ChinaNet Online Holdings, Inc.
Annual Report 2011

Plain-text annual report

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K [x]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2011 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. 000-52672 CHINANET ONLINE HOLDINGS, INC. (Exact name of registrant as specified in its charter)NEVADA 20-4672080(State or other jurisdiction ofincorporation 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 ClassName of Exchange On which Registered $0.001 Common StockNasdaq 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 o No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.Yes o No x  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 1934during 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 filingrequirements for the past 90 days.Yes x No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required tobe 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 thatthe registrant was required to submit and post such files).Yes x No o 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 bestof registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. Yes o No x 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 thedefinition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer o Smaller Reporting Company x Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).Yes o No x The aggregate market value of the 10,141,691 shares of common equity stock held by non-affiliates of the Registrant was approximately $14,806,869 on thelast 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 dateof $1.46 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, 2012 was 22,186,540. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant’s Proxy Statement relating to the Registrant’s 2012 Annual Meeting of Shareholders, are incorporated by reference into Part III ofthis Annual Report on Form 10-K where indicated.  TABLE OF CONTENTS PART I 2 ITEM 1BUSINESS2 ITEM 1A.RISK FACTORS25 ITEM 1B.UNRESOLVED STAFF COMMENTS39 ITEM 2PROPERTIES39 ITEM 3LEGAL PROCEEDINGS40 ITEM 4MINE SAFETY DISCLOSURES40PART II. 40 ITEM 5MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIES40 ITEM 6SELECTED FINANCIAL DATA41 ITEM 7MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS42 ITEM 7B.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK69 ITEM 8FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA69 ITEM 9CHANGES IN AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL DISCLOSURES69 ITEM 9A.CONTROLS AND PROCEDURES69 ITEM 9B.OTHER INFORMATION70PART III. 70 ITEM 10DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE71 ITEM 11EXECUTIVE COMPENSATION71 ITEM 12SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS71 ITEM 13CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE71 ITEM 14PRINCIPAL ACCOUNTANT FEE AND SERVICES71PART IV. 71 ITEM 15EXHIBITS AND FINANCIAL STATEMENT SCHEDULES71  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 ofthe 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 ofactivity, performance or achievements to be materially different from any future results, levels or activity, performance or achievements expressed or impliedby 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-lookingstatements 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 toreports 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 atthe 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 roomby 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 andother 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 1BUSINESS We are a holding company that conducts our primary businesses through our PRC subsidiary and PRC operating entities (the “VIEs”). We are one ofChina’s leading business-to-businesses (“B2B”), fully integrated internet service providers for expanding small and medium enterprises’ (“SMEs”) salesnetworks in China. Our services were founded on proprietary internet and advertising technologies that include (i) preparing and publishing rich mediaenabled 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 and (iv) providing online management tools tohelp SMEs manage the expansion of their sales networks. Our goal is to strengthen our position as the leading diversified one-stop internet service providerto SMEs for their sales network expansion in China. Our multi-channel advertising and promotion platform consists of the websites www.28.com (“28.com”),as well as www.liansuo.com (“liansuo.com”), www.chuangye.com (“chuangye.com”) and www.sooe.cn (“sooe.cn”), our Internet advertising portals, ChinaNetTV, our TV production and advertising unit and our bank kiosk advertising unit, which is primarily used as an advertising platform for clients in the financialservices industry and will be further utilized as an additional value-added communication channel for SME clients, and our brand management and saleschannel building services unit. Our advertising and marketing campaign services combine the Internet, mobile, television and bank kiosks advertising with additions of brandmanagement and sales channel building, thereby maximizing market exposure for our clients. 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, enterprises and entrepreneursadvertise their business information, brands, products and services, as well as other related business opportunities through their mini-sites hosted by 28.com. The platform also offers campaign management tools for our clients, including lead generation and management, advanced tracking, search enginemarketing, search engine optimization, resource scheduling and content management. Primarily through 28.com, our customers can potentially build saleschannels and develop business relationships directly for franchisees, sales agents, distributors and/or resellers. It also functions as a one-stop destination forthe general public seeking new business opportunities or other business ventures. In 2011, we also developed two new advertising web portals: liansuo.comand chuangye.com, operated through Beijing Chuang Fu Tian Xia Network Technology Co., Ltd., our newly formed majority-owned VIE, Liansuo.com isbuilt to serve larger SMEs than those served by 28.com. With additions of other internet related services, Liansuo.com is also intended to serve largeinternational clients in future. Chuangye.com is built to serve the community of enterprenuers to assist them with developing their business, as well assharing their resources in a web2.0 driven interaction in combination with popular web tools, such as weibo and renren. Upon acquiring Sou Yi Lian MeiNetwork Technology (Beijing) Co., Ltd., we obtained another established online advertising and marketing platform, sooe.cn, which focuses on smaller sizedenterprises and emerging SMEs. The ChinaNet TV division, which operated through Beijing CNET Online Advertising Co., Ltd., has in-house televisionproductions and distribution capabilities. We produce and distribute television shows that are typically 10 or 20 minutes in length and are broadcasted onlocal television stations. The television shows are comprised of advertisements, similar to infomercials, and also include promotions for severalclients. During 2011, we reduced the business scope of our TV division and integrated it into our advertising and marketing platform as a part of the value-added services offered to our existing clients. The bank kiosk division, which operated through Shanghai Borongdongsi Computer Technology Co., Ltd.,provides interactive LCD advertisement displays and targets banking customers. In cooperation with Henan provincial branch of China Construction Bankand Shanghai Rural Commercial Bank, as of December 31, 2011, we placed approximately 610 interactive kiosks in their branches in Henan province andShanghai. Each kiosk has an LCD advertising display panel, which provides advertising aimed at bank customers. Each kiosk also provides Internet accesson a separate screen so that customers can perform basic non-cash banking functions such as transferring money, purchasing annuities and/or insurance, andpaying bills. In 2011, 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 provided brand management and sales channel building services to ourSME clients, which services include brand investigation, brand modulization, brand application, brand promotion, as well as sales channel expansionmodeling, implementation and management. In 2011, we also invested in the cloud-computing based software technologies, operated through Sheng TianNetwork Technology (Hubei) Co., Ltd. 2 The technology is under integration and will be incorporated into www.feitengyun.com in 2012. This technology is intended to help our SME clientsmanage their sales channels more effectively in China. We derive our revenue principally by: l selling of internet advertising space on our website portals; l selling of value-added technical services to our clients through the internet advertising management systems and platforms developedand managed by us; l selling of advertising time slots on our television shows and on our installed bank kiosks; and l providing brand management and sales channel building services to a certain group of clients. The five largest industries in terms of revenue in which our advertising and marketing clients operate are (1) footwear, apparel and garments, (2)home goods and construction materials, (3) cosmetics and health care, (4) food and beverage and (5) environmental protection equipment. Advertisers fromthese industries together accounted for approximately 80% of our revenue in 2011. Due to Chinese government’s monetary policy of increasing interest rates and tightening the supply of money, and a general economic slowdown inChina that unexpectedly began in the second quarter of 2011, many of our clients, who are mostly SMEs, significantly reduced the amount that they spent onadvertising. As a result, we experienced a decline in our financial results in year 2011, as compared to 2010. We generated total revenues of US$28.7 millionin 2011, compared to US$41.6 million in 2010, and net income (after allocation to the noncontrolling interest shareholders) of US$3.0 million, compared toUS$16.6 million in 2010. Our net income attributable to common stockholders after the deduction of the cash dividend accrued for our preferredstockholders was US$2.6 million for the year ended December 31, 2011, compared to US$15.8 million for the year ended December 31, 2010. Excluding thenon-cash gain recognized for deconsolidation of subsidiaries of approximately US$0.93 million, the related deferred income tax expenses of approximatelyUS$0.21 million, the non-cash expenses of share-based compensation recognized for the restricted stock and common stock purchase options issued to ourmanagement, directors and employees on November 30, 2011 of approximately US$2.6 million and the non-cash charge of the changes in fair value of thecontingent consideration receivables of approximately US$0.07 million for the year ended December 31, 2011; and the non-cash gain of approximatelyUS$1.86 million for the year ended December 31, 2010, our adjusted Non-GAAP net income available to common stockholders was US$4.5 million andUS$13.9 million for the year ended December 31, 2011 and 2010, respectively. Our Corporate History, Background, Subsidiaries, Variable Interest Entities (VIEs) and Equity Investment Affiliates As of December 31, 2011, our Corporate Structure is set forth below: 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 ourincorporation 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 (“ChinaNet 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 inChina Net BVI becoming an indirect parent company of Rise King WFOE as the “Offshore Restructuring.” 3 Restructuring In October 2008, a restructuring plan was developed (the “Restructuring”). The Restructuring was accomplished in two steps. The first step was forRise King WFOE to acquire control over Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”) and BeijingCNET 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 PRCOperating 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 andMs. 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 acquireChina 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 andAugust 3, 2005, respectively. Shanghai Borongdingsi is 51% owned by Beijing CNET Online. Beijing CNET Online and Shanghai Borongdingsi enteredinto 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 Bankwhich allows Shanghai Borongdingsi, or its designated party, to conduct in-door advertising business within the business outlets throughout HenanProvince. The e-banking cooperation agreement has a term of eight years, which began in August 2008. However, Shanghai Borongdingsi was not able toconduct the advertising business as a stand-alone business due to the lack of an advertising business license and supporting financial resources. Pursuant tothe aforementioned cooperation agreements, Beijing CNET Online committed to purchase equipment, and to provide working capital, technical and otherrelated support to Shanghai Borongdingsi. Beijing CNET Online owns the equipment used in the kiosk business, is entitled to sign contracts in ShanghaiBorongdingsi’s name on behalf of the business, and holds the right to collect the advertising revenue generated from the kiosk business exclusively until itrecovers 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 incertain industries in the PRC and the PRC M&A regulations. The Foreign Investment Industrial Guidance Catalogue jointly issued by the Ministry of Commerce (“MOFCOM”) and the National Developmentand Reform Commission in 2007 classified various industries/business into three different categories: (i) encouraged for foreign investment, (ii) restricted toforeign investment and (iii) prohibited from foreign investment. For any industry/business not covered by any of these three categories, they will be deemedto be industries/business permitted to have foreign investment. Except for those expressly provided restrictions, encouraged and permittedindustries/businesses are usually open to foreign investment and ownership. With regard to those industries/businesses restricted to or prohibited fromforeign 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 valueadded telecommunication services, for which restrictions upon foreign ownership apply. As a result, Rise King WFOE is not allowed to do the businessthe PRC Operating Entities companies are currently pursuing. Advertising business is open to foreign investment but one of the requirements is that theforeign investors of a WFOE shall have been carrying out advertising business for over three years pursuant to the Foreign Investment Advertising Measuresas amended by MOFCOM and the State Administration of Industry and Commerce (“SAIC”) on August 22, 2008. Rise King WFOE is not allowed to engagein the advertising business because its shareholder, China Net HK, does not meet such requirements. In order to control the business and 4 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, RiseKing 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 WFOEprovides consulting services to the PRC Operating Entities. In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform theirobligations under the Contractual Arrangements, the PRC Shareholders have pledged all of their equity interests in the PRC Operating Entities to Rise KingWFOE. They have also entered into an option agreement with Rise King WFOE which provides that at such time as when the current restrictions under PRClaw on foreign ownership of Chinese companies engaging in the Internet content or information services in China are lifted, Rise King WFOE may exerciseits 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 ofRise King Investment Limited, a British Virgin Islands company (“Rise King BVI”), which is a 55% shareholder of China Net BVI. In entering into the ShareTransfer 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 ofChinaNet 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 theincentive options for the contributions that they made and continue to make to Rise King BVI. Under the Share Transfer Agreements Mr. Li granted each ofthe 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 RiseKing BVI, provided that certain financial performance thresholds were met by the China Net BVI Companies. The Share Transfer Agreement was formalizedand 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 PRCRestructuring 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 BVICompanies attaining consolidated gross revenue performance targets for fiscal 2009, the six month period ended June 30, 2010 and the six month periodended December 31, 2010 of RMB 100 million, RMB 60 million and RMB 60 million, respectively. If China Net BVI Companies achieve the performancetargets 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 theOption 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 theterms 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 theChina 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 anexercise of $1.00 per share to Mr. Yang Li. As a result of this exercise, as of April 12, 2012, Mr. Cheng, Mr. Liu and Mr. Zhang became the sole shareholdersof Rise King BVI and collectively hold 35% of our outstanding shares. 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 servicesduring the term of these agreements, which includes but is not limited to technical services, business consultations, equipment or property leasing, marketingconsultancy, system integration, product research and development, and system maintenance. In exchange for such services, each PRC Operating Entity hasagreed 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 byRise King WFOE based on services rendered by Rise King WFOE and operational needs of the PRC Operating Entities. The payment shall be made on amonthly 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 of100% 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 ofthese agreements may be extended if confirmed in writing by Rise King WFOE, prior to the expiration of the term. The extended term 5 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 RiseKing 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 interestin 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 andregulations. 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 theseagreements 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 itsobligations under the Exclusive Business Cooperation Agreements. If the PRC Operating Entities or any of the PRC Shareholders breaches its/his/herrespective contractual obligations under these agreements, or upon the occurrence of one of the events regarded as an event of default under each suchagreement, Rise King WFOE, as pledgee, will be entitled to certain rights, including the right to dispose of the pledged equity interests. The PRCShareholders of the PRC Operating Entities agreed not to dispose of the pledged equity interests or take any actions that would prejudice Rise King WFOE'sinterest, 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 theequity pledge agreements will be valid until all the payments related to the services provided by Rise King WFOE to the PRC Operating Entities due underthe Exclusive Business Cooperation Agreements have been fulfilled. Therefore, the equity pledge agreements shall only be terminated when the paymentsrelated to the ten-year Exclusive Business Cooperation Agreement are paid in full and the WFOE does not intend to extend the term of the ExclusiveBusiness 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 voteon their behalf on all PRC Operating Entities matters requiring shareholder approval. The term of each power of attorney is valid so long as such shareholderis 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 makingrights 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; decisionmaking 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 andexecution. Rise King WFOE also provides comprehensive services to the VIEs for their daily operations, such as operational technical support, OA technicalsupport, accounting support, general administration support and technical support for products and services. As a result of the Exclusive BusinessCooperation Agreements, the Equity Pledge Agreements and the Exclusive Option Agreements, we will bear all of the VIEs’ operating costs in exchange for100% of the net income of the VIEs. Under these agreements, we have the absolute and exclusive right to enjoy economic benefits similar to equityownership 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 noadjustment to the historical basis of the assets and liabilities of the PRC 6 Operating Entities. The operations of the PRC Operating Entities are consolidated as if the current corporate structure had been in existence throughout theperiod presented in the audited financial statements. The Restructuring is accounted for in this manner because, pursuant to an Entrustment Agreement datedJune 5, 2009 (the “Entrustment Agreement”) between Rise King BVI and the PRC Shareholders, Rise King BVI granted to the PRC Shareholders, on acollective basis, managerial control over each of the China Net BVI Companies by delegating the PRC Shareholders its shareholder rights, including theright to vote, and its rights to designate management of China Net BVI. The Entrustment Agreement, together with the Contractual Arrangementsdemonstrates the ability of the PRC Shareholders to continue to control Business Opportunity Online and Beijing CNET Online, which are under ourcommon control. On March 30, 2011, in connection with the exercise of the options pursuant to the Share Transfer Agreement, the Entrustment Agreementwas terminated. Share Exchange On June 26, 2009, we entered into a Share Exchange Agreement (the “Exchange Agreement”), with (i) ChinaNet BVI, (ii) ChinaNet BVI’sshareholders, Allglad Limited, a British Virgin Islands company (“Allglad”), Growgain Limited, a British Virgin Islands company ("Growgain"), Rise KingInvestments Limited, a British Virgin Islands company (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), SurplusElegant Investment Limited, a British Virgin Islands company (“Surplus”), Clear Jolly Holdings Limited, a British Virgin Islands company (“Clear” andtogether with Allglad, Growgain, Rise King BVI, Star and Surplus, the “ChinaNet BVI Shareholders”), who together own shares constituting 100% of theissued and outstanding ordinary shares of ChinaNet BVI (the “ChinaNet BVI Shares”), and (iii) G. Edward Hancock, the former principal stockholder of theCompany. Pursuant to the terms of the Exchange Agreement, the ChinaNet BVI Shareholders transferred to the Company all of the ChinaNet BVI Shares inexchange 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 withoperating 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 theState of Nevada called ChinaNet Online Holdings, Inc. (the "Merger Sub") and acquired one hundred shares of its common stock for cash. As such, MergerSub was merged with and into our company. As a result of the merger, the separate corporate existence of the Merger Sub ceased. As a further result of themerger, our corporate name was changed to “ChinaNet Online Holdings, Inc.” We are the surviving corporation in the merger and, except for the namechange 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 ConvertiblePreferred 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 proceedsof approximately $10.3 million (the “Financing”). Net proceeds from the Financing were approximately $9.2 million. We sold 4,121,600 units in theaggregate, 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 anexercise 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 ourCommon 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 expireon August 20, 2014. In connection with the Financing, we entered into a registration rights agreement (the “Registration Rights Agreement”) with the Investors in whichwe agreed to file a registration statement (the “Registration Statement”) with 7 the Securities and Exchange Commission (the “SEC”) to register the Common Stock underlying the Series A Preferred Stock, the Series A-1 Warrants and theSeries A-2 Warrants, thirty (30) days after the closing of the Financing. In accordance with the terms of the Registration Rights Agreement, we filed aRegistration Statement that was declared effective on December 31, 2009. We are required to keep the Registration Statement continuously effective under the Securities Act until such date as is the earlier of the date whenall of the securities covered by that registration statement have been sold or the date on which such securities may be sold without any restriction pursuant toRule 144 (the “Financing Effectiveness Period”). We will pay liquidated damages of 2% of each holder’s initial investment in the units sold in the Financingper month, payable in cash, up to a maximum of 10%, if the Registration Statement ceases to be effective prior to the expiration of the FinancingEffectiveness Period. However, no liquidated damages shall be paid with respect to any securities being registered that we are not permitted to include in theRegistration Statement due to the SEC’s application of Rule 415. In connection with the Financing, we entered into a securities escrow agreement with the Investors (the “Escrow Agreement”), pursuant to whichRise King BVI (the “Principal Stockholder”), initially placed 2,558,160 shares of Common Stock (the “Escrow Shares”) into an escrow account. Of theEscrow Shares, 1,279,080 shares (equivalent to 50% of the Escrow Shares) were held as security for the achievement of audited net income equal to or greaterthan $7.7 million for the fiscal year 2009 (the “2009 Performance Threshold”) and the remaining 1,279,080 Escrow Shares were held as security for theachievement of audited net income equal to or greater than $14 million for the fiscal year 2010 (the “2010 Performance Threshold”). The Escrow Agreementprovided that if we achieved at least 95% of the applicable Performance Threshold, all of the Escrow Shares for the corresponding fiscal year would bereturned to the Principal Stockholder. For the purposes of the Escrow Agreement, net income is defined in accordance with US GAAP and reported by us in our audited financialstatements for each of the fiscal years ended 2009 and 2010; provided, however, that net income for each of fiscal years ended 2009 and 2010 shall beincreased by any non-cash charges incurred (i) as a result of the Financing, including without limitation, as a result of the issuance and/or conversion of theSeries A Preferred Stock, and the issuance and/or exercise of the Warrants, (ii) as a result of the release of the Escrow Shares to the Principal Stockholderand/or the Investors, as applicable, pursuant to the terms of the Escrow Agreement, (iii) as a result of the issuance of ordinary shares of the PrincipalStockholder to Messrs. Handong Cheng and Xuanfu Liu and Ms. Li Sun, acting as nominee for Mr. Zhige Zhang, (the “PRC Shareholders”), upon the exerciseof options granted to the PRC Shareholders by the Principal Stockholder, (iv) as a result of the issuance of warrants to any placement agent and its designeesin connection with the Financing, (v) the exercise of any warrants to purchase Common Stock outstanding and (vi) the issuance under any performancebased equity incentive plan that we adopt. Both the 2009 and 2010 Performance Thresholds had been met, and 2,558,160 Escrow Shares were released to the Principal Stockholder. On August 21, 2011, pursuant to the Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock, all outstandingshares 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-2Warrants the opportunity to exchange their warrants in accordance with the following exchange ratios: (A) with respect to any Series A-1 Warrant, one shareof 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 December30, 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-2Warrants were tendered in exchange for approximately 35,680 shares of our common stock. Our VIEs, VIEs’ subsidiaries and equity investment affiliates 8 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 anew company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). Shenzhen Mingshan is 51% owned by BusinessOpportunity Online and 49% owned collectively by the other three individuals. Shenzhen Mingshan is primarily engaged in developing and designinginternet based software, online games and the related operating websites and providing related internet and information technology services necessary tooperate such games and websites. On January 6, 2011, as approved by the shareholders of Shenzhen Mingshan, an independent third party investor, who wasnot affiliated with us or any of our affiliates, invested RMB15,000,000 (approximately US$2,356,749) 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, ShenzhenMingshan. Therefore, as of December 31, 2011, 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”), acompany incorporated under PRC laws in December 2009. The contractual arrangements that we entered into with Shanghai Jing Yang allow us, throughRise King WFOE, to, among other things, secure significant rights to influence Shanghai Jing Yang’s business operations, policies and management, approveall 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% interest in a newly established company, Beijing Yang Guang Media Investment Co.,Ltd. (“Beijing Yang Guang”) for cash consideration of RMB 7,350,000 (approximately US$1,154,807). In August, 2011, Shanghai Jing Yang sold back its49% equity interest in Beijing Yang Guang to the majority shareholder of Beijing Yang Guang for cash consideration equal to the consideration paid when itacquired the 49% equity interest in December 2010. We, through one of our VIEs, Beijing CNET Online, entered into an equity interest acquisition agreement with the shareholders of Quanzhou ZhiYuan 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% equityinterest in Quanzhou Tian Xi Shun He, for cash consideration of RMB9,500,000 (approximately US$1,492,608) and RMB7,500,000 (approximatelyUS$1,178,374), respectively. These acquisitions were subsequently consummated on January 4, 2011 and February 23, 2011, respectively. Quanzhou ZhiYuan and Quanzhou Tian Xi Shun He are both independent advertising companies based in Fujian province of the PRC, which provide comprehensivebranding and marketing services to over fifty SMEs focused primarily in the sportswear and clothing industry. In June 2011, Beijing CNET Online enteredinto an additional agreement with the noncontrolling interest holders of Quanzhou Tian Xi Shun He to purchase the remaining 49% equity interest ofQuanzhou Tian Xi Shun He for cash consideration of RMB7,200,000 (approximately US$1,131,239). 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 whollyowned 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 advertisementdesign, 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 newcompany, Beijing Chuang Fu Tian Xia Network Technology Co., Ltd. (“Beijing Chuang Fu Tian Xia”). Business Opportunity Online and the co-foundingindividual owned 51% and 49% of the equity interests of Beijing Chuang Fu Tian Xia, respectively. In addition to capital investment, the co-founding 9 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 throughthe 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. (“HubeiCNET”). Hubei CNET is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy services. On April 18, 2011, Business Opportunity Online Hubei, together with an individual, who was not affiliated with us, formed a new company, ZhaoShang 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, twoindependent third party investors, who were not affiliated with us or any of our affiliates, invested RMB10,000,000 (approximately US$1,571,166) into ZhaoShang 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 inZhao 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 aninvestment in, and significant influence over, Zhao Shang Ke Hubei. Therefore, as of December 31, 2011, Zhao Shang Ke Hubei was an equity investmentaffiliate 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 YuanHubei”). Xin Qi Yuan Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy 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 SenHubei”). Mu Lin Sen Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy services. On July 1, 2011, Business Opportunity Online Hubei, together with an individual who is not affiliated with us, formed a new company, Sheng TianNetwork Technology (Hubei) Co., Ltd. (“Sheng Tian Hubei”). Business Opportunity Online Hubei and the co-founding individual owned 51% and 49% ofthe 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 OnlineTechnology Co., Ltd. (“Business Opportunity Online Chongqing”). Business Opportunity Online Chongqing is primarily engaged in internet advertisementdesign, production and promulgation. 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 for cash consideration of RMB51,600,000(approximately US$8,107,216). Sou Yi Lian Mei is based in Beijing, China, and is primarily engaged in providing online advertising and marketing services.Sou Yi Lian Mei operates its business primarily through its wholly-owned subsidiary, Jin Du Ya He (Beijing) Network Technology Co., Ltd (“Jin Du Ya He”).On December 20, 2011, the transaction was approved by, and registered with, the relevant local PRC government authorities of Beijing, the PRC. Sou Yi LianMei became a majority-owned subsidiary of Business Opportunity Online Hubei. As of December 31, 2011, we operated our business primarily in China through our PRC subsidiary and operating entities, or VIEs, as summarizedabove. Industry and Market Overview Overview of the Advertising Market in China 10 China has the largest advertising market in Asia, excluding Japan. According to ZenithOptimedia in 2011, China’s advertising market was the third-largest in the world by media expenditure, which was estimated to be approximately US$29.9 billion, accounting for 24.7% of the total advertising spendingin the Asia-Pacific region. ZenithOptimedia also projected that the advertising market in China will be one of the fastest growing advertising markets in theworld, at a compound annual growth rate of 15.7% from 2011 to 2014. By 2014, China is projected to account for 30.8% of the total advertising spending inthe Asia-Pacific region. The growth of China’s advertising market is driven by a number of factors, including the rapid and sustained economic growth andincreases in disposable income and consumption in China. China was the second largest economy in the world in 2011 in terms of gross domestic product,which amounted to US$7.3 trillion. According to the National Bureau of Statistics of China, the annual disposable income per capita in urban households increased from RMB19,109 in2010 to RMB21,810 in 2011, representing an increase of 14.1%. Adjusted by the price factors, the actual increase was 8.4%. According to ZenithOptimedia (December, 2011), China became the third largest advertising market in the world, and by 2014, China willcontribute approximately US$46.4 billion to global advertising spending, following the United States and Japan, which contributes approximately US$173.2billion and US$48.8 billion to global advertising spending, respectively. Japan, the largest advertising spender in the Asia-Pacific region, is only expectedto grow its advertising spending by 7.6% between 2011 and 2014, whereas an emerging market, like China, will grow its advertising spending by 54.9% inthe 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 to2014, with an average growth rate of 10.4%. 