000.

The Company estimated the fair value of these options granted on November 30, 2011 using the Black-Scholes option pricing model based on the following assumptions:

Adjusted underlying stock price
   $ 1.037  
Expected term (years)
     5.00  
Risk-free interest rate
     0.95 %
Dividend yield
     -  
Expected Volatility
     46.73 %
Exercise price of the option
   $ 1.20  
Value per option
   $ 0.37  

 
F-42
 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Adjusted underlying stock price is based on the closing bid price of the Company common stock on the grant date, after adjustment for the 2,000,000 restricted shares award issued on November 30, 2011. Expected tenor are used when estimates of the expected lives of the options, based on vesting schedule and exercise assumptions, which has taken into account of early exercise behavior of the option holders. Yield-to-maturities in continuous compounding of the United States Government Bonds with the time-to-maturities same as the expected tenor of the options of 5 year are adopted as the risk-free rate. Average/median of industry annualized historical stock price volatility from an appropriate index as at the grant date is deemed to be appropriate to serve as the expected volatility of the stock price of the Company. The dividend yield is calculated based on management’s estimate of dividends to be paid on the underlying stock. Exercise price of the option is the contractual exercise price of the option.

Options issued and outstanding at December 31, 2012 and 2011, and changes during the two-year period ended December 31, 2012 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, January 1, 2011
     54,000       3.92     $ 5.00       27,000       3.92     $ 5.00  
Granted/Vested
     885,440       10.00     $ 1.20       912,440       9.80     $ 1.31  
Forfeited
     -                       -                  
Exercised
     -                       -                  
Balance, December 31, 2011
     939,440       9.51     $ 1.42       939,440       9.51     $ 1.42  
Granted/Vested
     -                       -                  
Forfeited
     -                       -                  
Exercised
     -                       -                  
Balance, December 31, 2012
     939,440       8.51     $ 1.42       939,440       8.51     $ 1.42  
 
The aggregate unrecognized share-based compensation expenses as of December 31, 2012 and 2011 is approximately US$42,000 and US$6,000, respectively.
 
32.  
Subsequent Events

The Company has evaluated subsequent events from the balance sheet date through the date that the financial statements are issued and no material subsequent event found.
 
 
F-43