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 55.5% between 2011 and 2014 and reach US$113.3 billion in2014. Within China, the internet advertising market was particularly strong and grew to approximately US$7.6 billion in 2011, according to Enfodesk(January 2012). This growth is expected to stem primarily from a higher internet penetration rate of just 38.3% by the end of 2011(The Ministry of Industryand Information Technology of China, February 2012), the use of search engine, rich media and video and game embedded advertisements. According toiResearch Global Inc. (January 2012), the China Internet Advertising and Search Engine Market is expected to reach RMB79.1 billion Yuan ( approximatelyUS$12.5 billion) in 2012, representing an approximate 54.5% year-over-year growth. The diagram below depicts the Market Scale of China InternetAdvertising from 2006 to 2015: 11 High Demand for the Internet Advertising from the Franchise and Chain Store Business in China We believe that the Internet advertising market in China also has significant potential for future growth due to high demand from the rapiddevelopment 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 coveredapproximately 70 industries and offered over 5 million direct employment opportunities, and the number of franchise enterprises and chain stores increasedby approximately 13% and 21%, respectively, as compared to the prior year. The development of the SME market is still in its early stages in China and since their sales channels and distribution networks are stillunderdeveloped, they are driven to search for new participants by utilizing Internet advertising. The SMEs tend to be smaller, less-developed brandsprimarily focused on restaurants, garments, building materials, home appliances, and entertainment with low start-up costs, ranging between US$1,000 toUS$15,000. The Chinese government has promulgated a series of laws and regulations to protect and promote the development of SMEs which appeals toentrepreneurs looking to benefit from the central government’s support of increased domestic demand. SMEs are now responsible for about 60% of China’sindustrial output and employment of approximately 80% of the urban Chinese workforce. SMEs are creating new urban jobs, and they are the maindestination 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 site for information about small business opportunities in China. It was one of the earliest entrants inthis sector, allowing it to currently hold an over 33% market share in China. In 2011, we also developed two new advertising web portals, which areliansuo.com and chuangye.com. 12 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 largeinternational clients in future. Chuangye.com is built to serve the community of enterprenuers to assist them with developing their business, as well assharing their resources in a web2.0 driven interaction in combination with popular web social tools. Upon acquiring Sou Yi Lian Mei Network Technology(Beijing) Co., Ltd., in December 2011, we obtained another established online advertising and marketing platform, sooe.cn, which focuses on the smallersized and emerging SMEs. Our internet advertising services provide advertisers with the 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 platforms for the advertisers: · Allowing potential entrepreneurs interested in inexpensive franchise and other business ventures to find in-depth details about these businesses invarious industries and business categories, with real-time, online assistance using an instant messenger; · Providing one-stop integrated internet marketing and advertising services for SMEs by offering customized services such as design, website andmini-site setup, and advertisement placement on various communication channels through intelligent based promotion platforms; and · Bundling with advanced traffic generation techniques, search-engine optimization and marketing and other management tools to assist our clientswith monitoring, analyzing and managing their advertising on our web portals. We charge our clients a fixed monthly fee for the internet advertising services and the related value-added technical services that we provide. As ofDecember 31, 2011, we have approximately 765 active clients and our total revenue per month reached approximately US$1.67 million in 2011, as comparedto approximately US$2.4 million in 2010. This segment accounted for 70% of our revenue in 2011 and 69% of our revenue in 2010. Television Advertising As part of our advertising and marketing services, we produce and distribute television shows that are comprised of advertisements similar toinfomercials, 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,Shenzhen TV, Jiangxi TV, Qinghai TV, Gansu TV and Yunnan TV. Our total show time reached approximately 6,040 minutes in 2011, as compared toapproximately 14,420 minutes in 2010. This segment accounted for 22% of our revenue in 2011 and 30% of our revenue in 2010. As discussed above,during 2011, we reduced the business scope of this division and integrated it into our advertising and marketing platform as a part of the value-addedservices offered to our existing clients. Bank Kiosks We operate our bank kiosk advertising network, through Shanghai Borongdingsi. We place our kiosk machines, which include a large LCDadvertising display, in bank branches to target banking patrons. We market our LCD display network to advertisers in the financial services and insuranceindustries. As of December 31, 2011, we had a total of 610 flat-panel displays placed in branches of China Construction Bank in Henan province andShanghai Rural Commercial Bank in Shanghai. The kiosks are useful to the banks because, in addition to the LCD advertising display, they provide bankcustomers with free Internet access to on-line banking services, thereby potentially making wait times in branches for teller services more enjoyable for thebank customer. For the year ended December 31, 2011, we generated US$0.49 million revenue from this segment as compared to US$0.53 million revenue forthe year ended December 31, 2010. The bank kiosk advertising business is still in the early stages and many details still need to be further analyzed andfinalized before we allocate more capital into this business unit. It was not a significant contributor to revenue for either the year ended December 31, 2011and 2010. Management currently believes that for the year ended December 31, 2011, this business is unlikely to expand and that some of the technologyused in this business unit will be fully integrated into the overall advertising and marketing platform. Brand management and sales channel building 13 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 theintegration 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 63 clients and generated approximately US$1.8 million revenue in 2011. Our Competitive Strengths Over our seven year operating history, we believe that we have built a strong track record of significant competitive strengths. We believe that thesecompetitive 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 ourclients. These services are based on the needs of our existing clients. All of our value added services, including lead generation and capture, onlinemessaging and consulting, search engine marketing and optimization, mini-site hosting and, content management, simplify the business process forour clients by allowing them to effectively allocate their resources and budget for various advertising and marketing tools and channels. · Target market innovation and expansion of audience base. We believe that by offering a multichannel communication platform, we enable SMEsto reach a wide range of consumers with complementary and mutually reinforcing advertising and marketing campaigns. We are better able to attractbusiness 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 andcontent 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 withthe 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 chiefexecutive officer has over ten years’ experience in management. He demonstrated his entrepreneurship and business leadership by starting ourbusiness and he has successfully grown our business to become a leader in online media marketing and advertising services. He also secured ourstatus as the sole strategic alliance partner of China Construction Bank in Henan province with respect to bank kiosk advertising. George Chu, ourchief operating officer, has diversified and international industry experience that will help us to scale to the next level. Zhige Zhang, our chieffinancial officer has over six years’ experience in software development and Internet ad technology. First Mover Advantages We have over six years of operations as a vertically integrated ad portal and ad agency. We have eight years of experience as an Internet advertisingagency. We commenced our Internet advertising services business in 2003 and were among the first companies in China to create a site and a businessfocused 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 theadvertising industry and to be able to maintain a strong market share position. 14 Growth Strategy Our objectives are to strengthen our position as the leading B2B Internet service provider on advertising, marketing, brand and sales channelmanagement solutions for sales channel expansion of SMEs in China and to continue to achieve rapid growth. We intend to achieve these objectives byimplementing the following strategies: Expanding to a new client base with brand and sales channel expansion management and expansion solutions We are further expanding our target client group to the non-franchised SMEs, especially the enterprises which have been in the manufacturing andexporting business. Until recent years, as a result of the financial crisis in 2008 and the European debt crisis in 2011, foreign demand has dropped and manyof these enterprises have either been forced to or intend to expand their businesses in the domestic market in China. Many of these businesses are lackdomestic sales management and expansion experience, especially in second, third or lower tier cities. We estimate that there are 4 million businesses that fallinto the category of non-franchised SMEs, and we aim to assist them in expanding their business nationally in China in the form of franchising. Monetizing the existing customer base through the addition of cloud-computing based management tools platform We intend to launch integrated cloud-computing based management tools and/or solutions to our existing clients in the second quarter of 2012. These tools include, among other things, point of sales (POS), inventory supply chain management, office automation (OA) and customer relationshipmanagement (CRM). This service is intended to increase our recurring revenues and enhance the loyalty and service satisfaction of our clients. In August2009, we launched Internet Information Management (IIM) as part of this platform. Throughout the next few years, we intend to increase the depth of thistype 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, oracquiring, small regional advertising firms. We plan to accomplish cross-selling after expanding our client base through these regional advertising firms tomaterialize the synergies obtained through mergers and acquisitions. As a result, we will be able to provide additional, flexible and bundled advertising andmarketing packages that will allow SMEs to reach consumers through various communication channels. In addition, all other value added servicespreviously discussed will be provided to them, including management tools platform in the future. Promoting Our Brand Name and Augmenting Our Service Offerings to Attract a Wider Client Base and Increase Revenues Enhancing our brand name in the industry will allow us to solidify and broaden our client base by growing market awareness of our services. It willalso enhance our ability to target discrete consumer groups. We believe that as we expand our advertising client base and potential market, demand for andsale of time slots and frame space on our advertising services and other related marketing services will grow once the economy returns to a suitable growthpattern. Sales and Marketing For the year ended December 31, 2011, we derived 70% our revenues from our Internet advertising and provision of the related technical servicesand 22% from our TV advertising, compared to 69% and 30%, respectively, for the year ended December 31, 2010. The following table sets forth a breakdown of our revenue from Internet advertising and the related technical services, by industry, for the year endedDecember 31, 2011: 15 Industry Percentage of total revenue Food and beverage 17%Women Accessories 5%Footwear, apparel and garments 24%Home Goods and Construction Materials 18%Environmental Protection Equipment 12%Cosmetic and Health Care 9%Education Network 11%Others 4%Total 100% We employ experienced advertising sales people. We provide in-house education and training to our sales people to ensure that they provide ourcurrent and prospective clients with comprehensive information about our services, the benefits of using our advertising and marketing services and relevantinformation regarding the advertising industry. We also market our advertising services from time to time by placing advertisements on television, andacting as a sponsor of 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 consumermarkets. 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 marketingchannels. We also purchase or commission studies containing relevant market data from reputable third-party market research firms when necessary. Wetypically consult such studies to assist us in evaluating the effectiveness of our network to our advertisers. A number of these studies contain research on thenumbers 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 December31, 2011, Baidu counted for approximately 54% of our internet resource cost. For television, we have six major regional television stations which supply uswith 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 networksecurity. We also continue to develop proprietary software and systems in connection with the operation of and provision of services through 28.com andother internet portals to enhance ease of use. We focus on enhancing related software systems enabling us to track and monitor advertiser demands. With theintroduction 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. Intellectual Property As of December 31, 2011, we had twenty-six software copyright certificates issued by the State Copyright Office of the PRC (“SCO”) as set forthbelow: 16 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 V1.0Software V1.0 of General Monitoring and Management Platform on Internet AdvertisingEffect 2008SRBJ4073基于效果的搜索引擎服务平台软件 V1.0Software 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 V1.0Software V1.0 of General Analysis and Management Platform on Internet Based AdvertisingMessage 2008SRBJ4085基于互联网广告留言综合分析及管理平台软件 V2.0Software V2.0 of General Analysis and Management Platform on Internet Based AdvertisingMessage 2010SR038775基于广告管理和OA系统的综合运营技术平台软件V1.0Software V1.0 of General Operation Technology Platform on Advertisement Management andOA System 2010SR039308互联网用户监测及网民综合分析评价系统V3.0Software 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 V2.0Software 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V2.0Software 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V2.0Software 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V2.0Software V2.0 of General Analysis and Management Platform on Television AdvertisementEffect 2010SR039548 17 Name of Software Registration Number基于用户中心的短信、邮件群发的管理平台软件V1.0Software V1.0 of General Management Platform on Group Mailing and Group SMS 2010SR039551基于日志分析的访问热区和浏览轨迹分析系统V1.0Software 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V1.0Software V1.0 of Management Platform on Client/Service-Based Advertisement Effect 2010SR039556SOOE 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 2010SR017044SOOE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 2010SR017040SOOE搜索引擎效果分析软件V1.0Software 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V1.0Software V1.0 of Sou Yi General Service Platform on Internet Effect Marketing 2010SR017042BMtoBM业务综合服务平台软件V1.0Software 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 18 With this intellectual property, we can continue providing value-added services that are in demand by our customers and can track end users to helpour customers to assess and adjust their marketing strategies and enhance the 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 ournetwork and manage and monitor programs on the network. We also increased, and plan to continue increasing, investment in research and development aswe continue to expand, optimize and enhance the technologies of our portal websites, upgrade our advertising and internet management software anddevelop 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.cn3158.com 08.cn 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 andour 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 andradio. 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 linesof 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 withChinese 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 isreduced 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 newlypromulgated regulation that replaced the 2004 Provision as of October 1, 2008, except that according to the new regulation, the establishment of whollyforeign-owned advertising companies must be approved by the SAIC or its authorized provincial counterparts and provincial MOFCOM, instead of the SAICand MOFCOM only. Foreign-invested advertising companies can engage in advertising design, production, publishing and agency, provided that certainconditions 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, RiseKing WFOE, is ineligible to apply for the required licenses for providing advertising services in China. Our advertising business is operated by BusinessOpportunity Online and Beijing CNET Online in China. We have been, and are expected to continue to be, dependent on these companies to operate ouradvertising business. We do not have any equity interest in our PRC Operating Entities, but Rise King WFOE, receives the economic benefits of the samethrough the Contractual Arrangements. We have been advised by our PRC counsel, that each of the Contractual Agreements complies, and immediately after the completion of thetransactions contemplated herein, will comply with all applicable PRC laws and regulations and does not violate, breach, contravene or otherwise conflictwith any applicable PRC laws, rules or regulations. However, there exist substantial uncertainties regarding the application, interpretation and enforcement ofcurrent and future PRC laws and regulations and their potential effect on corporate structure and contractual 19 arrangements. The interpretation of these laws and regulations are subject to the discretion of competent PRC authorities. There can be noassurance that the PRC regulatory authorities will not take a view different from the opinions of our PRC counsel and determine that its corporatestructure and contractual arrangements violate PRC laws, rules and regulations. In the event that the PRC regulatory authorities determine in their discretionthat our corporate structure and contractual arrangements violate applicable PRC laws, rules and regulations, including restrictions on foreign investment inthe 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 whichbecame effective on February 1, 1995. According to the currently effective Advertising Law and its various implementing rules, companies engaging inadvertising activities must obtain from the SAIC or its local branches a business license which specifically includes within its scope the operation of anadvertising business. Companies conducting advertising activities without such a license may be subject to penalties, including fines, confiscation ofadvertising 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 localbranches of the SAIC as required by existing PRC regulations. We do not expect to encounter any difficulties in maintaining the business license. However, ifwe 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. Itprovides 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, outdooradvertisements in China must be registered with the local SAIC before dissemination. The advertising distributors are required to submit a registrationapplication form and other supporting documents for registration. After review and examination, if an application complies with the requirements, the localSAIC 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 localSAICs 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 ofthe advertisements. It is unclear whether the SAIC, or any of its local branches in the municipalities and provinces covered by our network, will deem ourbusiness as an outdoor advertising business, and thus require us to obtain the Outdoor Advertising Registration Certificate. If the PRC governmentdetermines that we are obligated to complete outdoor advertisement registration as an outdoor advertising network operator, we may be subject toadministrative 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 Noticepursuant 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, 20 shopping malls, banks, hospitals and other outdoor public media would be subject to approval by the SARFT. The December 2007 Notice requiredthe local branches of SARFT to investigate and record any organization or company engaging in the activities described in the December 2007 Noticewithout permission, to send written notices to such organizations or companies demanding their compliance with the December 2007 Notice, and to reportthe 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 branchesdemanding 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 alsospecific 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 andveterinary pharmaceuticals, together with any other advertisements which are subject to censorship by administrative authorities according to relevant lawsor 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 regulationsto ensure that the content of the advertisements they prepare or distribute is true and in full compliance with applicable laws. In providing advertisingservices, advertising operators and advertising distributors must review the supporting documents provided by advertisers for advertisements and verify thatthe content of the advertisements complies with applicable PRC laws, rules and regulations. Prior to distributing advertisements that are subject togovernment censorship and approval, advertising distributors are obligated to verify that such censorship has been performed and approval has beenobtained. Violation of these regulations may result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of theadvertisements and orders to publish an advertisement correcting the misleading information. In circumstances involving serious violations, the SAIC or itslocal branches may revoke violators’ licenses or permits for their advertising business operations. Furthermore, advertisers, advertising operators oradvertising distributors may be subject to civil liability if they infringe on the legal rights and interests of third parties in the course of their advertisingbusiness. We do not believe that advertisements containing content subject to restriction or censorship comprise a material portion of the advertisementsdisplayed on our media network. However, there can be no assurance that each advertisement displayed on our network complies with relevant PRCadvertising laws and regulations. Failure to comply with PRC laws and regulations relating to advertisement content restrictions governing the advertisingindustry 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 protectionof the exclusive rights of trademark owners. In order to enjoy an exclusive right to use a trademark, one must register the trademark with the TrademarkBureau 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, 1984and subsequently amended in 1992 and 2000. The Patent Law extends protection to three kinds of patents: invention patents, utility patents and designpatents. According to the 21 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 theshape, 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 industrialapplication. Inventors or designers must register with the State Intellectual Property Office to obtain patent protection. The term of protection is twenty yearsfor invention patents and ten years for utility patents and design patents. Unauthorized use of patent constitutes an infringement and the patent holders areentitled 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 onSeptember 7, 1990 and amended on October 27, 2001. Unlike patent and trademark protection, copyrighted works do not require registration for protectionin China. However, copyright owners may wish to voluntarily register with China’s National Copyright Administration to establish evidence of ownership inthe 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 PRCregulations 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 relevantPRC 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 orits 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 currencypayments 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 localbranch. Foreign currencies received under current account items can be either retained or sold to financial institutions engaged in the foreign exchangesettlement or sales business without prior approval from SAFE by complying with relevant regulations. Foreign exchange income under capital account canbe retained or sold to financial institutions engaged in foreign exchange settlement and sales business, with prior approval from SAFE unless otherwiseprovided. Our business operations, which are subject to the foreign currency exchange regulations, have all been implemented in accordance with theseregulations. 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 andInbound 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), as amended in 2000, and the Wholly Foreign Owned Enterprise LawImplementation Rules (1990), as amended in 2001. Under these laws and regulations, PRC subsidiaries and VIEs, including wholly owned foreignenterprises, or 22 WFOEs, and domestic companies in China, may pay dividends only out of their accumulated profits, if any, determined in accordance with PRCaccounting standards and regulations. In addition, its PRC significant subsidiaries and VIEs, including WFOEs and domestic companies, are required toset 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 amountof 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’sRepublic of China, or EIT Law, which became effective on January 1, 2008. On November 28, 2007, the State Council at the 197th Executive Meetingpassed 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 allenterprises (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 treatmentsgranted 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 theImplementation Rules, enterprises established under PRC laws, or enterprises established outside China whose “de facto management bodies” are located inChina, are considered “resident enterprises” and subject to the uniform 25% enterprise income tax rate for their global income. According to theImplementation Rules, “de facto management body” refers to a managing body that in practice exercises overall management and control over theproduction and business, personnel, accounting and assets of an enterprise. Our management is currently based in China and is expected to remain in Chinain the future. In addition, although the EIT Law provides that “dividends, bonuses and other equity investment proceeds between qualified residententerprises” is exempted income, and the Implementation Rules refer to “dividends, bonuses and other equity investment proceeds between qualified residententerprises” as the investment proceeds obtained by a resident enterprise from its direct investment in another resident enterprise, however, it is unclearwhether 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) haveestablishments or premises of business in China, but the relevant income does not have actual connection with their establishments or premises of business inChina. 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 inwhich its non-PRC shareholders reside. Under the Double Tax Avoidance Arrangement between Hong Kong and Mainland China, if the Hong Kong residententerprise owns more than 25% of the equity interest in a company in China, the 10% withholding tax on the dividends the Hong Kong resident enterprisereceived 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 TaxAvoidance 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 subjectto the reduced income tax rate of 5% under the Double Tax Avoidance Arrangement. However, based on the Notice on Certain Issues with Respect to theEnforcement of Dividend Provisions in Tax Treaties, issued on February 20, 2009 by the State Administration of Taxation, if the relevant PRC tax authoritiesdetermine, in their discretion, that a company benefits from such reduced income tax rate due to a structure or arrangement that is primarily tax-driven, suchPRC 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 materialadverse effect on our net income in 2008 and beyond. Reduction or elimination of the financial subsidies or preferential tax treatments we currently enjoy orimposition of additional taxes on us or our subsidiary in China may significantly increase our income tax expense and materially reduce our net income. 23 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 benotified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise and any of the followingsituations exist: (i) the transaction involves an important industry in China; (ii) the transaction may affect national “economic security”; or (iii) the PRCdomestic enterprise has a well-known trademark or historical Chinese trade name in China. The M&A Rules also contain a provision requiring offshore SPVsformed for the purpose of the overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals, toobtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC issued aclarification 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 overseaslistings; 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 clearrequirements 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 anoverseas stock exchange, the M&A Rules do not require that we obtain prior CSRC approval because: (i) the Share Exchange is a purely foreign relatedtransaction governed by foreign laws, not subject to the jurisdiction of PRC laws and regulations; (ii) we are not a special purpose vehicle formed orcontrolled 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 todetermine whether the transaction is subject to the approval of the CSRC, especially when taking into consideration of the performance-based incentiveoption arrangement by way of the Share Transfer Agreements. If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval isrequired 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 fromthe 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 fromthe 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 businesscombination would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies. These sanctions could include fines and penalties onour operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions that may materially andadversely 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 needto 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 businesscombination. 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 bythe CSRC and other PRC regulatory agencies. These sanctions could include fines and penalties on our operations in China, restrictions or limitations on ourability to pay dividends outside of China, and other forms of sanctions that may materially and adversely affect our business, results of operations andfinancial condition. The M&A Rules also established additional procedures and requirements expected to make merger and acquisition activities in China by foreigninvestors more time-consuming and complex, including requirements in some instances that the MOC be notified in advance of any change-of-controltransaction in which a foreign investor 24 takes control of a PRC domestic enterprise. These rules may also require the approval from the MOC where overseas companies established orcontrolled by PRC enterprises or residents acquire affiliated domestic companies. Complying with the requirements of the new regulations tocomplete such transactions could be time-consuming, and any required approval processes, including MOC approval, may delay or inhibit ourability to complete such transactions, which could affect our ability to expand our business. Employees As of December 31, 2011, we had 451 full-time employees, 107 of whom are in sales and marketing, 150 of whom are in operations and support, 85of whom are in management and administration and 109 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 makecontributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximumamount 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 salaryprevailing 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 contractwith other employees for a set period of years. According to these contracts, all of our employees are prohibited from engaging in any activities that competewith our business during the period of their employment with us. Furthermore, the employment contracts with officers or managers include a covenant thatprohibits 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. Ourtelephone 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, amongothers, in some cases have affected, and in the future could affect, our financial condition and results of operations and could cause our future results todiffer 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 makeelsewhere . Risks Related to Our Business The recent global economic crisis and the decline of China’s economy has had, and may continue to have, a negative effect on our business, and couldhave a material adverse effect on our business, financial condition, results of operations and cash flow. The global economic crisis and the decline of China’s economy from 2011has caused, among other things, a general tightening in the creditmarkets, lower levels of liquidity, increases in the default and bankruptcy rates, lower consumer and business spending, and lower consumer net worth, inChina and other parts of the world. These global economic uncertainties and the decline of China’s economy have had, and may continue to have, a negativeeffect 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 ourability to borrow funds or enter into other financial arrangements if and when 25 additional founds become necessary for our operations. We believe many of our advertisers have also been affected by the current economicdownturns in China. Current or potential advertisers may no longer be in business, may be unable to continue to purchase advertising or determineto reduce purchases. All of which would lead to reduced demand for our advertising services, reduced gross margins, and increased delays ofpayments of accounts receivable or defaults of payments. We are also limited in our ability to reduce costs to offset the results of a prolonged orsevere economic downturn given our fixed costs associated with our operations. Therefore, the global uncertainties and the downward trend ofChina’s economy from 2011 could have a material adverse effect on our business, financial condition, results of operations and cash flow. Inaddition, the timing and nature of any recovery in the credit and financial markets remains uncertain, and there can be no assurance that marketconditions 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 limitedoperating history and the early stage of development of the markets in which we operate makes it difficult to evaluate the viability and sustainability of ourbusiness and its acceptance by advertisers and consumers. Although we generated profits every year since our incorporation, we cannot assure you that wewill 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. Anysignificant 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 serviceswe 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, toensure 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 businessopportunities 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 misleadinginformation. 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 joinedthe store because she trusted the website. Pursuant to the PRC advertising law, Business Opportunity Online, as the publisher of advertisement, has theobligation to check relevant documents and verify the content of the advertisement. For commercial franchise business in China, a franchiser needs to file anapplication with the MOC or its local branches through the website http://txjy.syggs.mofcom.gov.cn/. When a franchiser publishes an advertisement throughBusiness Opportunity Online, Business Opportunity Online checks the business license, the franchiser’s registration form, the trade mark certificate and otherrelevant documents to verify the content of the advertisement. The Internet information services regulations and the unfair competition regulations havesimilar requirements for Internet advertisement publishers. Based on the laws and regulations above, it is our view that there is neither any mandatoryrequirement that Business Opportunity Online bear any responsibility for the franchiser’s business activities, nor any valid action or investigation that can bebrought by the consumer or the government against Business Opportunity Online based on the franchiser’s business activities. Nevertheless, the possibilityremains that Business Opportunity Online may be required to assume civil and administrative responsibilities subject to further investigation or enforcementby 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 ourbusiness may not expand or be successful. 26 The Internet and bank kiosk advertising platforms in China are relatively new and their potential is uncertain. We compete for advertising revenueswith many forms of more established advertising media. Our success depends on the acceptance of our advertising platforms by advertisers and theircontinuing interest in this media as part of their advertising strategies. Our success also depends on the viewing public’s continued receptiveness towards ouradvertising 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 notprovide sufficient value as an effective advertising medium. If a substantial number of advertisers lose interest in advertising on our platforms, we will beunable to generate sufficient revenues and cash flows to operate our business, and our financial condition and results of operations would be materially andadversely 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 expenditurestypically decrease during periods of economic downturn. Advertisers may reduce the amount of money they spend to advertise on our advertising platformsfor 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 ourability 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 fromour 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 uponadvertisers in China increasingly accepting the use of the Internet as a marketing channel, which is at an early stage in China. Penetration rates for personalcomputers, the Internet and broadband in China are all relatively low compared to those in more developed countries. Furthermore, many Chinese Internetusers 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 havelimited experience with the Internet as a marketing channel, and have not historically devoted a significant portion of their marketing budgets to Internetmarketing and promotion. As a result, they may not consider the Internet as effective in promoting their products and services as traditional print andbroadcast media. We face significant competition, and if we do not compete successfully against new and existing competitors, we may lose our market share, and ourprofitability 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 havecompetitive advantages, such as significantly greater financial, marketing or other 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 pricesand 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 businessand prospects. 27 We have been expanding our operations and plan to continue to expand in China. To meet the demand of advertisers for broader coverage, we mustcontinue to expand our platforms by showing our TV productions and advertisements on more television stations, and expanding the capacity and enhancingthe technology advantages of our internet advertising portals. The continued growth of our business has resulted in, and will continue to result in, substantialdemand 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 futureoperations effectively and efficiently or compete effectively in new markets we enter. If we are not able to manage our growth successfully, our business andprospects 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 officerare essential to our ability to continue to grow our business. They have established relationships within the industries in which we operate. If they were toleave 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 meetcurrent 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 andfinancial position. We may need additional cash resources due to changed business conditions or other future developments. If these sources are insufficient to satisfyour cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The incurrence of indebtedness would result inincreased 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;· 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. 28 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 businessdepends in part upon our continued ability to use our brand, trade names and copyrights to further develop and increase brand awareness. The infringementof our trade names and copyrights could diminish the value of our brand and its market acceptance, competitive advantages or goodwill. In addition, ourinformation and operational systems, which have not been patented or otherwise registered as our property, are a key component of our competitiveadvantage 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 areunable to adequately protect our brand, trade names, copyrights, domain name and other intellectual property rights, we may lose these rights and ourbusiness may suffer materially. Further, unauthorized use of our brand, domain name or trade names could cause brand confusion among advertisers and harmour 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, financialcondition and results of operations. We are dependent upon our computer software and hardware systems in supporting our network and managing and monitoring programs on thenetwork. In addition, we rely on our computer hardware for the storage, delivery and transmission of the data on our network. Any system failure thatinterrupts the input, retrieval and transmission of data or increases the service time could disrupt our normal operation. Any failure in our computer softwareor hardware systems could decrease our revenues and harm our relationships with advertisers and consumers, which in turn could have a material adverseeffect 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 havedetermined that the risks of disruption or liability from our business, the loss or damage to our property, including our facilities, equipment and officefurniture, the cost of insuring for these risks, and the difficulties associated with acquiring such insurance on commercially reasonable terms make itimpractical for us to have such insurance. As a result, we do not have any business liability, disruption, litigation or property insurance coverage for ouroperations in China except for insurance on some company owned vehicles. Any uninsured occurrence of loss or damage to property, or litigation or businessdisruption 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 establish 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 loseconfidence in our reported financial information and have a negative effect on the market price for shares of our Common Stock. Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We maintain a system of internalcontrol over financial reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer and principal financialofficer, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally acceptedaccounting principles. As a public company, we have significant additional requirements for enhanced financial reporting and internal controls. We are required todocument and test our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requiresannual management assessments of 29 the effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing theseassessments. However, recent changes to the rules of the Securities and Exchange Commission have delayed the requirement for inclusion ofsuch auditor attestation report in our annual report. The process of designing and implementing effective internal controls is a continuous effortthat requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significantresources 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. Wecannot 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 maintainadequate controls over our financial processes and reporting in the future as we continue our growth. If we are unable to establish appropriate internalfinancial 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 anegative 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 governmentalrestrictions 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 witheach of our PRC Operating Entities in China. PRC regulations require any foreign entities that invest in the advertising services industry to have at least twoyears 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 ofChina 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 currentlydirectly operate an advertising business outside of China and cannot qualify under PRC regulations any earlier than two or three years after we commenceany such operations outside of China or until we acquire a company that has directly operated an advertising business outside of China for the requiredperiod of time. Our PRC Operating Entities hold the requisite licenses to provide advertising services in China. Our PRC Operating Entities directly operateour advertising network. We have been and are expected to continue to be dependent on these PRC Operating Entities to operate our advertising business forthe 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 OperatingEntities 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 obtainor 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; · 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. 30 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 effectivein 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 contractualarrangements 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 PRCOperating 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 couldaffect changes, subject to any applicable fiduciary obligations, at the management level. However, under the current contractual arrangements, as a legalmatter, if the PRC Operating Entities or any of their subsidiaries and shareholders fail to perform its or their respective obligations under these contractualarrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies under PRC laws, includingseeking specific performance or injunctive relief, and claiming damages, which we cannot assure you to be effective. Accordingly, it may be difficult for us tochange 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 ifany 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 litigationin the PRC. Accordingly, these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRClegal 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 thePRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, wemay 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 findingthat we owe additional taxes or are ineligible for our tax exemption, or both, could substantially increase our taxes owed, and reduce our net incomeand 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 thetransactions 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 unreasonablereduction 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 PRCentities 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 paydividends or make other distributions to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractualarrangements 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 OperatingEntities only out of their retained earnings, if any, determined in accordance with PRC accounting standards and regulations. Under PRC laws andregulations, each of the PRC Operating Entities is also required to set aside a portion of its net income each year to fund specific reserve funds. These reservesare not distributable as cash dividends. In addition, subject to certain cumulative limits, the statutory general reserve fund requires annual appropriations of10% 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 restrictedin 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 PRCOperating Entities to pay dividends to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficialto our businesses, pay dividends, or otherwise fund and conduct our business. 31 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, importsand sources of supply, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on ourbusiness, results of operations and financial condition. Under its current leadership, the Chinese government has been pursuing economic reform policies thatencourage private economic activity and greater economic decentralization. There is no assurance, however, that the Chinese government will continue topursue 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 substantialproportion of our total sales in the near future. Any significant decline in the condition of the PRC economy could adversely affect consumer demand of ourservices, 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 ChineseRenminbi 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 ourrevenue and expenses are in Chinese Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. Forexample, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic andpolitical 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 governmentchanged 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 andmanaged band against a basket of certain foreign currencies. As a result of this policy change, Chinese Renminbi continually appreciated approximately2.6% 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 and 3.7% in 2011. It is possible that theChinese 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 theU.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operatingexpenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of theseforeign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are alsoexposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign operating subsidiary and VIEs into U.S. dollars inconsolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiary and VIEs’ financial statements into U.S. dollarswill 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 thatare denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilitiescreate fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange raterisks, 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 tosuccessfully hedge our exchange rate risks. 32 Although Chinese governmental policies were introduced in 1996 to allow the convertibility of Chinese Renminbi into foreign currency for currentaccount items, conversion of Chinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires theapproval 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 ouroperations or those Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Because asignificant amount of our future revenue may be in the form of Chinese Renminbi, our inability to obtain the requisite approvals or any future restrictions oncurrency exchanges could limit our ability to utilize revenue generated in Chinese Renminbi to fund our business activities outside of China, or to repayforeign 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 toenforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful, or other adverse circumstancesarise 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 fromaccessing important information regarding the financial and business operations of these acquired companies. The resolution of these matters may be subjectto the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute mayinfluence their determination. Any rights we may have to specific performance, or to seek an injunction under PRC law, in either of these cases, are severelylimited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. The occurrenceof 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 otherprohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are notsubject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If ourcompetitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage insecuring business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although weinform 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 wemight 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 exchangebusiness. The Renminbi is not a freely convertible currency, and the restrictions on currency exchanges may limit our ability to use revenues generated inRenminbi to fund our business activities outside the PRC or to make dividends or other payments in United States dollars. The PRC government strictlyregulates conversion of Renminbi into foreign currencies. Over the years, foreign exchange regulations in the PRC have significantly reduced thegovernment’s control over routine foreign exchange transactions under current accounts. In the PRC, the State Administration for Foreign Exchange, or theSAFE, regulates the conversion of the Renminbi into foreign currencies. Pursuant to applicable PRC laws and regulations, foreign invested enterprisesincorporated in the PRC are required to apply for “Foreign Exchange Registration Certificates.” Currently, conversion within the scope of the “currentaccount” (e.g. remittance of foreign currencies for payment of dividends, etc.) can be effected without requiring the approval of SAFE. However, conversionof currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. 33 Recent PRC regulations relating to mergers and acquisitions of domestic enterprises by foreign investors may increase the administrative burden weface and create regulatory uncertainties. On August 8, 2006, the Ministry of Commerce (the “MOC”), joined by the China Securities Regulatory Commission (the “CSRC”), State-ownedAssets Supervision and Administration Commission of the State Council (the “SASAC”), the State Administration of Taxation (the “SAT”), the StateAdministration of Industry and Commerce (the “SAIC”), and SAFE, jointly promulgated a rule entitled the Provisions Regarding Mergers and Acquisitions ofDomestic Enterprises by Foreign Investors (the “M&A Rules”), which took effect as of September 8, 2006. This new regulation, among other things, hascertain provisions that require special purpose vehicles, or SPVs, formed for the purpose of acquiring PRC domestic companies and controlled by PRCindividuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock market. However, the new regulation does notexpressly provide that approval from the CSRC is required for the offshore listing of the SPV which acquires, directly or indirectly, equity interest or shares ofdomestic PRC entities held by domestic companies or individuals by cash payment, nor does it expressly provide that approval from CSRC is not requiredfor the offshore listing of a SPV which has fully completed its acquisition of equity interest of domestic PRC equity prior to September 8, 2006. OnSeptember 21, 2006, the CSRC published on its official website a notice specifying the documents and materials that are required to be submitted forobtaining 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 offshorecompany such as us which owns controlling contractual interest in the PRC Operating Entities. We believe that the M&A Rules and the CSRC approval arenot required in the context of the share exchange under our transaction because (i) such share exchange is a purely foreign related transaction governed byforeign 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 theCSRC, would reach the same conclusion, and we still cannot rule out the possibility that CSRC may deem that the transactions effected by the shareexchange 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 facesanctions by the CSRC or another PRC regulatory agency. If this happens, these regulatory agencies may impose fines and penalties on our operations in thePRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this offering into the PRC, restrict or prohibit paymentor 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 makingit 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 relevantgovernment 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 uponcompliance with the SAFE registration requirements by such Chinese domestic residents, over whom we may have no control. In addition, such Chinesedomestic residents may be unable to complete the necessary approval and registration procedures required by the SAFE regulations. Such uncertainties mayrestrict 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 onour relationship with the local government in the province in which we operate our business. Chinese government has exercised and continues to exercisesubstantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may beharmed 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 34 legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations orinterpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with suchregulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economicreforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have asignificant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we thenhold 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 adoptionby Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and containinflation. High inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibiteconomic 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 mayexperience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of accountand corporate records and instituting business practices that meet Western standards. We may have difficulty establishing adequate management, legal andfinancial 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 UnitedStates 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 andexecutive 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 uponsome of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securitieslaws. 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 reciprocalrecognition 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 ofJanuary 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 enterpriseestablished outside of the PRC with “de facto management bodies” within the PRC is considered as a resident enterprise and will normally be subject to theenterprise 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 thePRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our global income will be subject to PRC income tax ata 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 newdomestic regulation reducing such withholding tax rate to a lower rate). Per the Double Tax Avoidance Arrangement between Hong Kong and MainlandChina, a Hong Kong company as the investor, which is considered a “non-resident enterprise” under the EIT Law, may enjoy the reduced withholding taxrate 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 ofour 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, wecannot assure whether such dividends may be taxed at a reduced withholding tax rate of 5% per the Double Tax Avoidance Arrangement between HongKong and Mainland China as the PRC tax authorities may regard our China Net HK as a shell company formed 35 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 Issueswith respect to the Enforcement of Dividend Provisions in Tax Treaties, issued on February 20, 2009 by the State Administration of Taxation, ifthe relevant PRC tax authorities determine, in their discretion, that a company benefits from such reduced income tax rate due to a structure orarrangement 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 ofnumerous terms as well as the interpretation and specific applications of various provisions unclear and unspecified. Any increase in our tax rate in the futurecould 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 consequencesto 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 “residententerprise,” meaning that it can be treated the same as a Chinese enterprise for enterprise income tax purposes. The implementing rules of the new EIT Lawdefines “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 PRCtax 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 incometax reporting obligations. This would mean that income such as interest on offering proceeds and other non-China source income would be subject to PRCenterprise 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 subsidiarywould qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchangecontrol authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities thatare 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 bytheir employees who are subject to PRC individual income tax. If they fail to withhold or pay such individual income tax in accordance with applicablePRC 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 thesalaries and other income received by their employees who are subject to PRC individual income tax. Such companies may be subject to certain sanctionsand 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 (whichcould include both PRC employees and expatriate employees subject to PRC individual income tax) are required to pay PRC individual income tax inrespect of their income derived from exercising or otherwise disposing of their stock options. Our PRC entities will be obligated to file documents related toemployee 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 orelsewhere, which could result in a significant loss of business, business opportunities or capital. 36 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 legalcases have little precedential value. Although legislation in the PRC over the past 30 years has significantly improved the protection afforded to variousforms of foreign investment and contractual arrangements in the PRC, these laws, regulations and legal requirements are relatively new. Due to the limitedvolume of published judicial decisions, their non-binding nature, the short history since their enactments, the discrete understanding of the judges orgovernment agencies of the same legal provision, inconsistent professional abilities of the judicators, and the inclination to protect local interest in the courtrooms, interpretation and enforcement of PRC laws and regulations involve uncertainties, which could limit the legal protection available to us, and foreigninvestors, 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. Inaddition, 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) thatmay 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. Inaddition, any litigation in the PRC, regardless of outcome, may be protracted and result in substantial costs and diversion of resources and managementattention. 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 tooccur. Our executive officers, directors, and principal stockholders hold approximately 35% of our outstanding Common Stock. Accordingly, thesestockholders are able to exert substantial influence over all matters requiring stockholder approval, including the election of directors and approval ofsignificant corporate transactions. This could delay or prevent an outside party from acquiring or merging with us even if our other stockholders wanted it tooccur. 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 bemaintained in the future. As of April 13, 2012, the closing trade price of our Common Stock was $1.00 per share. As of April 12, 2012, we had approximately628 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 hada trading range with a low price of $1.04 per share and a high price of $7.00 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 factorsthat may materially affect the market price of our Common Stock are beyond our control, such as changes in financial estimates by industry and securitiesanalysts, conditions or trends in the industry in which we operate or sales of our common stock. These factors may materially adversely affect the market priceof our Common Stock, regardless of our performance. In addition, the public stock markets have experienced extreme price and trading volume volatilityparticularly for companies whose primary operations are located in the PRC. This volatility has significantly affected the market prices of securities of manycompanies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect themarket 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 notprovide coverage of the Company since there is little incentive to brokerage firms to recommend the purchase of its Common Stock. No assurance can begiven that brokerage firms will want to conduct any secondary offerings on behalf of the Company in the future. 37 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 3,005,456 shares of our Common Stock. These warrants have a term ranging from threeyears to five years starting from August 21, 2009 and exercise price ranges from $2.50 to $3.75 per share, subject to adjustment in certain circumstances. Wealso have common stock options outstanding to purchase up to 54,000 shares of our Common Stock, issued to our independent directors, which will expireon 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 upto 885,440 shares of our Common Stock in the aggregate to our management, executive directors and employees, subject to forfeiture upon an employee'scessation 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 November30, 2021. Exercise of these warrants and options may cause dilution in the interests of other stockholders as a result of the additional Common Stock thatwould be issued upon exercise. In addition, sales of the shares of our Common Stock issuable upon exercise of these warrants and options could have adepressive 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 termson which we may obtain additional financing during the period any of these warrants and options remain outstanding may be adversely affected by theexistence 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 additionaldilution 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 oracquisitions we may decide to pursue. If our cash resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debtsecurities or obtain a credit facility. The sale of additional equity securities or equity-linked debt securities could result in additional dilution to ourshareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants thatwould 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 ourstock. We have never paid any cash dividends on our Common Stock and do not anticipate paying any cash dividends on our common stock in theforeseeable 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. 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 theintention 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 securitiesbetween 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 receivedin 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 marketmomentum and generate profits for themselves after selling a stock short. While traditionally these disclosed shorts were limited in their ability to accessmainstream business media or to otherwise create negative market rumors, the rise of the Internet and technological advancements regarding documentcreation, videotaping and publication by weblog (“blogging”) have allowed many disclosed shorts to publicly attack a company’s credibility, strategy andveracity by means of so-called research reports that mimic the type of investment analysis performed by large Wall Street firm and independent researchanalysts. 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 businessoperations based in China and who have limited trading volumes and are susceptible to higher volatility levels than U.S. domestic large-cap stocks, can beparticularly vulnerable to such short attacks. 38 These short seller publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are notsubject 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 risksinvolved in publishing such information, and the enormous profit that can be made from running just one successful short attack, unless the short sellersbecome 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 offreedom of speech, applicable state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceedagainst the relevant short seller. You should be aware that in light of the relative freedom to operate that such persons enjoy – oftentimes blogging fromoutside 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, orpossibly 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 andsubject 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 continuedlisting 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 rulesand 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.” Brokersand dealers effecting transactions in “penny stock” must disclose certain information concerning the transaction, obtain a written agreement from thepurchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability of brokers or dealers to sellthe Common Stock and may affect your ability to sell shares. ITEM 1B.UNRESOLVED STAFF COMMENTS None. ITEM 2PROPERTIES The following table summarizes the location of real property we lease. We do not own any real property.Item Address Leased/Owned1 No. 3 Min, Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC, 1stFloor Leased 39 2 No. 3 Min, Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC, 2ndFloor Leased 3 No. 3 Min, Zhuang Road, Building 6, Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC, 2ndFloor 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 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 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 listedin Items 4 and 5 above are the offices for our operating VIEs, and are primarily used by our internet advertising and TV advertising business segments. Theproperties listed in Items 6 and 7 above are the offices for our operating VIEs and are primarily used by our brand management and sales channel buildingbusiness segment. The property listed in Item 7 is used by one of our operating VIEs, 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 forthe foreseeable future. ITEM 3LEGAL 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 currentlya 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 legalexposure that has a more than remote possibility of having a material adverse effect on our business, financial condition or results of operations. ITEM 4MINE SAFETY DISCLOSURES Not applicable. PART II. ITEM 5MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY 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, ourcommon stock was quoted on the OTC Bulletin Board (“OTCBB “) under the trading symbol “EMZG”, until August 14, 2009, when our ticker symbol waschange to “CHNT”. The last reported price for our common stock on the Nasdaq Global Market on April 13, 2012was $1.00 per share. The following table shows the high and low bid quotations for our common stock reported by the OTCBB for the period from January 1, 2010through March 3, 2010, the high and low closing sale prices for our common stock reported by the NYSE AMEX Stock Exchange for the period from March4, 2010 through September 13, 2010, and 40 the high and low closing sale prices for our common stock reported by the Nasdaq Global Stock Exchange since September 14, 2010. TheOTCBB quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.Year Period High Low 2010 First Quarter $7.00 $3.50 Second Quarter $4.49 $3.10 Third Quarter $4.81 $3.35 Fourth Quarter $4.53 $3.50 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 Holders As of April 12, 2012 there were approximately 628 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 ourbusiness. Payment of future dividends, if any, will be at the discretion of the board of directors after taking into account various factors, including currentfinancial condition, operating results and current and anticipated cash needs. If we ever determine to pay a dividend, we may experience difficulties incompleting the administrative procedures necessary to obtain and remit foreign currency from China for the payment of such dividends from the profits of ourPRC 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 theheading "Equity Compensation Plan Information." Equity Repurchases During the fourth quarter of our fiscal year ended December 31, 2011, 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 ExchangeAct. 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, asapplicable, filed with the SEC. ITEM 6SELECTED FINANCIAL DATA As a smaller reporting company, we are not required to include disclosure under this Item. 41 ITEM 7MANAGEMENT’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 auditedconsolidated financial statements and the related notes to the consolidated financial statements included elsewhere in this Form 10-K. Our auditedconsolidated financial statements have been prepared in accordance with U.S. GAAP. In addition, our audited consolidated financial statements and thefinancial data included in this Form 10-K reflect our reorganization and have been prepared as if our current corporate structure had been in placethroughout the relevant periods. The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of theSecurities 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-lookingstatements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially fromthose 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 aNevada corporation in October 2006. From the date of our company’s incorporation until June 26, 2009, when our company consummated the ShareExchange (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 GroupLimited, a company organized under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s shareholders, Allglad Limited, a British VirginIslands company (“Allglad”), Growgain Limited, a British Virgin Islands company (“Growgain”), Rise King Investments Limited, a British Virgin Islandscompany (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus Elegant Investment Limited, a British VirginIslands 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 ChinaNet 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 andwe are now a holding company which, through certain contractual arrangements with operating companies in the People’s Republic of China (the “PRC”), isengaged in providing advertising, marketing, communication and brand management and sales channel building services to small and medium companies inChina. Our wholly owned subsidiary, China Net BVI, was incorporated in the British Virgin Islands on August 13, 2007. On April 11, 2008, China Net BVIbecame 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 ofRise 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 foreignownership of business entities engaging in the advertising business. In October 2008, a series of contractual arrangements (the “Contractual Agreements” orthe “VIE Agreements) were 42 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 otherthings, secure significant rights to influence the PRC Operating Entities’ business operations, policies and management, approve all mattersrequiring shareholder approval, and receive 100% of the income earned by the PRC Operating Entities. In return, Rise King WFOE providesconsulting services to the PRC Operating Entities. In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform theirobligations under the Contractual Arrangements, the PRC Shareholders have pledged all of their equity interests in the PRC Operating Entities toRise King WFOE. They have also entered into an option agreement with Rise King WFOE which provides that at such time as when the current restrictionsunder 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. At the time the above Contractual Agreements were entered into, the sole registered shareholder of Rise King BVI was Mr. Yang Li, who owned10,000 common stock of Rise King BVI, which constituted all of the issued and outstanding shares of Rise King BVI. Mr. Yang Li entered into slow-walkagreements with each of the Control Group individuals. Pursuant to the slow-walk agreements, upon the satisfaction of certain conditions, the Control Groupindividuals had the option to purchase the 10,000 shares of Rise King BVI (4,600 by Mr. Handong Cheng, 3,600 by Mr. Xuanfu Liu and 1,800 by Ms. LiSun, acting as a nominee for Mr. Zhige Zhang) held by Mr. Yang Li, at a purchase price of US$1 per share (the par value of Rise King BVI’s common stock). Under the terms of the slow-walk agreement, the Control Group will had the right to purchase the shares as follows: (1) one-third of the shares when China NetBVI and its PRC subsidiaries and affiliates (“ the Group”) will generate at least RMB 100,000,000 of the gross revenue for twelve months commencing onJanuary 1, 2009 and ending on December 31, 2009 (the “Performance Period I”); (2) one-third of the shares when the Group will generate at least RMB60,000,000 of the gross revenue for six months commencing on January 1, 2010 and ending on June 30, 2010 (the “Performance Period II); (3) one-third ofthe shares when the Group generates at least RMB 60,000,000 of the gross revenue for six months commencing on July 1, 2010 and ending on December 31,2010 (the “Performance Period III”). Each Control Group individual had the right to purchase one-third of the total number of shares that he or she waseligible to purchase under the slow-walk agreement upon the satisfaction of each condition described above. The Control Group individuals also entered an Entrustment Agreement with Rise King BVI, pursuant to which, based on the 55% equity interestheld in the Group, Rise King BVI entrusted the Control Group to manage the Group companies by irrevocably authorizing the Control Group to act on behalfof Rise King BVI, as the exclusive agents and attorneys with respect to all matters concerning Rise King BVI’s Shareholding, during the term of thisAgreement. The Control Group also agreed and confirmed that he or she would act in concert with one another when exercising the rights authorized to themin this Agreement. The Entrustment Period commenced on the execution date of the agreement and was effective for a period of ten years, until itstermination, as discussed below. As described above, each of Mssrs. Handong Cheng, and Xuanfu Liu and Ms. Li Sun entered into Share Transfer Agreements (slow-walk agreement)with Mr. Yang Li, the sole shareholder of Rise King BVI, which beneficially owns an aggregate of 7,434,940 shares of the Company’s Common Stock, (the“Subject Shares”). On March 30, 2011, pursuant to the terms of the Share Transfer Agreement, Ms. Li Sun transferred her right to acquire 18% of the shares ofRise King BVI under the Share Transfer Agreement to Mr. Zhige Zhang, the chief financial officer of the Company. On March 30, 2011, each of Mssrs.Handong Cheng, Xuanfu Liu and Zhige Zhang (the “PRC Persons”) exercised their right to purchase the outstanding stock of Rise King BVI. On the samedate, the Entrustment Agreement originally entered into among Rise King BVI and the Control Group was terminated. As a result of these transactions, theownership of Rise King BVI was transferred from Mr. Yang Li to the PRC Persons. Rise King BVI has sole voting and dispositive power over the SubjectShares. The PRC Persons may be deemed to share voting power over the shares as a result of their collective ownership of all of the outstanding stock of RiseKing BVI and are now the controlling shareholders of Rise King BVI. Pursuant to the above Contractual Agreements, all of the equity owners’ rights and obligations of the VIEs were assigned to Rise King WFOE, whichresulted in the equity owners lacking the ability to make decisions that have a significant effect on the VIEs, and Rise King WFOE’s ability to extract theprofits from the operation of the VIEs, 43 and assume the residual benefits of the VIEs. Because Rise King WFOE and its indirect parent are the sole interest holders of the VIEs, weincluded the assets, liabilities, revenues and expenses of the VIEs in our consolidated financial statements, which is consistent with theprovisions of FASB Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” subtopic 10. As a result of the Share Exchange on June 26, 2009, the former China Net BVI shareholders owned a majority of our common stock. The transactionwas regarded as a reverse acquisition whereby China Net BVI was considered to be the accounting acquirer as its shareholders retained control of ourcompany after the Share Exchange, although we are the legal parent company. The share exchange was treated as a recapitalization of our company. As such,China Net BVI (and its historical financial statements) is the continuing entity for financial reporting purposes. Following the Share Exchange, we changedour name from Emazing Interactive, Inc. to ChinaNet Online Holdings, Inc. The financial statements have been prepared as if China Net BVI had always beenthe reporting company and then on the share exchange date, had changed its name and reorganized its capital stock. As of the date of the Share Exchange, through a series of contractual agreements, we operate our business in China primarily through BusinessOpportunity Online and Beijing CNET Online. Beijing CNET Online owns 51% of Shanghai Borongdingsi Computer Technology Co., Ltd. (“ShanghaiBorongdingsi”). Business Opportunity Online, Beijing CNET Online and Shanghai Borongdingsi, were incorporated on December 8, 2004, January 27, 2003and August 3, 2005, respectively. On June 24, 2010, one of our VIEs, Business Opportunity Online, together with three other individuals, who were not affiliated with the Company,formed a new company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). Shenzhen Mingshan is 51% owned by BusinessOpportunity Online and 49% owned collectively by the other three individuals. Shenzhen Mingshan is located in Shenzhen City, Guangdong Province ofthe PRC and is primarily engaged in developing and designing internet based software, online games and the related operating websites and providingrelated internet and information technology services necessary to operate such games and websites. On January 6, 2011, as approved by the shareholders ofShenzhen Mingshan, an independent third party investor, who was not affiliated with us or any of our affiliates, invested RMB15,000,000 (approximatelyUS$2,356,749) into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan. As a result of this transaction, our share of the equityinterest in Shenzhen Mingshan decreased from 51% to 20.4% and we ceased to have a controlling financial interest in ShenZhen Mingshan, but still retainedan investment in, and significant influence over, Shenzhen Mingshan. Therefore, as of December 31, 2011, Shenzhen Mingshan was an equity investmentaffiliate 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”), acompany incorporated under PRC laws in December 2009. The contractual arrangements that we entered into with Shanghai Jing Yang allow us, throughRise King WFOE, to, among other things, secure significant rights to influence Shanghai Jing Yang’s business operations, policies and management, approveall matters requiring shareholder approval, and receive 100% of the income earned by Shanghai Jing Yang. From the date of incorporation until December 6,2010, Shanghai Jing Yang did not conduct any business activities. Therefore, Shanghai Jing Yang’s accounts were included in our consolidated financialstatements with no goodwill recognized in accordance with ASC Topic 810 “Consolidation”. On December 8, 2010, Shanghai Jing Yang acquired a 49% interest in a newly established company, Beijing Yang Guang Media Investment Co.,Ltd. (“Beijing Yang Guang”) for cash consideration of RMB 7,350,000 (approximately US$1,154,807). In August, 2011, Shanghai Jing Yang sold back its49% equity interest in Beijing Yang Guang to the majority shareholder of Beijing Yang Guang for cash consideration equal to the consideration paid when itacquired the 49% equity interest in December 2010. We, through one of our VIEs, Beijing CNET Online, entered into an equity interest acquisition agreement with the shareholders of Quanzhou ZhiYuan 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% equityinterest 44 in Quanzhou Tian Xi Shun He, for a cash consideration of RMB9,500,000 (approximately US$1,492,608) and RMB7,500,000 (approximatelyUS$1,178,374), 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 thePRC, 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 topurchase the remaining 49% equity interest of Quanzhou Tian Xi Shun He for a cash consideration of RMB7,200,000 (approximatelyUS$1,131,239). 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 advertisementdesign, 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 newcompany, Beijing Chuang Fu Tian Xia Network Technology Co., Ltd. (“Beijing Chuang Fu Tian Xia”). Business Opportunity Online and the co-foundingindividual owned 51% and 49% of the equity interests of Beijing Chuang Fu Tian Xia, respectively. In addition to capital investment, the co-foundingindividual 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 throughthe 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. (“HubeiCNET”). Hubei CNET is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy services. On April 18, 2011, Business Opportunity Online Hubei, together with an individual, who was not affiliated with us, formed a new company, ZhaoShang 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, twoindependent third party investors, who were not affiliated with us or any of our affiliates, invested RMB10,000,000 (approximately US$1,571,166) into ZhaoShang 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 inZhao 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 aninvestment in, and significant influence over, Zhao Shang Ke Hubei. Therefore, as of December 31, 2011, Zhao Shang Ke Hubei was an equity investmentaffiliate 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 YuanHubei”). Xin Qi Yuan Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy 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 SenHubei”). Mu Lin Sen Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy services. On July 1, 2011, Business Opportunity Online Hubei, together with an individual who is not affiliated with us, formed a new company, Sheng TianNetwork Technology (Hubei) Co., Ltd. (“Sheng Tian Hubei”). Business Opportunity Online Hubei and the co-founding individual owned 51% and 49% ofthe 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. 45 On September 5, 2011, Business Opportunity Online Hubei formed a new wholly owned company, Chongqing Business Opportunity OnlineTechnology Co., Ltd. (“Business Opportunity Online Chongqing”). Business Opportunity Online Chongqing is primarily engaged in internet advertisementdesign, production and promulgation. 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 interest in Sou Yi Lian Mei for a cash consideration of RMB51,600,000(approximately US$8,107,216). Sou Yi Lian Mei is based in Beijing, China, and is primary engaged in providing online advertising and marketing services.Sou Yi Lian Mei operates its business primarily through its wholly-owned subsidiary, Jin Du Ya He (Beijing) Network Technology Co., Ltd (“Jin Du Ya He”).On December 20, 2011, the transaction was approved by, and registered with, the relevant local PRC government authorities of Beijing, the PRC. Sou Yi LianMei became a majority-owned subsidiary of Business Opportunity Online Hubei. Through our PRC operating subsidiary and VIEs, we are one of China’s leading B2B fully integrated internet service providers for expanding SMEs’sales networks in China and our services primarily include proprietary internet and advertising technologies which prepare and publish rich media enabledadvertising and marketing campaigns for clients on the Internet, television and other valued added communication channels, host mini-sites with onlinemessaging and consulting functionalities, generate effective sales leads and provide online management tools to help SMEs manage the expansion of theirsales networks. Our goal is to strengthen our position as the leading diversified one-stop internet service provider to SMEs for their sales network expansionin China. Our multi-channel advertising and promotion platform consists of the websites www.28.com (“28.com”), www.liansuo.com (“liansuo.com”),www.chuangye.com (“chuangye.com”) and www.sooe.cn (“sooe.cn”), our Internet advertising portals, ChinaNet TV, our TV production and advertising unit,our bank kiosk advertising unit, which is primarily used as an advertising platform for clients in the financial services industry and will be further utilized asan additional value-added communication channel for SME clients and our brand management and sales channel building services unit. 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 ofAmerica (“U.S.GAAP”) and include the accounts of our Company, and all of our subsidiaries and VIEs. We prepare financial statements in conformity withU.S.GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets andliabilities on the date of the financial statements and the reported amounts of revenues and expenses during the financial reporting period. We continuallyevaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions thatwe believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual resultscould differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We consider thepolicies 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$”). Thefunctional currency of our PRC operating subsidiary and VIEs is Renminbi (“RMB’), and PRC is the primary economic environment in which we operate. For financial reporting purposes, the financial statements of our PRC operating subsidiary and VIEs, which are prepared using the RMB, aretranslated into our reporting currency, the United States Dollar (“U.S. dollar”). Assets and liabilities are translated using the exchange rate at each balancesheet date. Revenue and expenses are translated using average rates prevailing during each reporting period, and shareholders’ equity is translated athistorical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulated other comprehensive income inshareholders’ equity. 46 Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange ratesprevailing at the dates of the transactions. The resulting exchange differences are included in the determination of net income of the consolidated financialstatements for the respective periods. The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows: As of December 31, 2011 2010 Balance sheet items, except for equity accounts 6.3647 6.6118 For the Year ended December 31, 2011 2010 Items in the statements of income and comprehensive income, and statements cash flows 6.4735 6.7788 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 ofaccounting in accordance with ASC Topic 323 “Equity Method and Joint Ventures”. Whether or not we exercise significant influence with respect to anInvestee depends on an evaluation of several factors including, among others, representation on the investee companies’ board of directors and ownershiplevel, which is generally a 20% to 50% interest in the voting securities of the investee companies. Under the equity method of accounting, an investeecompany’s accounts are not reflected within our consolidated balance sheets and statements of income and comprehensive income; however, our share of theearnings or losses of the investee company is reflected in the caption “Share of earnings (losses) in equity investment affiliates” in the consolidatedstatements of income and comprehensive income. Our carrying value (including advance to the investees) in equity method investee companies is reflectedin 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 financialstatements unless we guaranteed obligations of the investee company or have committed additional funding. When the investee company subsequentlyreports 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 ofinterests 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 testswhen an event occurs or circumstances change that could indicate that the asset might be impaired. The test consists of two steps. First, identify potentialimpairment 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 thanits carrying amount, goodwill is not considered impaired. Second, if there is impairment identified in the first step, an impairment loss is recognized for anyexcess 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 byallocating 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, assigningassets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. The judgment inestimating the fair value of reporting units 47 includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these estimates andassumptions 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 netincome 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 incomeattributable 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 accordancewith ASC Topic 810 “Consolidation”, subtopic 10, which requires the transaction be accounted for as equity transactions (investments by owners anddistributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net income or comprehensiveincome. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary. Any differencebetween the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equityattributable to the parent and reallocated the subsidiary’s accumulated comprehensive income, if any, among the parent and the noncontrolling interestthrough 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 fourof 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 addedtechnical services, reselling of internet advertising spaces and other advertisement related resources. No revenue from advertising-for-advertising bartertransactions was recognized because the transactions did not meet the criteria for recognition in ASC Topic 605, subtopic 20. Advertising contracts establishthe fixed price and advertising services to be provided. Pursuant to advertising contracts, we provide 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 advertisingis 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 forrevenue recognition purposes. Value added technical services are provided based on two types of contracts: (i) fixed price and (ii) fixed price with minimumperformance threshold. For contracts with fixed price term, revenue is recognized on a pro-rata basis over the engaged service period. For fixed price contractswith minimum performance threshold, revenue is recognized when the specified performance criteria is met. Based upon our credit assessments of ourcustomers prior to entering into contracts, we determine if collectability is reasonably assured. In situations where 48 collectability is not deemed to be reasonably assured, we recognize revenue upon receipt of cash from customers, only after services have beenprovided 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 andliabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be ineffect 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 ofavailable 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 changein 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 statementrecognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on recognition ofincome tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated withtax positions, accounting for income taxes in interim periods, and income tax disclosures. For the year ended December 31, 2011 and 2010, we did not haveany 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 aholding company and do not conduct any substantial operations of our own after the Share Exchange. No provision for federal corporate income tax has beenmade in our financial statements as no assessable profits for the year ended December 31, 2011 and 2010, 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 reinvestedindefinitely. If undistributed earnings were distributed, foreign tax credits could become available under current law to reduce the resulting U.S. income taxliability. 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 orcapital 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 profitstax have been made in our financial statements as no assessable profits for the year ended December 31, 2011 and 2010, 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 PRCenterprise 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 andforeign invested enterprises. ·Rise King WFOE is a software company qualified by the related PRC governmental authorities and was approved by the local tax authorities ofBeijing, 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 firstprofitable year was fiscal year 2009 which has been verified by the local tax bureau by accepting the application filed by us. Therefore, it wasapproved 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 whichis 25% to 12.5% for fiscal year 2011 through fiscal year 2013. After fiscal year 2013, the applicable income tax rate of Rise King WFOE will be 25%under the current EIT law of PRC. Therefore, for the year ended December 31, 2011 and 2010, the applicable income tax rate for Rise King WFOE was12.5% and nil%, respectively. 49 ·Business Opportunity Online was qualified as a High and New Technology Enterprise in Beijing High-Tech Zone in 2005 and was approved by thelocal tax authorities of Beijing, the PRC, to be entitled to a three-year EIT exemption for fiscal year 2005 through fiscal year 2007 and a 50%reduction of its applicable EIT rate, which is 15% to 7.5% for the following three years from fiscal year 2008 through fiscal year 2010. However, inMarch 2007, a new enterprise income tax law (the “New EIT”) of PRC was enacted which was effective on January 1, 2008. Subsequently, on April 14,2008, relevant governmental regulatory authorities released new qualification criteria, application procedures and assessment processes for “High andNew Technology Enterprise” status under the New EIT which would entitle the re-qualified and approved entities to a favorable statutory tax rate of15%. Business Opportunity Online re-applied its qualification for a High and New Technology Enterprise in 2008 to the related PRC regulatoryauthorities. With an effective date of September 4, 2009, Business Opportunity Online obtained the approval of its reassessment of the qualification asa “High and New Technology Enterprise” under the New EIT law and was approved again by the local tax authorities to be entitled to a favorablestatutory tax rate of 15%. Under the previous EIT laws and regulations, High and New Technology Enterprises enjoyed a favorable tax rate of 15%and were exempted from income tax for three years beginning with their first year of operations, and were entitled to a 50% tax reduction to 7.5% forthe subsequent three years and 15% thereafter. The current EIT Law provides grandfathering treatment for enterprises that were (1) qualified as Highand New Technology Enterprises under the previous EIT laws, and (2) established before March 16, 2007, if they continue to meet the criteria for Highand New Technology Enterprises under the current EIT Law. The grandfathering provision allows Business Opportunity Online to continue enjoyingtheir unexpired tax holidays provided by the previous EIT laws and regulations, as it was established in December 2004 and qualified as a High andNew Technology Enterprises under the previous EIT laws in 2005. After the expiration of the current tax holiday as of December 31, 2010, theapplicable income tax rate of Business Opportunity Online increased to 15%, the standard preferential income tax rate for a High and New TechnologyEnterprise. Therefore, for the year ended December 31, 2011 and 2010, the applicable income tax rate for Business Opportunity Online was 15% and7.5%, respectively. Business Opportunity Online’s High and New Technology Enterprise certificate will expire on September 4, 2012 and subject to anadministrative review by the relevant PRC governmental regulatory authorities for obtaining the renewed certificate. As confirmed with the local taxauthorities of Beijing, the PRC, if Business Opportunity Online fails to pass the administrative review, the enacted tax rate will be increased to 25%starting from January 1, 2012. Business Opportunity Online assessed the situation and concluded that more likely than not it will be able to pass thisadministrative review and continue to enjoy the 15% preferential income tax rate as a High and New Technology Enterprise. ·Business Opportunity Online Hubei, Hubei CNET and Zhao Shang Ke Hubei were all incorporated in Xiaotian Industrial Park of Xiaogan EconomicDevelopment Zone in Xiaogan City, Hubei province of the PRC in 2011. These operating entities have been approved by the related local governmentauthorities to apply the deemed income tax method for its computation of income tax expense for the year ended December 31, 2011. Under thedeemed income tax method, the deemed profit is calculated based on 10% of the total revenue and the applicable income tax rate is 25%. Therefore,the income tax expenses under the deemed income tax method is calculated as 2.5% of the total revenue recognized for the year ended December 31,2011 for each of these operating entities. In December 2011, the local tax authorities of these operating entities informed the Company, that they willcancel the current applicable deemed income tax method for computation of income tax expenses starting from January 1, 2012 for these entities, butmay refund certain amount of the income tax paid by these operating entities as an local subsidy to these entities. Therefore, the applicable income taxrate for these operating entities will be 25% starting from January 1, 2012. ·The applicable income tax rate for the rest of our PRC operating entities was 25% for the years ended December 31, 2011 and 2010. ·The New EIT also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding companyoutside China, which were exempted under the previous enterprise income tax law and rules. A lower withholding tax rate will be applied if there is atax 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% preferentialwithholding tax rate upon distribution of the dividends to this intermediate holding company. 50 For the year ended December 31, 2011 and 2010, all of the preferential income tax treatments enjoyed by our PRC subsidiary and VIEs were basedon the current applicable laws and regulations of the PRC and approved by the related government regulatory authorities and local tax authorities where ourrespective PRC subsidiary and VIEs operate. Rise King WFOE, Business Opportunity Online, Business Opportunity Online Hubei, Hubei CNET and ZhaoShang Ke Hubei were most affected by these preferential income tax treatments within the structure of us. The preferential income tax treatments are subjectto change in accordance with the PRC government economic development policies and regulations. These preferential income tax treatments are mainlydetermined by the regulation and policies of the PRC government in the context of the overall economic policy and strategy. As a result, the uncertainty oftheses preferential income tax treatments are subject to, but not limited to, the PRC government policy on supporting any specific industry’s developmentunder the outlook and strategy of overall macroeconomic development. 2. Business tax and relevant surcharges Revenue of advertisement services are subject to 5.5% business tax and 3% cultural industry development surcharge of the net service income afterdeducting amount paid to ending media promulgators. Revenue of internet technical support services is subjected to 5.5% business tax. Business taxcharged was included in cost of sales. Recent Accounting Pronouncements In September 2011, the FASB issued ASU No. 2011-08 — “Intangibles — Goodwill and Other”. The amendments in this update will allow an entityto first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments,an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is morelikely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider inconducting the qualitative assessment. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginningafter December 15, 2011. Early adoption is permitted. The adoption of the provisions in ASU 2011-08 will have no material impact on our consolidatedfinancial statements. In December 2011, the FASB issued ASU No. 2011-12 — “Comprehensive Income”. The amendments in this update supersede certain pendingparagraphs in ASU No. 2011-05, to effectively defer only those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments outof accumulated other comprehensive income. The amendments will be temporary to allow the Board time to consider the presentation requirements forreclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. Theamendments in this update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. Fornonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The adoption ofthe provisions in ASU 2011-12 will have no material impact on our 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 afuture 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, 2011 AND 2010 51 The following table sets forth a summary, for the periods indicated, of our consolidated results of operations. Our historical resultspresented below are not necessarily indicative of the results that may be expected for any future period. All amounts, except number of sharesand per share data, are presented in thousands of US dollars. Year ended December 31, 2011 2010 US$ US$ Sales $28,105 $40,423 From unrelated parties 626 1,164 From related parties 28,731 41,587 Cost of sales 12,027 18,970 Gross margin 16,704 22,617 Operating expenses Selling expenses 3,506 3,403 General and administrative expenses 7,904 3,460 Research and development expenses 2,132 907 13,542 7,770 Income from operations 3,162 14,847 Other income (expenses) Changes in fair value of warrants - 1,861 Changes in fair value of contingent consideration receivables (70) - Interest income 13 13 Gain on deconsolidation of subsidiaries 925 - Other income 5 6 873 1,880 Income before income tax expense, equity method investments and noncontrolling interests 4,035 16,727 Income tax expense 1,035 352 Income before equity method investments and noncontrolling interests 3,000 16,375 Share of losses in equity investment affiliates (219) - Net income 2,781 16,375 Net loss attributable to noncontrolling interests 214 214 Net income attributable to ChinaNet Online Holdings, Inc. 2,995 16,589 Dividend of Series A convertible preferred stock (407) (794)Net income attributable to common stockholders of ChinaNet Online Holdings, Inc. $2,588 $15,795 Earnings per share Earnings per common share Basic $0.14 $0.94 Diluted $0.14 $0.79 Weighted average number of common shares outstanding: Basic 18,545,609 16,778,176 Diluted 18,759,240 20,896,061 52 NON-GAAP MEASURES To supplement the audited consolidated statement of income and comprehensive income presented in accordance with GAAP, we are also providingnon-GAAP measures of income from operations, income before income tax expenses, net income, net income attributable to us, net income attributable to ourcommon stockholders and basic and diluted earnings per share for the year ended December 31, 2011 and 2010, which are adjusted from results based onGAAP to exclude the non-cash gain and expenses recorded, which related to the gain on deconsolidation of subsidiaries, the related deferred income taxexpenses, 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 onNovember 30, 2011 for the year ended December 31, 2011, and the non-cash gain recorded for the fair value changes of the warrants we issued in our August2009 financing for the year ended December 31, 2010. The non-GAAP financial measures are provided to enhance the investors' overall understanding of ourcurrent performance in on-going core operations as well as prospects for the future. These measures should be considered in addition to results prepared andpresented in accordance with GAAP, but should not be considered a substitute for or superior to GAAP results. We use both GAAP and non-GAAPinformation in evaluating our operating business results internally and therefore deemed it important to provide all of this information to investors. The following table presents reconciliations of our non-GAAP financial measures to the audited consolidated statements of income andcomprehensive income for the years ended December 31, 2011 and 2010 (all amounts, except number of shares and per share data, are presented in thousandsof US dollars): Year Ended December 31, 2011 2010 GAAP NON GAAP GAAP NONGAAP US$ US$ US$ US$ Gross Profit $16,704 $16,704 $22,617 $22,617 Operating expenses Selling expenses 3,506 2,827 3,403 3,403 General and administrative expenses 7,904 6,647 3,460 3,460 Research and development expenses 2,132 1,461 907 907 13,542 7,770 7,770 10,935 Income from operations $3,162 $14,847 14,847 Adjusted income from operations $5,769 Other income (expenses): Changes in fair value of warrants - - 1,861 - Changes in fair value of contingent consideration receivables (70) - - - Interest income 13 13 13 13 Gain on deconsolidation of subsidiaries 925 - - - Other income 5 5 6 6 873 1,880 18 19 Income before income tax expense, equity method investments and noncontrolling interests 4,035 16,727 Adjusted income before income tax expense, equity method investments and noncontrollinginterests 5,787 14,866 Income tax expense 1,035 827 352 352 53 Income before equity method investments and noncontrolling interests 3,000 16,375 Adjusted income before equity method investments and noncontrolling interests 4,960 14,514 Share of losses in equity investment affiliates (219) (219) - - Net income 2,781 16,375 Adjusted net income 4,741 14,514 Net loss attributable to noncontrolling interest 214 214 214 214 Net income attributable to ChinaNet Online Holdings, Inc. 2,995 16,589 Adjusted net income attributable to ChinaNet Online Holdings, Inc. 4,955 14,728 Dividend for series A convertible preferred stock (407) (407) (794) (794)Net income attributable to common shareholders of ChinaNet Online $2,588 $15,795 Adjusted net income attributable to common shareholders of ChinaNet Online $4,548 $13,934 Earnings per common share-Basic $0.14 $0.94 Adjusted earnings per common share-Basic $0.25 $0.83 $0.14 Earnings per common share-Diluted $0.79 Adjusted earnings per common share-Diluted $0.24 $0.70 Weighted average number of common shares outstanding: Basic 18,545,609 18,545,609 16,778,176 16,778,176 Diluted 18,759,240(1) 20,384,766(2) 20,896,061 20,896,061 (1) For the year ended December 31, 2011, the effect of the 1,625,526 incremental shares resulted from assumed conversion of the convertible preferredstock 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 preferredstock was included, because the effect was dilutive for not including the non-cash gain and expenses related to the non-recurring transactions incurredunder NON-GAAP measures. REVENUE Beginning on January 1, 2011, we combined the Internet Advertisement Resources Reselling segment and the Internet Information Managementsegment with the Internet Advertisement segment, due to the fact that the relative percentages of these two combined segments’ financial performance wereimmaterial and will continue to be immaterial to our consolidated financial results going forward. Certain prior period amounts have been re-grouped toconform to the current period presentation. As a result of the acquisition of Quanzhou Zhi Yuan, Quanzhou Tianxi Shun He and the launch of Zhao ShangKe Hubei, we also now operate in an additional reportable business segment, Brand Management and Sales Channel Building. The following tables set forth a breakdown of our total revenue, divided into five segments for the periods indicated, with inter-segment transactionseliminated: 54 Year ended December 31, 2011 2010 Revenue type (Amounts expressed in thousands of US dollars, except percentages) Internet advertisement $15,359 53.4% $14,685 35.3%Technical services 4,622 16.1% 13,878 33.4%TV advertisement 6,434 22.4% 12,493 30.0%Bank kiosks 487 1.7% 531 1.3%Brand management and sales channel building 1,829 6.4% - -%Total $28,731 100% $41,587 100% Year ended December 31, 2011 2010 Revenue type (Amounts expressed in thousands of US dollars, except percentages) Internet advertisement $15,359 100% $14,685 100%—From unrelated parties 14,947 97% 14,342 98%—From related parties 412 3% 343 2%Technical services 4,622 100% 13,878 100%—From unrelated parties 4,451 96% 13,064 94%—From related parties 171 4% 814 6%TV advertisement 6,434 100% 12,493 100%—From unrelated parties 6,434 100% 12,486 99.9%—From related parties - -% 7 0.1%Bank kiosks 487 100% 531 100%—From unrelated parties 487 100% 531 100%—From related parties - -% - -% Brand management and sales channel building 1,829 100% - -%—From unrelated parties 1,786 98% - -%—From related parties 43 2% - -%Total $28,731 100% $41,587 100%—From unrelated parties 28,105 98% $40,423 97%—From related parties 626 2% $1,164 3% Total Revenues: Our total revenues decreased to US$28.7 million for the year ended December 31, 2011 from US$41.6 million for the year ended December31, 2010, representing a 31% decrease. We derive the majority of our advertising service revenues from the sale of advertising space on our internet portals and by providing the relatedtechnical support and services, internet marketing service and content management services to unrelated third parties and to certain related parties. We alsoderive revenue from the sale of advertising time purchased from different TV programs. We report our advertising service revenues between related andunrelated parties because historically approximately 3%-5% of our advertising service revenues came from clients related to certain shareholders of our PRCoperating entities. Our advertising services to related parties were provided in the ordinary course of business on the same terms as those provided to ourunrelated advertising clients. In fiscal year of 2011, we continued to execute our strategy of focusing on internet advertising and marketing business and therelated value-added technical services, which constituted approximately 70% of our total net revenue and achieved gross margins of 69% for the year endedDecember 31, 2011, as compared to 69% of the total net revenue and 76% of the gross margin achieved for the same period of last year. Our advertising service revenues are recorded net of any sales discounts. Sales discounts include volume discounts and other customary incentivesoffered to our small and medium-sized franchise and merchant clients, including providing them with additional advertising time for their advertisements ifwe have unused space available on our websites and represent the difference between our official list price and the amount we actually charge our clients. Wetypically sign service contracts with our small and medium-sized franchisor and other clients that require us to place the advertisements on our portalwebsites in specified locations on the sites and for agreed periods; and/or 55 place the advertisements onto our purchased advertisement time during specific TV programs for agreed periods. We recognize revenues as theadvertisement 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 beganproviding a number of value added technical services and management systems to our internet advertisement customers, which services enhance the qualityand performance of the internet advertising services provided by Business Opportunity Online. These value added technical services are primarily onlinetechnical management systems and platforms. Customers use these technical services to analyze, monitor and manage their advertisements on our keyadvertising portal, 28.com, their other traffic generating activities and their online marketing campaign activities. Revenues generated by Rise King WFOEare 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 marketingcampaign activities. Most of these services are based on fixed price terms; revenues are then generated and recognized from the use of the online managementsystem and tools on a periodic basis, together with the satisfaction of other applicable performance thresholds, if specified. Rise King WFOE’s customers aresimilar to our internet advertising customers, with over 70% of the WFOE’s customers also being customers of our internet advertisement services. The other30% of Rise King WFOE’s customers do not directly advertise on our web portal but use Rise King WFOE’s management systems and the internetinformation 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 internetadvertisement services provided by Business Opportunity Online. The revenue generating activities conducted by Rise King WFOE are not prohibited underthe 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 internetadvertising business or any other business that is subject to obtaining an Internet Content Provider License. For the internet advertisement servicesconducted by our VIE, Business Opportunity Online, customers use our internet advertising portal, www. 28.com, to place internet advertisements in differentformats, such as: banners, links, logos, buttons, as well as mini-sites. Customers get internet visits and messages from their advertisements placed on ourportal. For the value added technical services provided by our WFOE, customers primarily use the technical and management systems offered by it toanalyze, monitor and manage their advertisements and traffic generating activities on our advertising portal. For example, Rise King WFOE’s customers canuse our management tools to obtain analysis of messages and sales leads received from their internet adverting. The tables below summarize the revenues, cost of sales, gross margin and net income generated from each of our VIEs and subsidiaries for the yearended December 31, 2011 and 2010, respectively. 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 56 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 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 For the year ended December 31, 2010: 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 13,064 814 596 14,474 Business Opportunity Online 16,931 343 - 17,274 Beijing CNET Online 10,428 7 - 10,435 Inter-co., elimination - - (596) (596)Total revenue 40,423 1,164 - 41,587 For the year ended December 31, 2010: Name of subsidiary or VIE Cost of Sales Gross Margin $(’000) $(’000) Rise King WFOE 681 13,793 Business Opportunity Online 8,395 8,879 Beijing CNET Online 9,890 545 Inter-co., elimination - (596)Shenzhen Mingshan 4 (4)Total 18,970 22,617 57 For the year ended December 31, 2010 Name of subsidiary or VIE Net Income $(’000) Rise King WFOE 12,149 Business Opportunity Online 3,923 Beijing CNET Online 24 Shenzhen Mingshan (436)ChinaNet Online Holdings, Inc. (1,146)Changes in fair value of warrant 1,861 Total net income before allocation to the noncontrolling interest 16,375 Management considers revenues generated from internet advertising and the related technical services as one aggregate business operation andrelies 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, 2011 were approximately US$15.4 million as compared to US$14.7 million for the sameperiod in 2010, representing an increase of 5%. The increase in internet advertising revenue was primarily due to a slight increase in the overallaverage spending of our internet advertising customers in 2011 as compared to 2010. Although our clients reduced their total advertising spending,most of them retained their basic advertising service and reduced their subscription on value-added technical services in response to the economicdownturn in the PRC that began in the second half of 2011. In the meantime, we gradually gained some new clients as a result of the efforts we made insome new cities through our newly formed operating entities. However, their contribution to our revenue was limited in 2011. We also have graduallygained new clients on liansuo.com and presently there are approximately 4,000 clients listed on the site on a free trial period. While clients were usingliansuo.com for free, it further expanded our exposure to larger clients, providing a new array of income source. ·Revenues generated from technical services offered by Rise King WFOE were US$4.6 million for the year ended December 31, 2011, as compared toUS$13.9 million for the same period in 2010. Due to the Chinese government’s monetary policy of increasing interest rates and tightening the moneysupply, and other economic difficulties that unexpectedly began in the second quarter of 2011, many of our clients, including our branded clients,who are mostly SMEs, reduced their advertising spending significantly in response to the overall economic situation in China. The decrease in ourinternet advertising related technical services revenue for the year ended December 31, 2011 as compared with the same period in 2010 was primarilydue to a decrease in the average revenue per client by approximately 50%. In addition, some of our clients terminated the subscription of theseservices in the second half of 2011. ·We had a 49% decrease in TV advertising revenue to US$6.4 million for the year ended December 31, 2011 from US$12.5 million for the same periodin 2010. We generated this US$6.4 million of TV advertising revenue by selling approximately 6,040 minutes of advertising time that we purchasedfrom different provincial TV stations as compared with approximately 14,420 minutes of advertising time that we sold in the same period of 2010. Thedecrease in revenue we generated from the TV advertisement segment for the year ended December 31, 2011 as compared to the same period in 2010were a direct result of the decrease of approximately 8,380 total minutes of TV advertising time sold in the year of 2011 as compared to 14,420minutes sold in 2010. Increases in demand for TV advertising were relatively limited due to much higher cost as compared to other advertisingchannels, such as Internet advertising and print advertising, which resulted in lower demand from our customers for this service. Beginning in themiddle of the fiscal year 2010, due to the increase in the cost per minute charged by the TV stations, which cost was passed on to our end customers,our clients’ demand for the TV advertising service decreased significantly. We had to decrease our selling price in order to sell all of the TV minutespurchased from the TV stations, which led to a low gross profit margin of approximately 4% for this segment for the year ended December 31, 2010. Inresponse to this decreased demand, for the year ended December 31, 2011, we reduced the business scope of the TV division, which was integrated intoour overall advertising and marketing platform and provided to the existing Internet client base as one of the additional communication channels. Weonly kept a limited quantity of TV time slots with a relatively lower cost per minute, which led to more affordable prices for our customers and to abetter match for our customers’ needs and cost budgets. Accordingly, along with the 58 gradual increase in our selling price during 2011 as compared to 2010, the gross profit margin of this segment improved significantly for the yearended December 31, 2011 to approximately 19% as compared with 4% for the prior year. We will continue to monitor the demand from our customersfor this segment, and purchase additional TV advertisement time, if necessary. ·For the year ended December 31, 2011, we earned approximately US$0.49 million of revenue from the bank kiosk business segment as compared toapproximately US$0.53 million for the same period in 2010. The bank kiosk advertising business is still in the very early stages of development andmany details still need to be further analyzed and finalized before we allocate more capital to this business unit. It was not a significant contributor torevenue for either the year ended December 31, 2011 or 2010. Management currently believes that this business is unlikely to expand and some of thetechnology used in this business unit will be fully integrated into the overall advertising and marketing platform. ·As a result of the acquisition of Quanzhou Zhi Yuan, Quanzhou Tian Xi Shun He and the launch of Zhao Shang Ke Hubei, we operated our business inone more reportable business segment, Brand management and sales channel building segment. For the year ended December 31, 2011, we providedthis service to approximately 60 customers and achieved approximately US$1.8 million of revenue from this segment. Upon deconsolidation of ZhaoShang Ke Hubei in December 2011, only Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He’s revenue will be included in this segment in the futureperiods. Cost of revenues Beginning on January 1, 2011, we combined the Internet Advertisement Resources Reselling segment and the Internet Information Managementsegment with the Internet Advertisement segment, due to the fact that the relative percentage of these two combined segments’ financial performances wereimmaterial and will continue to be immaterial to our consolidated financial results going forward. Certain prior period amounts have been re-grouped toconform to the current period presentation. As a result of the acquisition of Quanzhou Zhi Yuan, Quanzhou Tianxi Shun He and the launch of Zhao ShangKe Hubei, we operate in an additional reportable business segment, Brand Management and Sales Channel Building. Our cost of revenue consisted of costs directly related to the offering of our advertising services, technical services, marketing services and brandmanagement and sales channel building services. The following table sets forth our cost of revenues, divided into five segments, by amount and gross profitratio for the periods indicated, with inter-segment transactions eliminated: Year ended December 31, 2011 2010 (Amounts expressed in thousands of US dollars, except percentages) Revenue Cost GP ratio Revenue Cost GP ratio Internet advertisement $15,359 6,033 61% $14,685 $6,266 57%Technical service 4,622 254 95% 13,878 613 95%TV advertisement 6,434 5,233 19% 12,493 11,974 4%Bank kiosk 487 42 91% 531 45 92%Brand management and sales channel building 1,829 465 75% - - -%Others - - - - 72 N/A Total $28,731 $12,027 58% $41,587 $18,970 54% Cost of revenues: Our total cost of revenues decreased to US$12.0 million for the year ended December 31, 2011 from US$19.0 million for the same period in2010. This was mainly due to the decrease in costs associated with our TV advertisement business segment, which was in line with the decrease in our TVadvertisement revenue. Our cost of revenues related to the offering of our advertising and marketing services primarily consists of internet resourcespurchased from other portal websites and technical services providers related to lead generation, sponsored search, TV advertisement time costs purchasedfrom TV stations, direct labor cost associated with providing services and business taxes and surcharges. 59 ·Cost associated with obtaining internet resources was the largest component of our cost of revenue for internet advertisement, accounting forapproximately 80% of our total internet advertisement cost of sales. We purchased these internet resources from other well-known portal websites inChina, such as: Baidu, Google and Tecent (QQ). Our purchasing of these internet resources in large volumes for ultimate use by our customers allowedus to negotiate discounts with our suppliers. The majority of the resources purchased were used by the internet advertising unit to attract more internettraffic to our advertising portals, assist our internet advertisement clients to obtain more diversified exposure and to generate more visits to theiradvertisements and mini-sites placed on our portal websites. For the years ended 2011 and 2010, our total cost of sales for internet advertising wasUS$6.0 million and US$6.3 million, respectively. The decrease in our cost of sales for internet advertising revenue was mainly due to a decreasedvolume of internet resources that we purchased to match the decreasing demands, and such decreases were partially offset by the increase in thepurchase price of such resources as compared in 2010. ·Beginning in December 2009, our WFOE began providing a number of value added technical services to our internet advertisement customers. Thedirect cost of sales for the WFOE’s technical services revenue recognized by our WFOE was primarily the PRC business tax expenses, which wasapproximately 5% of the total technical service revenue recognized by Rise King WFOE. The decrease in the business tax expenses incurred by ourWFOE in 2011 was in line with the decrease in the technical services revenue earned by our WFOE in 2011 as compared to that in 2010. ·TV advertisement time cost is the largest component of cost of revenue for TV advertisement revenue. We purchase TV advertisement time fromdifferent provincial TV stations and resell it to our TV advertisement clients. Our TV advertisement time cost was approximately US$5.2 million andUS$12.0 million for the years ended December 31, 2011 and 2010, respectively. The significant decrease in our total TV advertisement time cost inyear 2011 was mainly due to the decrease of the approximately 8,380 total minutes we purchased and resold in year 2011 as compared to year 2010.However, our gross profit margin for this segment increased to 19% for the year ended December 31, 2011 as compared to 4% for the same period of2010. This improvement was primarily due to the efficiency of purchasing TV time on a more cost effective basis while simultaneously matching ourcustomers’ needs. In addition, we only kept the TV advertising time from the stations that can be purchased on a more affordable cost basis ascompared with the selling price that our customers can afford. ·Cost recognized for Brand management and sales channel building business segment mainly consisted of director labor cost for providing theseservices to our customers and the related business tax and surcharges. Gross Profit As a result of the foregoing, our gross profit was US$16.7 million for the year ended December 31, 2011 as compared to US$22.6 million for the same periodin 2010. Along with the improvement of the gross profit margin of our TV advertisement segment and the gross profit generated from our newly establishedbusiness segment, Brand management and sales channel building, our overall gross margin increased to 58% for the year ended December 31, 2011 ascompared with 54% for the same period in 2010. Operating Expenses and Net Income Our operating expenses consist of selling expenses, general and administrative expenses and research and development expenses. The followingtables set forth our operating expenses, divided into their major categories by amount and as a percentage of our total revenues for the periods indicated. 60 Years ended December 31, 2011 2010 (Amounts expressed in thousands of US dollars, except percentages) Amount % of total revenue Amount % of total revenue Total Revenue $28,731 100% $41,587 100%Gross Profit 16,704 58% 22,617 54%Selling expenses 3,506 12% 3,403 8%General and administrative expenses 7,904 28% 3,460 8%Research and development expenses 2,132 7% 907 2%Total operating expenses 13,542 47% $7,770 19% Operating Expenses: Our operating expenses increased to US$13.5 million for the year ended December 31, 2011 from US$7.8 million for the same periodof 2010. ·Selling expenses: Selling expenses increased to US$3.5 million for the year ended December 31, 2011 from US$3.4 million for the same period of2010. Our selling expenses primarily consist of advertising expenses for brand development that we pay to TV stations and other media outlets for thepromotion and marketing of our advertising web portals, other advertising and promotional expenses, website server hosting and broadband leasingexpenses, staff salaries, staff benefits, performance bonuses, travelling expenses and communication expenses of our sales department. For the yearended December 31, 2011, the change in our selling expenses was mainly due to the following reasons: (1) the increase in the share-basedcompensation expenses in relation to the restricted stock and common stock purchase options issued to members of our sales department ofapproximately US$0.68 million; (2) the increase in staff salary, bonus, benefit expenses and other general selling expenses, such as entertainmentexpenses, travelling expenses and communication expenses of approximately US$0.08 million, due to expansion of our sales department throughnewly formed and acquired VIEs in 2011; and (3) our brand development advertising expenses for our advertising web portals decreased byapproximately US$0.65 million. We do not believe that brand-building expenses will continue to be a significant portion of our selling expenses on agoing-forward basis, because, through the investment we made in brand building over the last three years, we have achieved our expected results. Ourkey advertising web portal, 28.com has brand recognition as one of the most popular Chinese internet portals providing advertising and marketingservices and other value-added services to SMEs, particularly for small and medium-sized franchisors, in the PRC. Beginning in fiscal year 2010,management decided to gradually reduce such costs due to the significant increase in the costs of TV advertising. ·General and administrative expenses: General and administrative expenses increased to US$7.9 million for the year ended December 31, 2011 ascompared to US$3.5 million for the same period in 2010. Our general and administrative expenses primarily consist of salaries and benefits formanagement, accounting and administrative personnel, office rentals, depreciation of office equipment, professional service fees, maintenance,utilities and other office expenses. The change in our general and administrative expenses for the year ended December 31, 2011 was mainly due tothe following reasons: (1) the increase in the share-based compensation expenses in relation to the restricted stock and common stock purchase optionsissued to our management, directors and employees on November 30, 2011, of approximately US$1.26 million; (2) the increase in the bad debtsprovision of approximately US$2.58 million, which related to the account receivable balances of our internet advertising and the related technicalservices business segments, which had an aging over 6 to 9 months and the overdue contract execution deposits related to our TV advertising segment;(3) the increase in the amortization expenses related to the intangible assets identified in the acquisitions of Quanzhou Zhi Yuan and Quanzhou TianXi Shun He of approximately US$0.37 million; (4) the decrease of general and administrative expenses of Shenzhen Mingshan, which wasdeconsolidated from us in early 2011 of approximately US$0.27 million; and (5) the increase in salary expenses and other general administrativeexpenses of the newly formed and acquired VIEs in 2011 of approximately US$0.44 million. ·Research and development expenses: Research and development expenses increased to US$2.1 million for the year ended December 31, 2011 fromUS$0.9 million for the same period of 2010. Our research and development expenses primarily consist of salaries and benefits for the research anddevelopment staff, equipment depreciation 61 expenses, and office utilities and supplies allocated to our research and development department. The increase in our research and developmentexpenses for the year ended December 31, 2011 was mainly due to the following reasons: (1) the increase in the share-based compensation expenses inrelation to the restricted stock and common stock purchase options issued to members of our research and development department of approximatelyUS$0.67 million; (2) the increase in the amortization expenses of cloud-computing based software technologies we acquired in 2011 of approximatelyUS$0.07 million; and (3) the increase of salary, staff benefit expenses and other R&D expenses of approximately US$0.46 million due to expansion ofour research and development department in 2011. We expect that our research and development expenses will increase in future periods as wecontinue to expand, optimize and enhance the technology of our portal websites, upgrade our advertising and internet management software anddevelop our cloud-computing based management tools. In the next three to five years, we expect our research and development expenses to be withinthe range of four percent to six percent of our total revenues. Operating Profit: As a result of the foregoing, our operating profit decreased to US$3.2 million for the year ended December 31, 2011 from US$14.8 millionfor the same period of 2010. Changes in Fair Value of Warrants: We originally accounted for our warrants issued to investors and placement agent in our August 2009 financing asderivative liabilities under ASC Topic 815 “Derivatives and Hedging”, because it contains a “Down-round” protection that were applicable if we were toissue new shares of common stock or common stock equivalents at a price per share less than the exercise price of the Warrants. The “Down-round protection”provision is not considered to be an input to the fair value of a fixed-for-fixed option on equity shares which lead to the Warrants to fail to be qualified asindexed to the Company’s own stock and then fail to meet the scope exceptions of ASC Topic 815. Therefore, we accounted for the Warrants as derivativeliabilities under ASC Topic 815. Pursuant to ASC Topic 815, derivative should be measured at fair value and re-measured at fair value with changes in fairvalue recorded in earnings at each reporting period. On March 29, 2010, we and the holders of the Warrants entered into agreements to amend certainprovisions of the Warrants. The amendment to the investor and placement agent warrants removes the “Down-round protection” rights. In addition, theamendment to the warrants added a provision to grant the holders of a majority of the warrants an approval right until December 31, 2010, over any newissuance of shares of common stock or common stock equivalents at a price per share less than the exercise price of the warrants. As a result of thisamendment, the Warrants issued in the August 2009 financing were qualified as indexed to our own stock and then met the scope exceptions of ASC Topic815, and were eligible to be reclassified as equity. In accordance with ASC Topic 815, the classification of a contract should be reassessed at each balancesheet date. If the classification required under this ASC changes as a result of events during the period, the contract should be reclassified as of the date of theevent that caused the reclassification. If a contract is reclassified from an asset or a liability to equity, gains or losses recorded to account for the contract atfair value during the period that the contract was classified as an asset or a liability should not be reversed. Therefore, we re-measured the fair value of theWarrants as of March 29, 2010, the date of the event that caused the classification, which was approximately US$7.7 million and reclassified the amount toequity as additional paid-in capital. The gain of the changes in fair value during the period that the Warrants were classified as a derivative liability for theyear ended December 31, 2010, which was approximately US$1.86 million was recorded in earnings for the year ended December 31, 2010. Changes in Fair Value of Contingent Consideration Receivables: According to the acquisition agreements we entered into with Quanzhou Zhi Yuan andQuanzhou Tian Xi Shun He, if audited pretax profit for 2011 and 2012 increases by less than 30% compared to that of the prior year, the sellers shallcompensate us for the difference between the target pretax profit and actual results achieved in cash. Fair value of the contingent consideration receivable asof the respective acquisition date of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He was approximately US$0.05 million and US$0.06 million,respectively. As Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He have both achieved their respective target pre-tax profit for the year ended December31, 2011, they will not compensate us any cash in accordance with the acquisition agreement. We reassessed the fair value of these contingent considerationreceivables as of December 31, 2011 for the respective make good arrangement of these acquirees for the year ended December 31, 2012, based on theirrespective historical performance and other relevant assumptions. The changes in the fair value of these contingent consideration receivables ofapproximately US$0.07 million for the year ended December 31, 2011 was included in our consolidated statement of income and comprehensive income. 62 Gain on deconsolidation of subsidiaries: The deconsolidation of Shenzhen Mingshan and Zhao Shang Ke Hubei that occurred on January 6, 2011 andDecember 29, 2011, respectively, were accounted for in accordance with ASC Topic 810 “Consolidation”. We recognized a gain of approximately US$0.23million upon deconsolidation of Shenzhen Mingshan and a gain of approximately US$0.69 million upon deconsolidation of Zhao Shang Ke Hubei in ourconsolidated statements of income and comprehensive income for the year ended December 31, 2011, with a corresponding increase to the carrying value ofthe investment in Shenzhen Mingshan and Zhao Shang Ke Hubei, respectively, in our consolidated balance sheet. These deconsolidation gains representedthe 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 therespective date of deconsolidation. Income before income tax expense, equity method investments and noncontrolling interests: As a result of the foregoing, our income before income taxexpenses, equity method investment and noncontrolling interest decreased to US$4.0 million for the year ended December 31, 2011 from US$16.7 millionfor the same period in 2010. Income Tax expenses: We recognized an income tax expense of approximately US$1.04 million and US$0.35 million for the year ended December 31, 2011and 2010, respectively. The increase in income tax expenses was mainly due to the increase in the effective income tax rates of our PRC operating entities,Business Opportunity Online and Rise King WFOE for the year ended December 31, 2011 as compared to those for the same period of 2010, due toexpiration of the tax holidays. For fiscal year 2011, the applicable income tax rate for Business Opportunity Online and Rise King WFOE were 15% and12.5%, respectively. For fiscal year 2010, the applicable income tax rates for these two operating entities were 7.5% and nil%, respectively. For the yearended December 31, 2011, our income tax expenses also included an approximately US$0.21 million deferred income tax expenses in relation to theapproximately US$0.93 million gain on deconsolidation of subsidiaries recognized for the year ended December 31, 2011, an approximately US$0.09million deferred income tax benefit in relation to the approximately US$0.37 million amortization expenses of the intangible assets identified uponacquisition of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He for the year ended December 31, 2011 and an approximately US$0.09 million deferredincome tax benefit in relation to the approximately US$0.36 million net operating loss carry forward incurred by our PRC operating VIEs, which we considerlikely 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 andnoncontrolling interest decreased to US$3.0 million for the year ended December 31, 2011 from US$16.4 million for the same period of 2010. Share of earnings (losses) in equity investment affiliates: We acquired a 49% equity interest in Beijing Yang Guang in December 2010. In August 2011, wetransferred our 49% equity interest in Beijing Yang Guang to its majority shareholder. Our pro-rata share of earnings recognized in the aggregate for theperiod when we held the 49% equity interest in Beijing Yang Guang was approximately US$0.03 million, which was received as distribution of earningsfrom Beijing Yang Guang in early November 2011. Shenzhen Mingshan used to be 51% owned by one of our operating VIEs and was a consolidated entityof our company from its date of incorporation through January 6, 2011. On January 6, 2011, an independent third party investor invested RMB15,000,000(approximately US$2,356,749) to Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan, and our share of equity interestdecreased from 51% to 20.4% accordingly. Shenzhen Mingshan then became an equity investment affiliate of ours. Accordingly, we recognized our pro-ratashare of losses in Shenzhen Mingshan immediately after the deconsolidation, which was approximately US$0.25 million for the year ended December 31,2011 with a corresponding decrease to the carrying value of long term investment in Shenzhen Mingshan. Given the foregoing, net amount recognized asshare of losses in equity investment affiliates was approximately US$0.22 million for the year ended December 31, 2011. Net Income: As a result of the foregoing, our net income decreased to US$2.8 million for the year ended December 31, 2011 from US$16.4 million for thesame period of 2010. Excluding the non-cash gain recognized for deconsolidation of subsidiaries of approximately US$0.93 million, the related deferredincome tax expenses of approximately US$0.21 million, the non-cash expenses of share-based compensation recognized for the restricted stock and commonstock purchase options issued on November 30, 2011 of approximately US$2.6 million and the non-cash charge of the changes in fair value of the contingentconsideration receivables of approximately US$0.07 63 million for the year ended December 31, 2011; and the non-cash gain in relation to the changes in fair value of warrants of US$1.86 million for theyear ended December 31, 2010, we achieved adjusted Non-GAAP net income amounting to US$4.7 million and US$14.5 million for the yearsended December 31, 2011 and 2010, respectively. Loss attributable to noncontrolling interest: Shenzhen Mingshan was 51% owned by Business Opportunity Online upon incorporation until it wasdeconsolidated 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 incorporationuntil it was deconsolidated from us in December 2011. Beijing Chuang Fu Tian Xia and Sheng Tian Hubei were 51% owned by Business Opportunity Onlineand Business Opportunity Online Hubei, respectively, upon incorporation. Accordingly, net losses incurred by these entities during the period when theywere majority-owned subsidiaries of our PRC VIEs were allocated between their respective shareholders based on their respective percentage of theownership in these entities for the year ended December 31, 2011 and 2010. For the year ended December 31, 2011, the net losses allocated to thenoncontrolling interest of Quanzhou Tian Xi Shun He, Zhao Shang Ke Hubei, Beijing Chuang Fu Tian Xia and Sheng Tian Hubei were approximatelyUS$0.21 million. For the year ended December 31, 2010, net loss allocated to the noncontrolling interest of Shenzhen Mingshan was also approximatelyUS$0.21 million. Net income attributable to ChinaNet Online Holdings, Inc.: Total net income as adjusted by the net loss attributable to the noncontrolling interestshareholders as discussed above yields the net income attributable to ChinaNet Online Holdings, Inc. Our net income attributable to ChinaNet OnlineHoldings, Inc. decreased to US$3.0 million for the year ended December 31, 2011 from US$16.6 million for the same period of 2010. Adjusted Non-GAAPnet income attributable to ChinaNet Online Holdings, Inc. which excludes the previously discussed non-cash gains or expenses recognized for non-recurringtransactions for the year ended December 31, 2011 and 2010, was approximately US$5.0 million and US$14.7 million for the year ended December 31, 2011and 2010, 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 theliquidation 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 eachof the reporting period. The cash dividends we accrued for the Series A convertible preferred stock were approximately US$0.41 million and US$0.79 millionfor the years ended December 31, 2011 and 2010, respectively. Net income attributable to ChinaNet’s common shareholders: Net income attributable to ChinaNet’s common shareholders represents the net income afterallocation to noncontrolling interests minus the cash dividend accrued for Series A convertible preferred stock. Our net income attributable to ChinaNet’scommon shareholders decreased to US$2.6 million for the year ended December 31, 2011 from US$15.8 million for the same period of 2010. 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$4.5 million and US$13.9 million for the years ended December 31, 2011 and 2010, respectively. 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 originalmaturities of three months or less at the time of purchase to be cash equivalents. As of December 31, 2011, we had cash and cash equivalents ofapproximately US$10.7 million. Our liquidity needs include (i) net cash used in operating activities that consists of (a) cash required to fund the initial build-out and continuedexpansion of our network and (b) our working capital needs, which include deposits and advance payment to TV advertising slots and internet resourceproviders, payment of our operating expenses and financing of our accounts receivable; and (ii) net cash used in investing activities that consist of thepayment for acquisitions to further expand our business and client base, investment in software technologies to enhance the functionality of the managementtools provided by our advertising portals and investment in other general office equipment. To date, we have financed our liquidity need primarily throughproceeds from our operating activities generated in prior years. 64 The following table provides detailed information about our net cash flow for the periods indicated: Year ended December 31, 2011 2010 Amounts in thousands of US dollars Net cash (used in)/provided by operating activities $(603) $11,582 Net cash used in investing activities (6,084) (9,373)Net cash provided by/(used in) financing activities 1,482 (767)Effect of foreign currency exchange rate changes on cash 310 231 Net (decrease)/increase in cash and cash equivalents $(4,895) $1,673 Net cash (used in)/provided by operating activities: For the year ended December 31, 2011, our net cash used in operating activities of approximate 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 2,000,000shares of restricted stock and 885,440 shares of common stock purchase options issued to our management and employees on November 30, 2011and US$1.3 million of other non-cash expenses of depreciation, amortizations and our share of losses in equity investment affiliates ofapproximately 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$5.3 million, which was mainly due to the collection of the third party loans and thepartial collection of the loan made for the production of the TV series “Xiao Zhan Feng Yun”; - accounts payable, other payables and accrued payroll and other accruals increased by approximately U$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, mainly due to the prepayments and deposits paidfor the TV advertisement time purchase agreements signed for year 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 tothem for the cost and operating expenses paid by them on behalf of the company in previous years; and - we also paid approximately US$0.2 million for other current assets. For the year ended December 31, 2010, our net cash provided by operating activities of approximate US$11.6 million were primarily attributable to: 65(1) net income excluding the US$1.86 million of non-cash gain recorded for the changes in fair value of warrants and the US$0.8 million of non-cashexpenses of depreciation, amortization and share-based compensation expenses of approximately US$15.3 million; (2) the receipt of cash from operations from changes in operating assets and liabilities such as: - advance from customers increased by approximately US$1.1 million; - due to related parties and due to director increased by approximately US$0.7 million; - accrued payroll and other accruals increased by approximately US$0.3 million; - taxes payable increased by approximately US$0.1 million; and - prepayment to suppliers decreased by approximately US$0.9 million; (3) offset by the use from operations from changes in operating assets and liabilities such as: - accounts receivable and due to related parties for the advertising services provided increased by approximately US$0.7 million; - other receivables increased by approximately US$5.0 million, which mainly due to the increase of the temporary loans lent to thirdparties and the approximate US$3.8 million loan for marketing campaign activities to the production of a TV series of “Xiao ZhangFeng Yun”. This TV series is produced for the commemoration of “The Republican Revolution of 1911”, we would be shown duringthe credit at the closing of each episode with our logo presented and also shown as a separate card during the closing before the creditscreen; and - we also settled the amount due to control group for approximately US$1.1 million for the cost and expenses paid by them on behalf ofour company in previous years. Net cash used in investing activities: For the year ended December 31, 2011, our net cash used in investing activities included the following transactions: (1) we paid approximatelyUS$9.7 million in connection with the acquisitions incurred during the year, including the acquisitions of a 100% equity interest of Quanzhou Zhi Yuan anda 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 inJune 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 ascash inflow from investing activities during the year was approximately US$0.3 million, (3) we paid approximately US$1.7 million to our equity investmentaffiliates during the year, including an additional US$1.5 million working capital loan to Beijing Yang Guang in the first quarter of 2011 and anapproximately US$0.2 million additional cash investment to ShenZhen Mingshan in the third quarter of 2011; (4) from August to December 2011, after wedisposed our investment in Beijing Yang Guang, we collected approximately US$8.9 million in the aggregate for (i) the cash consideration of the disposal ofthe 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 the49% 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 ofdeconsolidation of Shenzhen Mingshan and Zhao Shang Ke Hubei recorded as cash outflow from investing activities during the year was approximatelyUS$1.7 million, which represented the cash balance of the deconsolidated subsidiaries as of their respective deconsolidation dates; (6) we also investedapproximately 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 activitiesof approximately US$6.1 million for the year ended December 31, 2011. For the year ended December 31, 2010, our net cash used in investing activities included the following transactions: (1) we prepaid approximatelyUS$1.5 million as deposit for the acquisition of a 100% equity interest in Quanzhou Zhi Yuan and a 51% equity interest in Quanzhou Tian Xi Shun He. These two acquisitions were 66 subsequently consummated in the first quarter of 2011; (2) we paid approximately US$1.1 million and acquired a 49% equity interest in a newlyestablished company, Beijing Yang Guang; (3) after the acquisition of a 49% equity interest in Beijing Yang Guang, we lent Beijing Yang Guangapproximately US$5.9 million to provide sustainable level of its working capital for the expansion of TV advertisement business; (4) we alsoinvested approximately US$1.1 million in fixed assets for the year ended December 31, 2010, including approximately US$0.5 million for thepurchase of new bank kiosk equipment; and (5) as a result of the acquisition of Shanghai Jing Yang, we consolidated approximately US$0.2million cash from this VIE, which was recorded as cash inflow from investing activities during the year. In the aggregate, these transactionsresulted in a net cash outflow from investing activities of approximately US$9.4 million for the year ended December 31, 2010. Net cash provided by/ (used in) financing activities: For the year ended December 31, 2011, our net cash provided by financing activities was approximately US$1.5 million which mainly consisted ofthe following transactions: (1) cash dividends paid to our preferred stockholders of approximately US$0.7 million; (2) cash contributed by thenoncontrolling 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, whichwas recorded as cash inflow from financing activities during the year; and (4) we, through one of our VIEs borrowed approximately US$0.2 million workingcapital loan from Zhao Shang Ke Hubei, which was also recorded as cash inflow from financing activities during the year. For the year ended December 31, 2010, our net cash used in financing activities was approximately US$0.77 million which mainly consisted of thefollowing transactions: (1) cash dividends paid to our preferred stockholders of approximately US$0.91 million; and (2) cash contributed by thenoncontrolling interest shareholders of Shenzhen Mingshan of approximately US$0.15 million in connection with the establishment of the company. 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 receivingdistributions of funds from our PRC subsidiary and VIEs. Relevant PRC statutory laws and regulations permit payments of dividends by our PRC subsidiaryand 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 PRCrequirements for appropriation to statutory reserves. Paid in capital of the PRC subsidiary and VIEs included in our consolidated net assets are also notdistributable for dividend purposes. In accordance with the PRC regulations on Enterprises with Foreign Investment, a WFOE established in the PRC is required to provide certainstatutory reserves, namely general reserve fund, the enterprise expansion fund and staff welfare and bonus fund which are appropriated from net profit asreported 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 suchreserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. Appropriations to the enterprise expansion fund and staffwelfare and bonus fund are at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are notdistributable as cash dividends. Rise King WFOE is subject to the above mandated restrictions on distributable profits. Additionally, in accordance with theCompany 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 suchreserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide for adiscretionary surplus reserve, at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are notdistributable 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, our PRC subsidiary and VIEs are restricted in their ability to transfer a portion of their net assets to us. As of December 31, 2011 and 2010, net assets restricted in the aggregate, which includes paid-in capital and statutory reserve funds of our PRC subsidiaryand VIEs that are included in our consolidated net assets, was approximately US$4.7 million and US$3.4 million, respectively. 67 The New PRC Enterprise Income Tax (“EIT”) Law, which was effected on January 1, 2008, also imposed a 10% withholding income tax fordividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous EIT law. Alower 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 Kongand 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 exchangeand 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, interestpayments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation ofinvestments and investments in securities outside of China, unless the prior approval of the State Administration of Foreign Exchange (the “SAFE”) isobtained and prior registration with the SAFE is made. Foreign-invested enterprises like Rise King WFOE that need foreign exchange for the distribution ofprofits to its shareholders may effect payment from their foreign exchange accounts or purchase and pay foreign exchange rates at the designated foreignexchange banks to their foreign shareholders by producing board resolutions for such profit distribution. Based on their needs, foreign-invested enterprisesare permitted to open foreign exchange settlement accounts for current account receipts and payments of foreign exchange along with specialized accountsfor 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 ofChinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of SAFE, which isunder the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign currency conversion. We cannot besure that it will be able to obtain all required conversion approvals for our operations or the Chinese regulatory authorities will not impose greater restrictionson the convertibility of Chinese Renminbi in the future. Currently, most of our retained earnings are generated in Renminbi. Any future restrictions oncurrency exchanges may limit our ability to use retained earnings generated in Renminbi to make dividends or other payments in U.S. dollars or fundpossible business activities outside China. As of December 31, 2011 and 2010, there were approximately US$34.0 million and US$26.8 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$2.2 million andUS$1.6 million statutory reserve funds as of December 31, 2011 and 2010, respectively, that may be affected by increased restrictions on currency exchangesin 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 tothe approximately US$4.7 million and US$3.4 million restricted net assets as of December 31, 2011 and 2010, respectively, as discussed above. C. Off-Balance Sheet Arrangements None. D. Tabular Disclosure of Contractual Obligations The following table sets forth our company’s contractual obligations as of December 31, 2011: 68 Server hosting and board-band lease Purchase of TV advertisement time Total US$(‘000) US$(‘000) US$(‘000)Year ended December 31, -2012110 32,941 33,051 -Thereafter- - -Total110 32,941 33,051 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 8FINANCIAL 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 9CHANGES IN AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL DISCLOSURES The practice of Bernstein & Pinchuk LLP (“B&P”), our company’s independent registered public accounting firm, entered into a joint ventureagreement with Marcum LLP and formed Marcum Bernstein & Pinchuk LLP (“MarcumBP”) in a transaction pursuant to which B&P merged its Chinaoperations into MarcumBP and certain of the professional staff of B&P joined MarcumBP as employees of MarcumBP (“the “Merger”). Accordingly, andsolely as a result of the Merger, effective April 14, 2011, B&P effectively resigned as our company’s independent registered public accounting firm andMarcumBP became our company's independent registered public accounting firm. This change in our company’s independent registered public accountingfirm was approved by the Audit Committee of our company’s Board of Directors. There were no disagreements with Marcum BP and BP on accounting and financial disclosures during the period that they serviced as ourcompany’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 conductedan 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) underthe Exchange Act, as of the end of December 31, 2011. Based on this evaluation, our chief executive officer and chief financial officer concluded as ofDecember 31, 2011 that our disclosure controls and procedures were effective such that the material information required to be included in our SEC reports isrecorded, processed, summarized and reported within the time periods specified in SEC rules and forms relating to our company, including our consolidatingsubsidiaries 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 isdefined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regardingthe reliability of financial reporting and 69 the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States ofAmerica. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degreeof 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 evaluationof the effectiveness of its internal control over financial reporting as of December 31, 2011. The framework on which such evaluation was based is containedin 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 financialreporting was effective as of December 31, 2011. Changes in Internal Controls over Financial Reporting There were no significant changes in our internal controls over financial reporting identified in connection with this evaluation that occurred duringour 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 processacross our major operations to evaluate our internal control over financial reporting, engaging employees at all levels of the organization. Our internalcontrol environment includes a corporate-wide attitude of integrity and control consciousness. This is exemplified by our ethics education program thatincludes long-standing principles and policies on ethical business conduct that require employees to maintain the highest ethical and legal standards in theconduct of our business. We have distributed the Board of Directors approved policy on ethics and code of business conduct to all employees and requiredthem to study and abide by the policy. We encourage any employee may report suspected violations of law or our policy. The internal control system furtherincludes 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. OurBoard of Directors, assisted by the Audit Committee, monitors the integrity of our financial statements and financial reporting procedures, the performance ofour internal audit function and independent auditors, and other matters set forth in its charter. The Committee, which currently consists of three independentdirectors, meets regularly with representatives of management, and with the independent auditors and the Internal Auditor, with and without managementrepresentatives 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 financialreporting. 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 notreported. 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 forour next Annual Meeting of Stockholders, pursuant to Regulation 14A of the 70 Securities Exchange Act of 1934, as amended (the “Proxy Statement”), within 120 days of the end of the fiscal year covered by this report, andcertain information to be included in the Proxy Statement is incorporated herein by reference. ITEM 10DIRECTORS, 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—Nominatingand Corporate Governance Committee—last paragraph is incorporated herein by reference. ITEM 11EXECUTIVE COMPENSATION The information set forth in the Proxy Statement under the captions Election of Directors—Executive Compensation is incorporated herein byreference. ITEM 12SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS The information set forth in the Proxy Statement under the caption Security Ownership of Certain Beneficial Owners and Management isincorporated herein by reference. ITEM 13CERTAIN 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 thedirectors and in the last paragraph under that caption, and the information under the caption Election of Directors—Certain Relationships and RelatedTransactions is incorporated herein by reference. ITEM 14PRINCIPAL ACCOUNTANT FEE AND SERVICES The information set forth in the Proxy Statement under the captions Ratification of the Appointment of Independent Accountants—Services andFees of Independent Accountants and Ratification of the Appointment of Independent Accountants—Pre-Approval of Services is incorporated herein byreference. PART IV. ITEM 15EXHIBITS 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:2.1Share Exchange Agreement, dated as of June 26, 2009, by and among Emazing Interactive, Inc., G. Edward Hancock, China Net Online Media GroupLimited, and the shareholders of China Net Online Media Group Limited.(1) 71 2.2Escrow Agreement, dated as of June 8, 2009, by and between Emazing Interactive, Inc., China Net Online Media Group Limited, Edward Hancockand Leser, Hunter, Taubman & Taubman. (1) 2.3Agreement and Plan of Merger (2) 3.1Articles of Incorporation of Emazing Interactive, Inc., as amended (1) 3.2Articles of Merger. (2) 3.3By-laws. (4) 4.1Registration Rights Agreement, dated as of June 26, 2009, by and among Emazing Interactive, Inc. and certain stockholders listed therein. (1) 4.2Form of Series A-1 Warrant. (3) 4.3Form of Series A-2 Warrant. (3) 4.4Registration Rights Agreement, dated as of August 21, 2009. (3) 4.5*2011 Omnibus Securities and Incentive Plan (9) 10.1Exclusive 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) 10.2Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., BeijingCNET Online Advertising Co., Ltd. and Handong Cheng with respect to Mr. Cheng’s equity interest in Beijing CNET Online Advertising Co., Ltd.(1) 10.3Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., BeijingCNET Online Advertising Co., Ltd. and Xuanfu Liu with respect to Mr. Liu’s equity interest in Beijing CNET Online Advertising Co., Ltd. (1) 10.4Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., BeijingCNET Online Advertising Co., Ltd. and Li Sun with respect to Ms. Sun’s equity interest in Beijing CNET Online Advertising Co., Ltd.(1) 10.5Equity 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 AdvertisingCo., Ltd. (1) 10.6Equity 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) 10.7Equity 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) 72 10.8Power of Attorney of Handong Cheng, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. ashis agent and attorney in connection with his equity interest in Beijing CNET Online Advertising Co., Ltd. (1) 10.9Power of Attorney of Xuanfu Liu, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as hisagent and attorney in connection with his equity interest in Beijing CNET Online Advertising Co., Ltd. (1) 10.10Power of Attorney of Li Sun, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as her agentand attorney in connection with her equity interest in Beijing CNET Online Advertising Co., Ltd. (1) 10.11Exclusive 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) 10.12Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., BusinessOpportunity Online (Beijing) Network Technology Co., Ltd. and Handong Cheng with respect to Mr. Cheng’s equity interest in BusinessOpportunity Online (Beijing) Network Technology Co., Ltd. (1) 10.13Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., BusinessOpportunity Online (Beijing) Network Technology Co., Ltd. and Xuanfu Liu with respect to Mr. Liu’s equity interest in Business OpportunityOnline (Beijing) Network Technology Co., Ltd. (1) 10.14Exclusive Option Agreement, dated as of October 8, 2008, by and among Rise King Century Technology Development (Beijing) Co., Ltd., BusinessOpportunity 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) 10.15Equity 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 BusinessOpportunity Online (Beijing) Network Technology Co., Ltd. (1) 10.16Equity 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 BusinessOpportunity Online (Beijing) Network Technology Co., Ltd. (1) 10.17Equity 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 OpportunityOnline (Beijing) Network Technology Co., Ltd. (1) 10.18Power of Attorney of Handong Cheng, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. ashis agent and attorney in connection with his equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1) 10.19Power of Attorney of Xuanfu Liu, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as hisagent and attorney in connection with his equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1) 73 10.20Power of Attorney of Li Sun, dated as of October 8, 2008, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as her agentand attorney in connection with her equity interest in Business Opportunity Online (Beijing) Network Technology Co., Ltd. (1) 10.21Entrustment Agreement, dated June 5, 2009, by and between Rise King Investments Limited and Handong Cheng, Xuanfu Liu and Li Sun. (1) 10.22Share Transfer Agreement, dated April 28, 2009, by and between Yang Li and Handong Cheng (1) 10.23Share Transfer Agreement, dated April 28, 2009, by and between Yang Li and Xuanfu Liu (1) 10.24Share Transfer Agreement, dated April 28, 2009, by and between Yang Li and Li Sun (1) 10.25Internet Banking Experiencing All-in-One Engine Strategic Cooperation Agreement, dated August 7, 2008, by and between Henan Branch of ChinaConstruction Bank and Shanghai Borongdingsi Computer Technology Co., Ltd. (1) 10.26Cooperation Agreement, dated July 8, 2008, by and between Beijing CNET Online Advertising Co., Ltd. and Shanghai Borongdingsi ComputerTechnology Co., Ltd. (1) 10.27Supplemental Agreement to the Cooperation Agreement, dated December 10, 2008, by and between Beijing CNET Online Advertising Co., Ltd. andShanghai Borongdingsi Computer Technology Co., Ltd. (1) 10.28Office Lease Agreement, dated January 1, 2009, by and between Beijing YuQuanHuiGu Realty Management Ltd. Co. and Business OpportunityOnline (Beijing) Network Technology Ltd. Co. (1) 10.29Office Lease Agreement, dated January 1, 2009, by and between Beijing YuQuanHuiGu Realty Management Ltd. Co. and Beijing CNET OnlineAdvertising Co., Ltd. (1) 10.30Office Lease Agreement, dated January 1, 2009, by and between Beijing YuQuanHuiGu Realty Management Ltd. Co. and Rise King CenturyTechnology Development (Beijing) Co., Ltd. (1) 10.31Securities Purchase Agreement, dated as of August 21, 2009. (3) 10.32Securities 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) 10.36Warrant Amendment Agreement 10.37Exclusive 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) 74 10.38Exclusive Option Agreement, dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., WeiYanmin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8) 10.39Exclusive Option Agreement, dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., WuHuamin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8) 10.40Equity 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) 10.41Equity Interest Pledge Agreement dated as of December 6, 2010, by and among Rise King Century Technology Development (Beijing) Co., Ltd., WuHuamin and Rise King (Shanghai) Advertisement & Media Co., Ltd. (8) 10.42Power of Attorney of Wei Yanmin, dated as of December 6, 2010, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as hisexclusive agent and attorney in connection with his equity interest in Rise King (Shanghai) Advertisement & Media Co., Ltd. (8) 10.43Power of Attorney of Wu Huamin, dated as of December 6, 2010, appointing Rise King Century Technology Development (Beijing) Co., Ltd. as hisexclusive agent and attorney in connection with his equity interest in Rise King (Shanghai) Advertisement & Media Co., Ltd. (8) 10.44Equity Transfer Agreement, dated as of December 15, 2011, Among Business Opportunity Online (Hubei) Network Technology Co., Ltd., LiuYihang, Wei Yanmin and Soo Yi Lian Mei Network Technology (Beijing) Co. Ltd. (10) 14Code of Ethics (6) 21.1Subsidiaries of the Registrant (7) 23.1Consent of Marcum Bernstein & Pinchuk LLP 23.2Consent of Bernstein & Pinchuk LLP 31.1Certification pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. + 31.2Certification pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. + 32.1Certification 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 onOctober 20, 2006. 75 (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 (7)Incorporated by reference herein to the Company’s Registration Statement on Form S-1 filed on September 22, 2009. (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. (b)The exhibits listed on the Exhibit Index are filed as part of this report. (c)Not applicable. 76 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 besigned on its behalf by the undersigned thereunto duly authorized. ChinaNet Online Holdings, Inc. Dated: April 16, 2012By:/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 registrantand in the capacities and on the dates indicated.Dated: April 16, 2012By:/s/ Handong Cheng Name:Handong Cheng Title:Chairman and Chief Executive Officer(Principal Executive Officer)Dated: April 16, 2012By:/s/ Zhige Zhang Name:Zhige Zhang Title:Chief Financial Officer(Principal Financial Officer) and DirectorDated: April 16, 2012By:/s/ Zhiqing Chen Name:Zhiqing Chen Title:DirectorDated: April 16, 2012By:/s/ Mototaka Watanabe Name:Mototaka Watanabe Title:DirectorDated: April 16, 2012By:/s/ Douglas MacLellan Name:Douglas MacLellan Title:Director 77 CHINANET ONLINE HOLDINGS, INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 Pages Report of Independent Registered Public Accounting Firm – Marcum Bernstein & Pinchuk LLPF-1 Report of Independent Registered Public Accounting Firm – Bernstein & Pinchuk LLPF-2 Consolidated Balance Sheets as of December 31, 2011 and 2010F-3-F-4 Consolidated Statements of Income and Comprehensive Income for the Years ended December 31, 2011 and 2010F-5-F-6 Consolidated Statements of Cash Flows for the Years ended December 31, 2011 and 2010F-7-F-8 Consolidated Statements of Changes in Stockholders’ Equity for the Years ended December 31, 2011 and 2010F-9-F-10 Notes to Consolidated Financial StatementsF-11-F-51  REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Audit Committee of the Board of Directors and Shareholders ofChinaNet Online Holdings, Inc. We have audited the accompanying consolidated balance sheet of ChinaNet Online Holdings, Inc. and Subsidiaries (the “Company”) as of December 31,2011, and the related consolidated statements of income and comprehensive income, changes in equity and cash flows for the year then ended. Thesefinancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based onour audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal controlover financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinionon 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 significantestimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis forour 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 31,2011, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the UnitedStates of America. /s/ Marcum Bernstein & Pinchuk LLPNew York, New YorkApril 16, 2012 NEW YORK OFFICE • 7 Penn Plaza • Suite 830 • New York, New York 10001 • Phone 646.442.4845 • Fax 646.349 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders ofChinaNet Online Holdings, Inc. We have audited the accompanying consolidated balance sheets of ChinaNet Online Holdings, Inc. and Subsidiaries (“the Company”) as of December 31,2010, and the related consolidated statements of income and comprehensive income, changes in equity and cash flows for the year ended December 31, 2010.The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based onour audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal controlover financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinionon 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 significantestimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis forour 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 31,2010 and the results of its operations and its cash flows for the year ended December 31, 2010 in conformity with accounting principles generally accepted inthe United States of America. /s/ Bernstein & Pinchuk LLPNew York, New YorkMarch 31, 2011, except for revised disclosures in Note 1, 2, 22, 27 and 28, which is dated February 29, 2012 F-2 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED BALANCE SHEETS(In thousands) As of December 31, 2011 2010 (US $) (US $) Assets Current assets: Cash and cash equivalents $10,695 $15,590 Accounts receivable, net 4,444 4,319 Other receivables, net 3,631 7,811 Prepayment and deposit to suppliers 15,360 3,325 Due from related parties 324 185 Deposit for acquisitions - 1,512 Contingent consideration receivables 159 - Other current assets 129 31 Total current assets 34,742 32,773 Investment in and advance to equity investment affiliates 1,396 7,162 Property and equipment, net 1,902 2,010 Intangible assets, net 8,151 51 Goodwill 10,999 - Deferred tax assets-non current 92 - Total Assets $57,282 $41,996 Liabilities and Equity Current liabilities: Accounts payable * $268 $174 Advances from customers * 724 2,120 Accrued payroll and other accruals * 616 470 Due to equity investment affiliate * 220 - Due to related parties * 161 291 Due to Control Group * - 81 Due to director - 559 Payable for acquisition * 550 - Taxes payable * 5,040 2,193 Other payables * 114 10 Dividend payable 5 255 Total current liabilities 7,698 6,153 F-3 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED BALANCE SHEETS (CONTINUED)(In thousands, except for number of shares and per share data) As of December 31, 2011 2010 (US $) (US $) Long-term liabilities: Deferred tax liability-non current * 1,893 - Long-term borrowing from director 137 132 Total Liabilities 9,728 6,285 Commitments and contingencies Equity: Series A convertible preferred stock (US$0.001 par value; authorized 8,000,000 shares; issued and outstanding Nil and2,877,600 shares at December 31, 2011 and 2010, respectively; aggregate liquidation preference amount: $5 and$7,449, including accrued but unpaid dividends of $5 and $255, at December 31, 2011 and 2010, respectively. - 3 Common stock (US$0.001 par value; authorized 50,000,000 shares; issued and outstanding 22,146,540 shares and17,102,320 shares at December 31, 2011 and 2010, respectively) 22 17 Additional paid-in capital 20,747 18,614 Statutory reserves 2,117 1,587 Retained earnings 16,688 14,630 Accumulated other comprehensive income 2,132 930 Total ChinaNet Online Holdings, Inc.’s stockholders’ equity 41,706 35,781 Noncontrolling interests 5,848 (70)Total equity 47,554 35,711 Total Liabilities and Equity $57,282 $41,996 *All of the VIEs' assets can be used to settle obligations of its primary beneficiary. Liabilities recognized as a result of consolidating these VIEs do notrepresent additional claims on the Company’s general assets (Note 2). See notes to consolidated financial statements F-4 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME(In thousands) Year ended December 31, 2011 2010 (US $) (US $) Sales From unrelated parties $28,105 $40,423 From related parties 626 1,164 28,731 41,587 Cost of sales 12,027 18,970 Gross margin 16,704 22,617 Operating expenses Selling expenses 3,506 3,403 General and administrative expenses 7,904 3,460 Research and development expenses 2,132 907 13,542 7,770 Income from operations 3,162 14,847 Other income (expenses) Changes in fair value of warrants - 1,861 Changes in fair value of contingent consideration receivables (70) - Interest income 13 13 Gain on deconsolidation of subsidiaries 925 - Other income 5 6 873 1,880 Income before income tax expense, equity method investments and noncontrolling interests 4,035 16,727 Income tax expense 1,035 352 Income before equity method investments and noncontrolling interests 3,000 16,375 Share of losses in equity investment affiliates (219) - Net income 2,781 16,375 Net loss attributable to noncontrolling interests 214 214 Net income attributable to ChinaNet Online Holdings, Inc. 2,995 16,589 F-5 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, 2011 2010 (US $) (US $) Net income attributable to ChinaNet Online Holdings, Inc. $2,995 $16,589 Dividend of Series A convertible preferred stock (407) (794) Net income attributable to common stockholders of ChinaNet Online Holdings, Inc. $2,588 $15,795 Earnings per share Earnings per common share Basic $0.14 $0.94 Diluted $0.14 $0.79 Weighted average number of common shares outstanding: Basic 18,545,609 16,778,176 Diluted 18,759,240 20,896,061 Comprehensive Income Net income 2,781 16,375 Foreign currency translation gain 1,254 813 $4,035 $17,188 Comprehensive Income Comprehensive loss attributable to noncontrolling interest (162) (214) Comprehensive income attributable to ChinaNet’s Online Holdings, Inc. 4,197 17,402 $4,035 $17,188 See notes to consolidated financial statements F-6 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands) Year ended December 31, 2011 2010 (US $) (US $) Cash flows from operating activities Net income $2,781 $16,375 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 1,012 465 Share-based compensation expenses 2,900 337 Changes in fair value of warrants - (1,861) Changes in fair value of contingent consideration receivables 70 - Allowances for doubtful debts 2,583 - Share of losses in equity investment affiliates 219 - Gain on deconsolidation of subsidiaries (925) - Gain on disposal of property and equipment (3) - Deferred taxes 27 - Changes in operating assets and liabilities Accounts receivable (2,100) (1,013) Other receivables 5,276 (4,961) Prepayment and deposit to suppliers (11,247) 905 Due from related parties (130) 315 Other current assets (197) 1 Accounts payable 27 (123) Advances from customers (1,575) 1,146 Accrued payroll and other accruals 166 271 Due to Control Group (82) (1,073) Due to director (559) 559 Due to related parties (139) 112 Other payables 490 (17) Taxes payable 803 144 Net cash (used in) provided by operating activities (603) 11,582 Cash flows from investing activities Purchases of vehicles and office equipment (741) (1,001) Purchase of intangible assets (1,445) (60) Cash from acquisition of VIEs 330 148 Cash effect on deconsolidation of VIEs (1,670) - Long-term investment in and advance to equity investment affiliates (1,712) (6,985) Payment for acquisition of VIEs (9,731) (1,475) Disposal of investment in and loan repayment from equity investment affiliate 8,885 - Net cash used in investing activities (6,084) (9,373) F-7 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)(In thousands) Year ended December 31, 2011 2010 (US $) (US $) Cash flows from financing activities Cash investment contributed by noncontrolling interests 378 145 Dividend paid to convertible preferred stockholders (657) (912) Short-term loan borrowed from equity investment affiliate 216 - Capital contributions received in advance from new shareholders of Zhao Shang Ke Hubei before deconsolidation 1,545 - Net cash provided by (used in) financing activities 1,482 (767) Effect of exchange rate fluctuation on cash and cash equivalents 310 231 Net (decrease) / increase in cash and cash equivalents (4,895) 1,673 Cash and cash equivalents at beginning of year 15,590 13,917 Cash and cash equivalents at end of year $10,695 $15,590 Supplemental disclosure of cash flow information Income taxes paid $319 $1,434 Income taxes refunded $- $928 Non-cash transactions: Warrant liability reclassify to additional paid in capital $- $7,703 Restricted stock and options granted for future service $6 $299 See notes to consolidated financial statements F-8 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY(In thousands, except for number of shares) Total stockholders’ equity Series A convertiblepreferred stock Common Stock Additionalpaid-incapital Statutoryreserves Retainedearnings Accumulatedothercomprehensiveincome Non-ControllingInterests TotalEquity Number ofshares Amount Number ofshares Amount (US $) (US $) (US $) (US $) (US $) (US $) (US $) (US $) Balance, January 1,2010 4,121,600 4 15,828,320 16 10,574 372 50 117 - 11,133 Reclassification ofwarrant liabilities - - - - 7,703 - - - - 7,703 Share basedcompensation relatedto services - - - - 156 - - - - 156 Restricted shares issuedfor services - - 30,000 - 111 - - - - 111 Restricted sharesgranted for services - - - - 70 - - - - 70 Preferred stockconverted intocommon stock (1,244,000) (1) 1,244,000 1 - - - - - - Preferred stockdividend - - - - - - (794) - - (794)Noncontrolling equityinterests in a newlyformed VIE - - - - - - - - 144 144 Net income for the year - - - - - - 16,589 - (214) 16,375 Appropriation ofstatutory reserves - - - - - 1,215 (1,215) - - - Foreign currencytranslationadjustment - - - - - - - 813 - 813 Balance, December31, 2010 2,877,600 3 17,102,320 17 18,614 1,587 14,630 930 (70) 35,711 Preferred stockconverted intocommon stock (2,877,600) (3) 2,877,600 3 - - - - - - Share basedcompensation relatedto services - - - - 141 - - - - 141 Restricted shares issuedfor services - - 60,000 - 152 - - - - 152 See notes to consolidated financial statements F-9 CHINANET ONLINE HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (CONTINUED)(In thousands, except for number of shares) Total stockholders’ equity Series A convertiblepreferred stock Common Stock Additionalpaid-incapital Statutoryreserves Retainedearnings Accumulatedothercomprehensiveincome Non-ControllingInterests TotalEquity Number ofshares Amount Number ofshares Amount (US $) (US $) (US $) (US $) (US $) (US $) (US $) Restricted stock andoptions issued tomanagement,employees anddirectors onNovember 30, 2011 - - 2,000,000 2 2,605 - - - - 2,607 Share issued under theWarrant TenderOffer on December30, 2011 - - 106,620 - - - - - - - Noncontrolling equityinterests in acquiredVIEs - - - - - - - - 6,054 6,054 Noncontrolling equityinterests in newlyformed VIEs - - - - (703) - - - 1,079 376 Deconsolidation ofVIEs - - - - - - - - (20) (20)Purchased ofnoncontrollinginterests in a VIE - - - - (62) - - - (1,033) (1,095)Net income for theyear - - - - - - 2,995 - (214) 2,781 Appropriation ofstatutory reserves - - - - - 530 (530) - - - Preferred stockdividend - - - - - - (407) - - (407)Foreign currencytranslationadjustment - - - - - - - 1,202 52 1,254 Balance, December31, 2011 - - 22,146,540 22 20,747 2,117 16,688 2,132 5,848 47,554 See notes to consolidated financial statements F-10 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and nature of operationsChinaNet Online Holdings, Inc. (formerly known as Emazing Interactive, Inc.), (the “Company”), was incorporated in the State of Texas in April 2006and re-domiciled to become a Nevada corporation in October 2006. From the date of the Company’s incorporation until June 26, 2009, when theCompany consummated the Share Exchange, the Company’s activities were primarily concentrated in web server access and company branding inhosting 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 GroupLimited, a company organized under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s shareholders, Allglad Limited, a BritishVirgin Islands company (“Allglad”), Growgain Limited, a British Virgin Islands company ("Growgain"), Rise King Investments Limited, a British VirginIslands company (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus Elegant Investment Limited, aBritish 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 andoutstanding ordinary shares of China Net BVI (the “China Net BVI Shares”) and (iii) G. Edward Hancock, the principal stockholder of the Company atthat time. Pursuant to the terms of the Exchange Agreement, the China Net BVI Shareholders transferred to the Company all of the China Net BVI Sharesin 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 providingadvertising, marketing, communication and brand management and sales channel building services to small and medium companies in China throughwww.28.com (the portal website of the Company’s PRC operating entity), TV media and bank kiosks.The Company’s wholly owned subsidiary, China Net BVI was incorporated in the British Virgin Islands on August 13, 2007. On April 11, 2008, ChinaNet BVI became the parent holding company of a group of companies comprised of CNET Online Technology Limited, a Hong Kong company (“ChinaNet HK”), which established and is the parent company of Rise King Century Technology Development (Beijing) Co., Ltd., a wholly foreign-ownedenterprise (“WFOE”) established in the PRC (“Rise King WFOE”). The Company refers to the transactions that resulted in China Net BVI becoming anindirect 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 foreignownership of business entities engaging in advertisement business. In October 2008, a series of contractual arrangements (the “Contractual Agreements”or “VIE Agreements”) were entered into among Rise King WFOE and Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“BusinessOpportunity Online”), Beijing CNET Online Advertising Co., Ltd. (“Beijing CNET Online”) (collectively the “PRC Operating Entities”) and its commonindividual 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 mattersrequiring shareholder approval, and receive 100% of the income earned by the PRC Operating Entities. In return, Rise King WFOE provides consultingservices to the PRC Operating Entities. In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform their obligations underthe Contractual Arrangements, the PRC Shareholders have pledged all of their equity interests in the PRC Operating Entities to Rise King WFOE. Theyalso entered into an option agreement with Rise King WFOE which provides that at such time as when the current restrictions under PRC law on foreignownership of Chinese companies engaging in the Internet content, information services or advertising business in China are lifted, Rise King WFOE mayexercise its option to purchase the equity interests in the PRC Operating Entities, directly (See Note 2 for significant terms of these ContractualArrangements).At the time the above Contractual Agreements were entered into, the controlling shareholder of China Net BVI was Rise King BVI, who holds 55% of theCompany’s common stock. The sole registered shareholder of Rise King BVI was Mr. Yang Li, who owned 10,000 shares of common stock of Rise KingBVI, which constituted all of the issued and outstanding shares of Rise King BVI. Mr. Yang Li entered into slow-walk agreements with each of theControl Group individuals, pursuant to which, upon the satisfaction of certain conditions, the Control Group individuals had the option to purchase the10,000 shares of Rise King BVI, (4,600 by Mr. Handong Cheng, 3,600 by Mr. Xuanfu Liu and 1,800 by Ms. Li Sun, acting as nominee for Mr. ZhangZhige) held by Mr. Yang Li, at a purchase price of US$ 1 per share (the par value of Rise King BVI’s common stock). Under the terms of the slow-walkagreement, the Control Group had the right to purchase the shares as follows: (1) one-third of the shares when China Net BVI and its PRC subsidiary andVIEs (“the Group”) generates at least RMB 100,000,000 of the gross revenue for twelve months commencing on January 1, 2009 and ending onDecember 31, 2009 (the “Performance Period I”); (2) one-third of the shares when the Group generates at least RMB 60,000,000 of the gross revenue forsix months commencing on January 1, 2010 and ending on June 30, 2010 (the “Performance Period II); (3) one-third of the shares when the Groupgenerates at least RMB 60,000,000 of the gross revenue for six months commencing on July 1, 2010 and ending on December 31, 2010 (the“Performance Period III”). Each Control Group individual had the right to purchase one-third of the total number of shares that he or she was eligible topurchase under the slow-walk agreement upon the satisfaction of each condition described above. F-11 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Control Group individuals also entered an Entrustment Agreement with Rise King BVI, pursuant to which, based on the 55% equity interest held inthe Group, Rise King BVI entrusted the Control Group to manage the Group companies by irrevocably authorizing the Control Group to act on behalf ofRise King BVI, as the exclusive agents and attorneys with respect to all matters concerning Rise King BVI’s holdings in the Group, during the term of theEntrustment Agreement. The Control Group agreed and confirmed that he or she would act in concert with one another when exercising the rightsauthorized to them in this Agreement. The Entrustment Period commenced on the execution date of the agreement and was effective for a period of tenyears, until its termination, as discussed below.As described above, each of Mssrs. Handong Cheng, and Xuanfu Liu and Ms. Li Sun entered into Share Transfer Agreements (slow-walk agreement) withMr. Yang Li, the sole shareholder of Rise King BVI, which beneficially owns an aggregate of 7,434,940 shares of the Company’s Common Stock, (the“Subject Shares”). On March 30, 2011, pursuant to the terms of the Share Transfer Agreement, Ms. Li Sun transferred her right to acquire 18% of theshares of Rise King BVI under the Share Transfer Agreement to Mr. Zhige Zhang, the chief financial officer of the Company. On March 30, 2011, each ofMssrs. Handong Cheng, Xuanfu Liu and Zhige Zhang (the “PRC Persons”) exercised their right to purchase the outstanding stock of Rise King BVI. Onthe same date, the Entrustment Agreement originally entered into among Rise King BVI and the Control Group was terminated. As a result of thesetransactions, the ownership of Rise King BVI was transferred from Mr. Yang Li to the PRC Persons. Rise King BVI has sole voting and dispositive powerover the Subject Shares. The PRC Persons may be deemed to share voting power over the shares as a result of their collective ownership of all of theoutstanding stock of Rise King BVI and are now the controlling shareholders of Rise King BVI.Pursuant to the above Contractual Agreements, all of the equity owners' rights and obligations of the VIEs were assigned to Rise King WFOE, whichresulted in the equity owners lacking the ability to make decisions that have a significant effect on the VIEs, and Rise King WFOE's ability to extract theprofits from the operation of the VIEs, and assume the residual benefits of the VIEs. Because Rise King WFOE and its indirect parent are the sole interestholders of the VIEs, the Company included the assets, liabilities, revenues and expenses of the VIEs in its consolidated financial statements, which isconsistent with the provisions of FASB Accounting Standards Codification ("ASC") Topic 810 “Consolidation”, subtopic 10.As a result of the Share Exchange on June 26, 2009, the former China Net BVI shareholders owned a majority of the common stock of the Company. Thetransaction was regarded as a reverse acquisition whereby China Net BVI was considered to be the accounting acquirer as its shareholders retainedcontrol of the Company after the Share Exchange, although the Company is the legal parent company. The share exchange was treated as arecapitalization of the Company. As such, China Net BVI (and its historical financial statements) is the continuing entity for financial reportingpurposes. Following the Share Exchange, the company changed its name from Emazing Interactive, Inc. to ChinaNet Online Holdings, Inc. The financialstatements have been prepared as if China Net BVI had always been the reporting company and then on the share exchange date, had changed its nameand reorganized its capital stock.As of the date of the Share Exchange, through the above Contractual Agreements, the Company operates its business in China primarily throughBusiness 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 cooperationagreement in June 2008, followed up with a supplementary agreement in December 2008, to conduct bank kiosk advertisement business. Thebusiness is based on a bank kiosk cooperation agreement between Shanghai Borongdingsi and Henan provincial branch of China ConstructionBank which allows Shanghai Borongdingsi or its designated party to conduct in-door advertisement business within the business outletsthroughout Henan Province. The bank kiosk cooperation agreement has a term of eight years starting August 2008. However, ShanghaiBorongdingsi was not able to conduct the advertisement business as a stand-alone business due to the lack of an advertisement businesslicense and supporting financial resources. Pursuant to the aforementioned cooperation agreements, Beijing CNET Online committed topurchase equipment, and to provide working capital, technical and other related support to Shanghai Borongdingsi. Beijing CNET Online ownsthe 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 theadvertisement revenue generated from the bank kiosk business exclusively until the recovery of the cost of purchase of the equipment.Thereafter, Beijing CNET Online has agreed to distribute 49% of the succeeding net profit generated from the bank kiosk advertising business,if any, to the minority shareholders of Shanghai Borongdingsi. F-12 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On June 24, 2010, one of the Company’s VIEs, Business Opportunity Online, together with three other individuals, who were not affiliated with theCompany, formed a new company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). The registered capital and paid-incapital of Shenzhen Mingshan was RMB10,000,000 and RMB5,000,000, respectively. Shenzhen Mingshan is 51% owned by Business OpportunityOnline and 49% owned collectively by the other three individuals. Shenzhen Mingshan is located in Shenzhen City, Guangdong Province of the PRCand is primarily engaged in developing and designing of internet based software, online games and the related operating websites and providing relatedinternet and information technology services necessary to operate such games and websites. On January 6, 2011, as approved by the shareholders ofShenzhen Mingshan, an independent third party investor, who was not affiliated with the Company or any of its affiliates, invested RMB15,000,000(approximately US$2,356,749) cash into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan, and Shenzhen Mingshan’sregistered capital and paid-in capital increased from RMB10,000,000 (approximately US$1,571,166) and RMB5,000,000 (approximately US$785,583)to RMB25,000,000 (approximately US$3,927,915) and RMB20,000,000 (approximately US$3,142,332), respectively. Therefore, beginning on January6, 2011, the new investor became the majority shareholder of Shenzhen Mingshan. The Company’s share of the equity interest in ShenZhen Mingshandecreased from 51% to 20.4% and the Company ceased to have a controlling financial interest in ShenZhen Mingshan, but still retains an investment in,and significant influence over, Shenzhen Mingshan.On December 6, 2010, Rise King WFOE entered into a series of exclusive contractual arrangements, which were similar to the Contractual Agreementsdiscussed above, with Rise King (Shanghai) Advertisement Media Co., Ltd. (“Shanghai Jing Yang”), a company incorporated under the PRC laws inDecember 2009 and primarily engaged in advertisement business, pursuant to which the Company, through its wholly owned subsidiary, Rise KingWFOE obtained all of the equity owners' rights and obligations of Shanghai Jing Yang, and the ability to extract the profits from the operation andassume the residual benefits of Shanghai Jing Yang, and hence became the sole interest holder of Shanghai Jing Yang. As of the date these contractualagreements were entered into, Shanghai Jing Yang had not establish any resources to conducted any business activities by itself and the carrying amountof the net assets of Shanghai Jing Yang which was all cash and cash equivalents approximate fair values due to their short maturities. Therefore,Shanghai Jing Yang’s accounts were included in the Company’s consolidated financial statements with no goodwill recognized in accordance to ASCTopic 810 “Consolidation”.On December 8, 2010, the Company, through one of its VIEs, Shanghai Jing Yang acquired a 49% interest in a newly established company, BeijingYang Guang Media Investment Co., Ltd. (“Beijing Yang Guang”) for cash consideration of RMB 7,350,000 (approximately US$1,154,807), whichrepresents 49% of Beijing Yang Guang’s paid-in capital and net assets of RMB15,000,000 (approximately US$2,356,749). Beijing Yang Guang had notcommenced its operations as of December 8, 2010 and the carrying amount of the net assets of Beijing Yang Guang which were mainly consist of cashand cash equivalents and other receivables approximate fair values due to their short maturities. Therefore, the cash consideration paid was accounted foras investment in an equity investment affiliate in accordance with ASC Topic 323 “Equity Method and Joint Ventures”. In August, 2011, Shanghai JingYang sold back its 49% equity interest in Beijing Yang Guang to the majority shareholder of Beijing Yang Guang for cash consideration ofRMB7,350,000, which was equal to the consideration paid when Shanghai Jing Yang acquired the 49% equity interest in December 2010.The Company, through one of its VIEs, Beijing CNET Online, entered into an equity interest acquisition agreement with the shareholders of QuanzhouZhi Yuan Marketing Planning Co., Ltd. (“Quanzhou Zhi Yuan”) and Quanzhou Tian Xi Shun He Advertisement Co., Ltd. (“Quanzhou Tian Xi ShunHe”), (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, for cash consideration of RMB9,500,000 (approximately US$1,492,608) and RMB7,500,000(approximately US$1,178,374), respectively. The acquisition was subsequently approved by, and registered with, the relevant PRC governmentauthorities of Quanzhou City, Fujian province of PRC on January 4, 2011 and February 23, 2011, respectively. Quanzhou Zhi Yuan and Quanzhou TianXi Shun He are both independent advertising companies based in Fujian province of the PRC, which provide comprehensive branding and marketingservices to over fifty small to medium sized companies focused primarily in the sportswear and clothing industry. In June 2011, Beijing CNET Onlineentered into an additional agreement with the noncontrolling interest of Quanzhou Tian Xi Shun He to purchase the remaining 49% equity interest inQuanzhou Tian Xi Shun He for cash consideration of RMB7,200,000 (approximately US$1,131,239). On June 27, 2011, this transaction was approvedby, and registered with, the relevant PRC government authorities of Quanzhou City, Fujian province of PRC. Quanzhou Tian Xi Shun He became awholly owned subsidiary of Beijing CNET Online accordingly. F-13 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”). The registered capital and paid in capital of Business OpportunityOnline Hubei is RMB2,000,000 (approximately US$314,233). Business Opportunity Online Hubei is primarily engaged in internet advertisementdesign, 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”). The registered capital and paid incapital of Beijing Chuang Fu Tian Xia is RMB1,000,000 (approximately US$157,117). Business Opportunity Online and the co-founding individualinvested RMB510,000 (approximately US$80,130) and RMB490,000 (approximately US$76,987) cash in Beijing Chuang Fu Tian Xia, respectively,representing 51% and 49% of the equity interests in Beijing Chuang Fu Tian Xi, respectively. In addition to capital investment, the co-foundingindividual is required to provide the controlled domain names, www.liansuo.com and www.chuangye.com to be registered under the establishedcompany. Beijing Chuang Fu Tian Xia is primarily engaged in providing and operating internet advertising, marketing and communication services tosmall 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 CNETAdvertising Media Co., Ltd. (“Hubei CNET”). The registered capital and paid in capital of Hubei CNET is RMB1,000,000 (approximatelyUS$157,117). Hubei CNET is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketingconsultancy services.On April 18, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, together with an individual, who was not affiliated with theCompany, formed a new company, Zhao Shang Ke Network Technology (Hubei) Co., Ltd. (“Zhao Shang Ke Hubei”). The registered capital of ZhaoShang Ke Hubei is RMB2,000,000 (approximately US$314,233). Business Opportunity Online Hubei and the co-founding individual investedRMB1,020,000 (approximately US$160,259) and RMB980,000 (approximately US$153,974) cash in Zhao Shang Ke Hubei, respectively, and owned51% and 49% of the equity interests in Zhao Shang Ke Hubei, respectively. Zhao Shang Ke Hubei is primarily engaged in providing advertisementdesign, production, promulgation and sales channels building services. On December 29, 2011, as approved by the shareholders of Zhao Shang KeHubei, two independent third party investors, who were not affiliated with the Company or any of its affiliates, invested RMB10,000,000 (approximatelyUS$1,571,166) cash into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interest in Zhao Shang Ke Hubei in the enlarged registeredcapital. As a result of this cash investment, the registered capital and paid in capital of Zhao Shang Ke Hubei increased to RMB4,000,000(approximately US$628,466) from RMB2,000,000 (approximately US$314,233), the additional cash investment of RMB8,000,000 (approximatelyUS$1,256,933) was credited as additional paid-in capital of Zhao Shang Ke Hubei. Therefore, beginning on December 29, 2011, the Company’s share ofthe 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 Hubeibut 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”). The registered capital and paid in capital of Xin Qi Yuan Hubei is RMB100,000 (approximately US$15,712). Xin QiYuan Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancyservices.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”). The registered capital and paid in capital of Mu Lin Sen Hubei is RMB100,000 (approximately US$15,712). Mu LinSen Hubei is primarily engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancyservices. F-14 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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”). The registered capital and paid in capital of ShengTian Hubei is RMB2,000,000 (approximately US$314,233). Business Opportunity Online Hubei and the co-founding individual investedRMB1,020,000 (approximately US$160,259) and RMB980,000 (approximately US$153,974) cash in Sheng Tian Hubei, respectively, and owned 51%and 49% of the equity interests in Sheng Tian Hubei, respectively. Sheng Tian Hubei is primarily engaged in computer system design, development andpromotion; 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 BusinessOpportunity Online Technology Co., Ltd. (“Business Opportunity Online Chongqing”). The registered capital and paid in capital of BusinessOpportunity Online Chongqing is RMB2,000,000 (approximately US$314,233). Business Opportunity Online Chongqing is primarily engaged ininternet advertisement design, production and promulgation.On December 15, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei entered into an equity transfer agreement with Sou Yi Lian MeiNetwork Technology (Beijing) Co. Ltd., (“Sou Yi Lian Mei”) and its shareholders, to acquire a 51% equity interest in Sou Yi Lian Mei for cashconsideration of RMB51,600,000 (approximately US$8,107,216). Sou Yi Lian Mei is based in Beijing, China, and is primary engaged in providingonline advertising and marketing services. Sou Yi Lian Mei operates its business primarily through its wholly-owned subsidiary, Jin Du Ya He (Beijing)Network Technology Co., Ltd (“Jin Du Ya He”). The equity transfer agreement contained certain "make good" provisions, under which thenoncontrolling interest shareholder of Sou Yi Lian Mei will pledge to the Company the 49% of the equity interest of Sou Yi Lian Mei he owns to securethe make good obligation under the equity transfer agreement. The equity transfer agreement established minimum audited after tax net profit thresholdfor Sou Yi Lian Mei for fiscal year 2012 ("2012 Performance Threshold"). In the event that the 2012 Performance Threshold is achieved less than 95%by Sou Yi Lian Mei, the noncontrolling shareholder will compensate the Company in cash in the amount equal to the shortfall between the 95% of 2012Performance Threshold and actual audited after tax net profit for fiscal year 2012 of Sou Yi Lian Mei. In the event that the noncontrolling shareholder isnot required to compensate the Company in cash under Shareholders’ make good obligation, the Company will then cancel the pledge over the 49% ofequity interests of the noncontrolling shareholder. On December 20, 2011, the transaction was approved by, and registered with, the relevant PRCgovernment authorities of Beijing, the PRC. Sou Yi Lian Mei became a majority-owned subsidiary of Business Opportunity Online Hubei accordingly.As of December 31, 2011, the Company operated its business primarily in China through its PRC subsidiary and PRC operating entities, or VIEs asdescribed above. 2. Variable Interest EntitiesTo satisfy PRC laws and regulations, the Company conducts certain business in the PRC through its Variable Interest Entities (“VIEs”).As described in Note 1, On October 8, 2008, a series of contractual arrangements (the “VIE Agreements”) were entered into between Rise King WFOE andBusiness Opportunity Online, Beijing CNET Online (collectively the “PRC Operating Entities”) and its common individual owners (the “PRCShareholders” or the “Control Group”). Resulting from these VIE Agreements entered into between Rise King WFOE and the PRC Operating Entities, theCompany includes the assets, liabilities, revenues and expenses of these PRC Operating Entities and its subsidiaries in its consolidated financialstatements.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 KingWFOE and each of the PRC Operating Entities, Rise King WFOE has the exclusive right to provide to the PRC Operating Entities complete technicalsupport, 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 systemmaintenance. 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 netincome of each PRC Operating Entity. Adjustments may be made upon approval by Rise King WFOE based on services rendered by Rise King WFOEand 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 financialstatements of any PRC Operating Entities, there is determined to be any shortfall in the payment of 100% of the annual net income, such PRC OperatingEntity 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 inwriting by Rise King WFOE, prior to the expiration of the term. The extended term shall be determined by Rise King WFOE, and the PRC OperatingEntities shall accept such extended term unconditionally. F-15 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Exclusive Option Agreements: Under the Exclusive Option Agreements entered into by and among Rise King WFOE, each of the PRC Shareholdersirrevocably 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 oftheir 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 withapplicable PRC laws and regulations. Rise King WFOE, or its designated person, has the sole discretion to decide when to exercise the option, whether inpart 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 ofthe PRC Shareholders, the PRC Shareholders pledged all of their equity interests in the PRC Operating Entities to guarantee the PRC OperatingEntities’ performance of its obligations under the Exclusive Business Cooperation Agreements. If the PRC Operating Entities or any of the PRCShareholders breaches its/his/her respective contractual obligations under these agreements, or upon the occurrence of one of the events regarded as anevent of default under each such agreement, Rise King WFOE, as pledgee, will be entitled to certain rights, including the right to dispose of the pledgedequity interests. The PRC Shareholders of the PRC Operating Entities agreed not to dispose of the pledged equity interests or take any actions that wouldprejudice 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'sinterest 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 tothe PRC Operating Entities due under the Exclusive Business Cooperation Agreements have been fulfilled. Therefore, the equity pledge agreementsshall only be terminated when the payments related to the ten-year Exclusive Business Cooperation Agreement are paid in full and the WFOE does notintend 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 theirexclusive attorneys-in-fact to vote on their behalf on all PRC Operating Entities matters requiring shareholder approval. The term of each power ofattorney is valid so long as such shareholder is a shareholder of the respective PRC Operating Entity.On December 6, 2010, Rise King WFOE entered into a series of exclusive contractual arrangements, which were similar to the VIE Agreements discussedabove, with Rise King (Shanghai) Advertisement Media Co., Ltd. (“Shanghai Jing Yang”), a company incorporated under the PRC laws in December2009 and primarily engaged in advertisement business, pursuant to which the Company, through its wholly owned subsidiary, Rising King WFOEobtained all of the equity owners' rights and obligations of Shanghai Jing Yang, and the ability to extract the profits from the operation and assume theresidual benefits of Shanghai Jing Yang, and hence became the sole interest holder of Shanghai Jing Yang. Therefore, the Company also includes theassets, liabilities, revenues and expenses of Shanghai Jing Yang in its consolidated financial statements.As a result of these VIE Agreements, the Company through its wholly-owned subsidiary, Rise King WFOE, was granted with unconstrained decisionmaking rights and power over key strategic and operational functions that would significantly impact the PRC Operating Entities or the VIEs’ economicperformance, which includes, but is not limited to, the development and execution of the overall business strategy; important and material decisionmaking; decision making for merger and acquisition targets and execution of merger and acquisition plans; business partnership strategy developmentand execution; government liaison; operation management and review; and human resources recruitment and compensation and incentive strategydevelopment and execution. Rise King WFOE also provides comprehensive services to the VIEs for their daily operations, such as operational technicalsupport, OA technical support, accounting support, general administration support and technical support for products and services. As a result of theExclusive Business Cooperation Agreements, the Equity Pledge Agreements and the Exclusive Option Agreements, the Company will bear all of theVIEs’ operating costs in exchange for 100% of the net income of the VIEs. Under these agreements, the Company has the absolute and exclusive right toenjoy economic benefits similar to equity ownership through the VIE Agreements with our PRC Operating Entities and their shareholders. F-16 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS These contractual arrangements may not be as effective in providing the Company with control over the VIEs as direct ownership. Due to its VIEstructure, 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 ofcontract 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 Companymay conflict and the Company may fail to resolve such conflicts; the shareholders may believe that breaching the contracts will lead to greater economicbenefit 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 orarbitral proceedings to enforce its contractual rights, including specific performance or injunctive relief, and claiming damages. Such arbitral and legalproceedings may cost substantial financial and other resources, and result in a disruption of its business, and the Company cannot assure that theoutcome 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 orlitigation in the PRC, they would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legalprocedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in thePRC legal system could further limit the Company’s ability to enforce these contractual arrangements. Furthermore, these contracts may not beenforceable in China if PRC government authorities or courts take a view that such contracts contravene PRC laws and regulations or are otherwise notenforceable for public policy reasons. In the event the Company is unable to enforce these contractual arrangements, it may not be able to exert effectivecontrol 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, 2011 and 2010, respectively: As of December 31, 2011 2010 US$(’000) US$(’000) Assets Current assets: Cash and cash equivalents $8,322 $6,535 Accounts receivable, net 3,705 1,487 Other receivables, net 3,619 7,803 Prepayment and deposit to suppliers 15,360 3,322 Due from related parties 192 156 Deposit for acquisitions - 1,512 Contingent consideration receivables 159 - Other current assets 23 2 Total current assets 31,380 20,817 Investment in and advance to equity investment affiliates 1,354 7,162 Property and equipment, net 1,507 1,445 Intangible assets, net 8,111 - Goodwill 10,999 - Deferred tax assets-non current 92 - Total Assets $53,443 $29,424 Liabilities Current liabilities: Accounts payable $268 $174 Advances from customers 724 783 Accrued payroll and other accruals 251 162 Due to equity investment affiliate 220 - Due to related parties 161 155 Due to Control Group 11 91 Payable for acquisition 550 - Taxes payable 4,409 1,753 Other payables 107 10 Total current liabilities 6,701 3,128 Deferred tax Liabilities-non current 1,893 - Total Liabilities $8,594 $3,128 F-17 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All of the VIEs' assets can be used to settle obligations of its primary beneficiary. Liabilities recognized as a result of consolidating these VIEs do notrepresent additional claims on the Company’s general assetsFor the year ended December 31, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income andcomprehensive income includes sales of approximately US$24,109,000, cost of sales of approximately US$11,772,000, operating expenses ofapproximately US$6,424,000 and net income before allocation to noncontrolling interests of approximately US$5,849,000.For the year ended December 31, 2010, the financial performance of the VIEs reported in the Company’s consolidated statements of income andcomprehensive income includes sales of approximately US$27,709,000, cost of sales of approximately US$18,288,000, operating expenses ofapproximately US$4,971,000 and net income before allocation to noncontrolling interests of approximately US$4,107,000. 3. Summary of significant accounting policies a) Basis of presentation The consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States(“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 andbalances between the Company and its subsidiaries and VIEs have been eliminated upon consolidation. According to the agreements betweenBeijing CNET Online and Shanghai Borongdingsi, although Beijing CNET Online legally owns 51% of Shanghai Borongdingsi’s interests, BeijingCNET Online only controls the assets and liabilities related to the bank kiosks business, which has been included in the financial statements ofBeijing CNET Online, but does not control other assets of Shanghai Borongdingsi, thus, Shanghai Borongdingsi’s financial statements were notconsolidated by the Company. c) Use of estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”)requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure ofcontingent assets and liabilities at the date of these consolidated financial statements, and the reported amounts of revenue and expenses during thereporting period. The Company continually evaluates these estimates and assumptions based on the most recently available information, historicalexperience and various other assumptions that the Company believe to be reasonable under the circumstances. Since the use of estimates is anintegral component of the financial reporting process, actual results could differ from those estimates. d) Reclassification Certain prior year amounts have been regrouped or reclassified to conform to the current year presentation, which did not have any impact on theCompany’s prior year consolidated financial position, consolidated results of operations and consolidated cash flows. e) 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$”). The functional currency of the Company’s PRC operating subsidiary and VIEs is Renminbi (“RMB”), and PRC is the primary economicenvironment in which the Company operates. F-18 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For financial reporting purposes, the financial statements of the Company’s PRC operating subsidiary and VIEs, which are prepared using the RMB,are translated into the Company’s reporting currency, the United States Dollar (“U.S. dollar”). Assets and liabilities are translated using the exchangerate at each balance sheet date. Revenue and expenses are translated using average rates prevailing during each reporting period, and stockholders’equity is translated at historical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulatedother comprehensive income in stockholders’ equity. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange ratesprevailing at the dates of the transactions. The resulting exchange differences are included in the determination of net income of the consolidatedstatements of income and comprehensive income for the respective periods. The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows: As of December 31, 2011 2010 Balance sheet items, except for equity accounts 6.3647 6.6118 Year ended December 31, 2011 2010 Items in the statements of income and comprehensive income, and statements cash flows 6.4735 6.7788 No representation is made that the RMB amounts could have been, or could be converted into US$ at the above rates. f) 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 allhighly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents. 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 accountsreceivable. The Company determines the allowance based on aging data, historical collection experience, customer specific facts and economicconditions. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recoveryis considered remote. The Company did not have any off-balance-sheet credit exposure relating to its customers, suppliers or others. 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 equitymethod of accounting in accordance to ASC Topic 323 “Equity Method and Joint Ventures”. Whether or not the Company exercises significantinfluence 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 equitymethod of accounting, an investee company’s accounts are not reflected within the Company’s consolidated balance sheets and statements ofincome 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’scarrying value (including advance to the investee) in equity method investee companies is reflected in the caption “Investment in and advance toequity 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’sconsolidated financial statements unless the Company guaranteed obligations of the investee company or has committed additional funding. Whenthe investee company subsequently reports income, the Company will not record its share of such income until it equals the amount of its share oflosses not previously recognized. F-19 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 intoaccount their respective estimated residual values over the following estimated useful lives: Vehicles5 yearsOffice equipment3-5 yearsElectronic devices5 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 dispositionfor the difference between the net book value and proceeds received thereon. Maintenance and repairs which do not improve or extend the expecteduseful 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 usefuleconomic 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 nolonger indefinite. The Company reviews intangible assets' remaining useful lives in each reporting period. If such an asset is later determined tohave a finite useful life, the asset will be tested for impairment. That asset will then be amortized prospectively over its estimated remaining usefullife 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 thedevelopment or purchase of internal-use software and systems as well as the costs incurred in the application development stage related to itswebsite be capitalized and amortized over the estimated useful life of the software or system. ASC Topic 350-50 also require that costs related to thepreliminary project stage, data conversion and post implementation/operation stage of an internal-use software development project be expensed asincurred. Based on the Company analysis of its website development cost which is subject to capitalization in accordance with ASC Topic 350-50 incurredfor the development of www.liansuo.com and www.chuangye.com, the Company did not capitalize such cost, as the amount was consideredimmaterial, which was primarily the labor cost of its staff in the research and development department. 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 orchanges in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held andused is measured by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to be generated bythe asset. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recognized for the differencebetween the carrying amount of the asset and its fair value. For the years ended December 31, 2011 and 2010, the Company did not record any impairment losses associated with long-lived assets. F-20 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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'sacquisitions 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 testswhen an event occurs or circumstances change that could indicate that the asset might be impaired. The test consists of two steps. First, identifypotential impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reportingunit is greater than its carrying amount, goodwill is not considered impaired. Second, if there is impairment identified in the first step, an impairmentloss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of goodwill. The implied fairvalue of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordancewith Topic 805 “Business Combinations.” Application of a goodwill impairment test requires significant management judgment, including the identification of reporting units, assigningassets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. The judgment inestimating the fair value of reporting units includes estimating future cash flows, determining appropriate discount rates and making otherassumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit. For the years ended December 31, 2011 and 2010, 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 netincome 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 incomeattributable to the noncontrolling interest) at the date the subsidiary is deconsolidated. b. The carrying amount of the former subsidiary’s assets and liabilities. 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 inaccordance with ASC Topic 810 “Consolidation”, subtopic 10, which requires the transaction be accounted for as equity transactions (investmentsby owners and distributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net incomeor comprehensive income. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in thesubsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest isadjusted shall be recognized in equity attributable to the parent and reallocated the subsidiary’s accumulated comprehensive income, if any, amongthe parent and the noncontrolling interest through an adjustment to the parent’s equity. F-21 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS o) Fair Value The Company’s financial instruments primarily consist of cash and cash equivalents, accounts receivable, other receivables, prepayment anddeposits, accounts payable, advances from customers, accruals and other payables. The carrying values of these financial instruments approximatefair 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 totransfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between marketparticipants on the measurement date. This topic also establishes a fair value hierarchy which requires classification based on observable andunobservable 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 notactive; 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 hierarchydisclosures 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 beenrendered, (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 addedtechnical services, reselling of internet advertising spaces and other advertisement related resources. No revenue from advertising-for-advertisingbarter transactions was recognized because the transactions did not meet the criteria for recognition in ASC Topic 605, subtopic 20. Advertisingcontracts establish the fixed price and advertising services to be provided. Pursuant to advertising contracts, the Company provides advertisementplacements in different formats, including but not limited to banners, links, logos, buttons, rich media and content integration. Revenue isrecognized ratably over the period the advertising is provided and, as such, the Company considers the services to have been delivered. TheCompany treats all elements of advertising contracts as a single unit of accounting for revenue recognition purposes. Value added technical servicesare provided based on two types of contracts: (i) fixed price and (ii) fixed price with minimum performance threshold. For contracts with fixed priceterms, 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 enteringinto contracts, the Company determines if collectability is reasonably assured. In situations where collectability is not deemed to be reasonablyassured, the Company recognizes revenue upon receipt of cash from customers, only after services have been provided and all other criteria forrevenue recognition have been met. q) Cost of sales Cost of sales primarily includes the cost of media advertising time, internet advertisement related resources and other technical services purchasedfrom third parties, labor cost and benefits and PRC business tax. F-22 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 theestimated beneficial period and are included in “selling expenses” in the statement of income and comprehensive income. For the years endedDecember 31, 2011 and 2010, advertising expenses for the Company’s own brand building were approximately US$1,357,000 and US$2,002,000,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 dailyoperations in research and development cost. Research and development costs are charged to expense when incurred. Expenses for research anddevelopment for the years ended December 31, 2011 and 2010 were approximately US$2,132,000 and US$907,000, 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 assetsand liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax ratesthat will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred taxassets, 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 theenactment 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 notthreshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation alsoprovides 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. Forthe years ended December 31, 2011 and 2010, the Company did not have any interest and penalties associated with tax positions and did not haveany significant unrecognized uncertain tax positions. 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 recognizedas compensation expense over the requisite service period, or vesting period. w) Noncontrolling interest The Company accounts for noncontrolling interest in accordance with ASC Topic 810-10-45, which requires the Company to presentnoncontrolling interests (previously referred to as minority interests) as a separate component of total shareholders’ equity on the consolidatedbalance sheet and the consolidated net income attributable to the parent and the noncontrolling interest be clearly identified and presented on theface of the consolidated income and comprehensive income statement. ASC Topic 810-10-45 also requires that losses attributable to the parent andthe noncontrolling interest in a subsidiary be attributed to those interests even if it results in a deficit noncontrolling interest balance. x) Comprehensive incomeThe Company accounts for comprehensive income in accordance with ASC Topic 220 “Comprehensive Income”, which establishes standards forreporting and displaying comprehensive income and its components in the consolidated financial statements. Comprehensive income is defined asthe change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting frominvestments from owners and distributions to owners. Accumulated other comprehensive income, as presented in the Company’s consolidatedbalance sheets are the cumulative foreign currency translation adjustments. F-23 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 dividingincome attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Dilutedearnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or convertedinto common stock. Common shares issuable upon the conversion of the convertible preferred shares are included in the computation of dilutedearnings per share on an “if-converted” basis when the impact is dilutive. The dilutive effect of outstanding common stock warrants and options arereflected 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 thefinancial statements indicates that it is probable that a liability have been incurred and the amount of the loss can be reasonably estimated. Legalexpenses associated with the contingency are expensed as incurred. If a loss contingency is not probable or reasonably estimable, disclosure of theloss contingency is made in the financial statements when it is at least reasonably possible that a material loss could be incurred. aa) Recent accounting pronouncements In September 2011, the FASB issued ASU No. 2011-08 — “Intangibles — Goodwill and Other”. The amendments in this update will allow an entityto first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under theseamendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitativeassessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events andcircumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim goodwillimpairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of the provisions in ASU2011-08 will have no material impact on the Company’s consolidated financial statements. In December 2011, the FASB issued ASU No. 2011-12 — “Comprehensive Income”. The amendments in this update supersede certain pendingparagraphs in ASU No. 2011-05, to effectively defer only those changes in ASU No. 2011-05 that relate to the presentation of reclassificationadjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to re-deliberate thepresentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements forpublic, private, and non-profit entities. The amendments in this update are effective for public entities for fiscal years, and interim periods withinthose years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15,2012, and interim and annual periods thereafter. The adoption of the provisions in ASU 2011-12 will have no material impact on the Company’sconsolidated 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 afuture date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption. F-24 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. Acquisitions In order to further diversify the channels of the Company’s adverting and marketing campaign services, achieve an entry into Fujian province, a base offast growing small to medium enterprises, and expand the Company’s market opportunities from these enterprises, which are looking to domesticallyexpand their businesses through franchises, dealerships and merchants in China, the Company acquired a 100% equity interest and a 51% equity interestin Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He, respectively. In order to establish the distinct brands in each of the Company’s targetedcustomer segment and achieved more diversified operational synergies of the Company’s internet advertising and marketing business, the Companyacquired a 51% equity interest in Sou Yi Lian Mei, an established internet advertising and marketing services provider for merchant and franchiseenterprises and organizations primarily involved in small office/home office ("SOHO") and emerging business, through its web portal, www.sooe.cn. Asdescribed in Note 1, the acquisition of a 100% equity interest in Quanzhou Zhi Yuan, the acquisition of a 51% equity interest in Quanzhou Tian Xi ShunHe and the acquisition of a 51% equity interest in Sou Yi Lian Mei, was consummated on January 4, 2011, February 23, 2011and December 20, 2011,respectively. Each acquisition was accounted for using the acquisition method of accounting in accordance with ASC Topic 805 “Business Combinations”, andaccordingly the acquired assets and liabilities were recorded at their fair values on the dates of acquisitions and the results of their operations have beenincluded 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 forsuch valuation include: weighted average cost of capital (“WPCC”), discount rate, and terminal growth rate. The income approach explicitly recognizesthat the current value of an asset is premised upon the expected receipt of future economic benefits focusing on the income producing capability of abusiness 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 arate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risk associated with the particular investmentwhich reflects both current return requirements of the market and specific investment. The discount rate selected is generally based on rates of returnavailable from alternative investments of similar type and quality as of each assessment date. The Cost approach is applied for software technologiesvaluation based on the estimated replacement cost of the software technologies. The Monte Carlo simulation is applied for the valuation of contingentconsideration receivables. Contingent consideration receivables arose from certain “make good” provisions stipulated in the acquisition agreementswith 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 percentagewhile compared to audited pretax profit or after tax profit of the prior year, the sellers need to compensate the Company in cash for the differencebetween 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 andintangibles not qualifying for separate recognition. Goodwill is nondeductible for income tax purpose in the tax jurisdiction of these acquisitiontransactions 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 ofQuanzhou Zhi Yuan): 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 $1,388 F-25 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Acquisition of Quanzhou Tian Xi Shun He The following table summarized the assignment of fair value to identifiable assets and liabilities assumed as of February 23, 2011 (the acquisition date ofQuanzhou Tian Xi Shun He): Fair Value Amortization Period US$(’000) (Years) Cash and cash equivalents $12 Accounts receivables and other receivables 55 Property and equipment, net 41 Other current liabilities (34) Deferred tax liabilities (289) Acquired intangible assets: Trade Name 182 Indefinite Contract Backlog 170 0.6 Customer Relationship 722 9 Non-Compete Agreement 83 5 Goodwill: Assembled Workforce 23 Other unidentifiable intangibles 1,143 1,166 Total Value 2,108 Purchase price 1,138 Fair value of non-controlling interest 1,034 Contingent consideration receivable (64) Total amount to be allocated 2,108 F-26 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Acquisition of Sou Yi Lian Mei The following table summarized the assignment of fair value to identifiable assets and liabilities assumed as of December 20, 2011 (the acquisition dateof Sou Yi Lian Mei): Fair Value Amortization Period US$(’000) (Years) Cash and cash equivalents $310 Receivables and prepayments 1,957 Other current assets 23 Property and equipment, net 33 Other current liabilities (2,140) Deferred tax liabilities (1,266) Acquired intangible assets: 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 non-controlling 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, thefinancial performance of the acquirees reported in the Company’s consolidated statements of income and comprehensive income includes sales ofapproximately 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 and 2010, combines the historical operating results of theCompany with those of Quanzhou Zhi Yuan, Quanzhou Tian Xi Shun He and Sou Yi Lian Mei in the aggregate, as if these acquisitions had beencompleted as of the beginning of the reporting periods, and also includes the adjustments for the business combination effect of the amortization chargesfrom acquired intangible assets and the related tax effects. (Amounts in thousands, except for per share data): Year ended December 31, 2011 2010 Revenue $35,659 $47,717 Net income before allocation to the noncontrolling interests $4,508 $17,556 Earnings per share-Basic $0.19 $0.99 Earnings per share-Diluted $0.19 $0.84 The pro forma information does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results ofoperations. 5. Cash and cash equivalent As of December 31, 2011 2010 US$(’000) US$(’000) Cash 181 39 Bank deposit 10,514 15,551 10,695 15,590 F-27 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. Accounts receivable, net As of December 31, 2011 2010 US$(’000) US$(’000) Accounts receivable 6,546 4,319 Allowance for doubtful debts (2,102) - Accounts receivable, net 4,444 4,319 All of the accounts receivable are non-interest bearing. Based on the assessment of the collectability of the accounts receivable as of December 31,2011, the Company provided approximately US$2,102,000 allowance for doubtful debts for the year ended December 31, 2011, which was relatedto the accounts receivable of the Company’s internet advertising business segment with an aging over six months. 7. Other receivables, net As of December 31, 2011 2010 US$(’000) US$(’000) Short-term loan for marketing campaign 2,985 3,781 Short-term loans to third parties - 3,781 Staff advances for normal business purpose 279 249 Overdue contract execution deposits 891 - Allowance for doubtful debts (524) - Other receivables, net 3,631 7,811 Short-term loan for marketing campaign: for one of the major marketing campaigns, the Company made a marketing-related loan ofRMB25,000,000 (approximately US$3,781,000) to a TV series of 36 episodes, called “Xiao Zhang Feng Yun”. This TV series was produced for thecommemoration of “The Republican Revolution of 1911” (the Chinese bourgeois democratic revolution led by Dr. Sun Yat-sen which overthrew theQing Dynasty). By participating in this TV series, the Company will be shown during the credit at the closing of each episode with its logopresented and also shown as a separate card during the closing before the credit screen. This TV series has been broadcasted on CCTV 8 andwww.sina.com.cn from September 2011 and is continually selling its broadcasting rights to other provincial TV channels for additional exposure. InNovember and December, 2011, the Company collected its first two repayments of RMB6,000,000 (approximately US$942,700) in the aggregatefrom the borrower. In accordance with the communication between the Company and the debtor, the Company has extended the term of this loanfrom December 31, 2011 to December 31, 2012, as this TV series had only completed its first round selling broadcasting rights. The Company willcontinue to assess the collectability of this loan and if an event occurs or circumstances change that could indicate that the collectability of this loanis remote, a full allowance of bad debts provision will be provided for the remaining outstanding balance of this loan. The Company lends third parties on a subjective condition of search and/or obtaining other potential value added communication channel resourceswith lower cost from time to time. Any of the third parties is required to pay back the capital within three months or on demand if they have notcontributed any searches. The acquired resources are mainly used to self-advertising and marketing or advertising for clients in internet bundlepackages in second and third tier cities or regions. The outstanding third party loans as of December 31, 2010 were paid in full in March 2011. As ofDecember 31, 2011, there was no third party loan outstanding under these arrangements. For all advertising resources purchase contracts signed by the Company with its resources providers, the Company is required to deposit contractexecution guarantees, the contract execution guarantees will be used to offset the contact amount need to be paid for the resources provided in thelast month of each contract period or refunded to the company upon expiration of the purchase contract. Overdue contract execution deposits as ofDecember 31, 2011 represented the portion of the contract execution deposits, which related advertising resources purchase contracts had beencompleted as of December 31, 2011. Based on the assessment of the collectability of these overdue contract execution deposits as of December 31,2011, the Company provided approximately US$524,000 allowance for doubtful debts for the year ended December 31, 2011, which was related tothe contract execution deposits of its TV advertising business segment. F-28 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. Prepayments and deposit to suppliers As of December 31, 2011 2010 US$(’000) US$(’000) Contract execution guarantees to TV advertisement and internet resources providers 10,050 2,778 Prepayments to TV advertisement and internet resources providers 5,285 413 Prepayment to online game operating service provider - 91 Other deposits and prepayments 25 43 15,360 3,325 Contract execution guarantees to TV advertisement and internet resource providers are paid as contractual deposits to the Company’s resources andservices providers. These amounts will be used to offset the contact amount and service fee need to be paid for the resources and services providedin the last month of each contract period or refunded to the Company upon expiration of the purchase contracts. According to the contracts signed between the Company and its suppliers, the Company is normally required to pay the contract amount inadvance. These prepayments will be transferred to cost of sales when the related services are provided. 9. Due from related parties As of December 31, 2011 2010 US$(’000) US$(’000) Beijing Fengshangyinli Technology Co., Ltd. 113 - Beijing Saimeiwei Food Equipment Technology Co., Ltd. 74 - Beijing Telijie Century Environmental Technology Co., Ltd. 137 39 Sou Yi Lian Mei Advertising Co., Ltd. - 146 324 185 These related parties are directly or indirectly owned by the Control Group or the management of the Company. Control Group refers to Mr.Handong Cheng, Mr. Xuanfu Liu and Ms. Li Sun (acting as nominee for Mr. Zhang Zhige), the owners of the Company’s PRC VIEs, BusinessOpportunities Online and Beijing CNET Online before the Offshore Restructuring. The Company provided advertising services to these relatedparties or purchased advertising resources on behalf of these related parties during the years ended December 31, 2011 and 2010. Due from relatedparties as of December 31, 2011 and 2010 represented the outstanding receivables from these related parties for the services the Company providedto them. F-29 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. Deposit for acquisitions As of December 31, 2011 2010 US$(’000) US$(’000) Quanzhou Zhi Yuan - 983 Quanzhou Tian Xi Shun He - 529 - 1,512 In accordance with the acquisition agreement the Company entered into with the shareholders of Quanzhou Zhi Yuan and Quanzhou Tian Xi ShunHe on December 18, 2010 and December 22, 2010, respectively, the Company prepaid RMB6,500,000 (approximately US$983,000) andRMB3,500,000 (approximately US$529,000) of the cash consideration for the acquisition of a 100% equity interest in Quanzhou Zhi Yuan and a51% equity interest in Quanzhou Tian Xi Shun He, respectively, as deposits to an independent agent who was entrusted by both of the counter-parties upon signing the agreement. The shareholders of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He would then fulfill the relatedobligations and process the relevant legal procedures and formalities as required in the acquisition agreements to complete the transaction. Asagreed by all parties, the completion dates of these acquisition transactions and the transfer of the control of the acquirees were the dates that theequity interest transfers were approved by, and registered with, the relevant PRC government authorities and the prepaid cash consideration wouldbe released to the shareholders of the acquirees on their respective transaction completion date. Therefore, as of December 31, 2010, the cashconsiderations prepaid were recorded as deposit for acquisitions. On January 4, 2011 and February 23, 2011, the acquisition of a 100% equity interest in Quanzhou Zhi Yuan and the acquisition of a 51% equityinterest in Quanzhou Tian Xi Shun He were approved by, and registered with, the relevant PRC government authorities of Quanzhou City, FujianProvince, respectively, and the prepaid cash considerations deposits were released to the shareholders of the acquirees in accordance. The Companydetermined the acquisition dates of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He as of January 4, 2011 and February 23, 2011, respectively,and the prepaid cash deposits were accounted for as part of the purchase price allocation (see Note 4). 11. Contingent consideration receivables Amount US$(’000) Balance as of January 1, 2011 - Recognized from acquisition of VIEs: (Note 4) --Quanzhou Zhi Yuan 52 --Quanzhou Tian Xi Shun He 64 --Sou Yi Lian Mei 111 Changes in fair value of contingent consideration receivables (72)Exchange translation adjustment 4 Balance as of December 31, 2011 159 According to the acquisition agreements the Company entered into with Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He, if audited pretaxprofit for 2011 and 2012 increases by less than 30% while compared to that of the prior year, the sellers shall compensate the Company for thedifference between the target pretax profit and actual results achieved in cash. Fair value of the contingently consideration receivable as of therespective acquisition date of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He was approximately US$52,000 and US$64,000, respectively (SeeNote 4). As Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He have both achieved its respective target pre-tax profit for the year ended December31, 2011, they will not compensate the Company any cash in accordance with the acquisition agreement. The Company reassessed the fair value ofthese contingent consideration receivables as of December 31, 2011 for the respective make good arrangement for the year ended December 31,2012, based on their respectively historical performance and other relevant assumptions. The changes in the fair value of the contingentconsideration receivables for the year ended December 31, 2011 was included in the Company’s statement of income and comprehensive income. According to the acquisition agreement the Company entered into with Sou Yi Lian Mei, if Sou Yi Lian Mei achieved less than 95% of its 2012Performance Threshold, which is RMB15,800,000 (approximately US$2.4 million) of audited after tax net profit for the year ended December 31,2012, the noncontrolling shareholder of Sou Yi Lian Mei shall compensation the Company the shortfall between the 95% of 2012 PerformanceThreshold and actual audited after tax net profit for fiscal year 2012. Fair value of the contingently consideration receivable as of the acquisitiondate of Sou Yi Lian Mei was approximately US$111,000 (See Note 4). F-30 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Investment in and advance to equity investment affiliates As of December 31, 2011 2010 US$(’000) US$(’000) Investment in equity investment affiliates 1,354 1,112 Advance to equity investment affiliates 42 6,050 1,396 7,162 The following table summarizes the movement of the investment in and advance to equity investment affiliates for the year ended December 31,2011: Beijing Yang Guang Shenzhen Mingshan Zhao Shang Ke Hubei Total US$(’000) US$(’000) US$(’000) US$(’000) Balance as of December 31, 2010 7,162 - - 7,162 Deconsolidation of Shenzhen Mingshan - 395 - 395 Gain on deconsolidation of Shenzhen Mingshan - 237 - 237 Advance to Shenzhen Mingshan - 42 - 42 Loan to Beijing Yang Guang 1,571 - - 1,571 Loan repayment from Beijing Yang Guang (7,856) - - (7,856) Additional investment to Shenzhen Mingshan - 170 - 170 Share of earnings (losses) in equity investment affiliates 26 (249) - (223) Disposal of investment in Beijing Yang Guang (1,181) - - (1,181) Deconsolidation of Zhao Shang Ke Hubei - - 97 97 Gain on deconsolidation of Zhao Shang Ke Hubei - - 704 704 Exchange translation adjustment 278 - - 278 Balances as of December 31, 2011 - 595 801 1,396 Beijing Yang Guang: Beijing Yang Guang was incorporated on October 25, 2010. On December 8, 2010, one of the Company’s VIEs, Shanghai Jing Yang acquired a 49%interest in Beijing Yang Guang for cash consideration of RMB7,350,000 (approximately US$1,112,000) and became the noncontrolling interestholder of Beijing Yang Guang. The investment in Beijing Yang Guang was accounted for under the equity method until the Company withdrew itsinvestment and ceased to have any noncontolling interest in Beijing Yang Guang in August 2011. The Company did not recognize its pro-rata share of losses in Beijing Yang Guang for the year ended December 31, 2010 as the amount isimmaterial. For the year ended December 31, 2011, before the Company disposed its investment in Beijing Yang Guang, the Company recognizedits pro-rata share of earnings in Beijing Yang Guang of approximately US$26,000, which was reflected in the caption of “Share of earnings (losses)in equity investment affiliates” in the Company’s consolidated statements of income and comprehensive income with a corresponding increase tothe carrying value of the investment in Beijing Yang Guang in the Company’s consolidated balance sheet. F-31 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In August 2011, the Company withdrew its investment in Beijing Yang Guang and sold back its 49% equity interest to the majority shareholder ofBeijing Yang Guang for cash consideration equal to the amount the Company paid for the acquisition of the 49% equity interest in December 2010,which amount has been fully collected as of December 31, 2011. In November 2011, Beijing Yang Guang also distributed to the Company its pro-rata share of net income of approximately US$26,000, generated by Beijing Yang Guang during the period when the Company held 49% of theequity interest of Beijing Yang Guang. As of December 31, 2011, the Company collected the aggregate of RMB50,000,000 (approximately US$7,856,000) working capital loan borrowedby Beijing Yang Guang in 2010 and 2011, which was the total amount due under the loan.Shenzhen Mingshan:Shenzhen Mingshan was incorporated on June 24, 2010 by one of the Company’s VIEs, Business Opportunities Online and three other individualswho were not affiliated with the Company. Shenzhen Mingshan was 51% owned by the Company and was a consolidated subsidiary of theCompany from the date of incorporation through January 6, 2011. On January 6, 2011, an independent third party investor investedRMB15,000,000 (approximately US$2,357,000) cash into Shenzhen Mingshan in exchange for a 60% equity interest in Shenzhen Mingshan. TheCompany’s share of equity interest decreased from 51% to 20.4% accordingly. The carrying value of the investment to Shenzhen Mingshan uponthe deconsolidation of approximately US$395,000 was included in the balance sheet as “Investment in equity investment affiliates”. The deconsolidation of Shenzhen Mingshan was accounted for in accordance with ASC Topic 810 “Consolidation”. The Company recognized again of approximately US$237,000 upon deconsolidation of Shenzhen Mingshan, which has been recorded as a gain on deconsolidation ofsubsidiaries in the Company’s consolidated statements of income and comprehensive income with a corresponding increase in the carrying value ofthe investment in Shenzhen Mingshan in the Company’s consolidated balance sheet. This gain represents the excess of the fair value of theCompany’s retained equity interest over its carrying value as of the date of deconsolidation. The Company determined the estimated fair value of its retained equity interest in Shenzhen Mingshan based on the valuation of ShenzhenMingshan used when an independent third party investor purchased an equity interest in Shenzhen Mingshan, which purchase price was negotiatedon an arm’s length basis. Under these circumstances, the Company estimated the fair value of its retained equity interest based on the fair value ofthe equity interest purchased by the independent third party investor. In March 2011, the Company, through its wholly-owned subsidiary Rise King WFOE, sold some spared computer servers to Shenzhen Mingshan forapproximately US$42,000. The Company does not intend to collect this amount within one year, as the amount is immaterial. Therefore, thisbalance was recorded as part of the long-term investment to Shenzhen Mingshan. In August 2011, the Company made an additional capital injection of RMB1,080,000 (approximately US$170,000) in cash to Shenzhen Mingshanfor its portion of the unpaid registered capital, which was required to be fully contributed within two years from the incorporation of ShenzhenMingshan. This amount was recorded as an increase in investment in equity investment affiliates in the Company’s consolidated balance sheet. The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the year endedDecember 31, 2011, the Company recognized its pro-rata share of losses in Shenzhen Mingshan of approximately US$249,000, which was reflectedin the caption of “Share of earnings (losses) in equity investment affiliates” in the Company’s consolidated statements of income and comprehensiveincome 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-foundingindividual who was not affiliated with the Company. Zhao Shang Ke Hubei was 51% owned by the Company and was a consolidated subsidiary ofthe Company from the date of incorporation through December 29, 2011. On December 29, 2011, two independent third party investors investedRMB10,000,000 (approximately US$1,571,000) cash into Zhao Shang Ke Hubei in exchange for an aggregate 50% equity interest in Zhao ShangKe Hubei. The Company’s share of equity interest decreased from 51% to 25.5% accordingly. The carrying value of the investment to Zhao ShangKe Hubei upon deconsolidation of approximately US$97,000 was included in the balance sheet as “Investment in equity investment affiliates”. F-32 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The deconsolidation of Zhao Shang Ke Hubei was accounted for in accordance with ASC Topic 810 “Consolidation”. The Company recognized again of approximately US$704,000 upon deconsolidation of Zhao Shang Ke Hubei, which has been recorded as a gain on deconsolidation ofsubsidiaries in the Company’s consolidated statements of income and comprehensive income with a corresponding increase in the carrying value ofthe investment in Zhao Shang Ke Hubei in the Company’s consolidated balance sheet. This gain represents the excess of the fair value of theCompany’s retained equity interest over its carrying value as of the date of deconsolidation. The Company determined the estimated fair value of its retained equity interest in Zhao Shang Ke Hubei based on the valuation of Zhao Shang KeHubei used when the two independent third party investors purchased equity interest in Zhao Shang Ke Hubei, which purchase price was negotiatedon an arm’s length basis. Under these circumstances, the Company estimated the fair value of its retained equity interest based on the fair value ofequity interest purchased by the independent third party investors. The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the year endedDecember 31, 2011, the Company did not recognize its pro-rata share of losses in Zhao Shang Ke Hubei as the amount is immaterial. 13. Property and equipment, net As of December 31, 2011 2010 US$(’000) US$(’000) Vehicles 683 584 Office equipment 1,399 1,183 Electronic devices 1,196 969 Property and equipment, cost 3,278 2,736 Less: accumulated depreciation (1,376) (726)Property and equipment, net 1,902 2,010 Depreciation expenses in aggregate for the years ended December 31, 2011 and 2010 were approximately US$551,000 and $383,000, respectively. 14. Intangible assets, net As of December 31, 2011 2010 US$(’000) US$(’000) Intangible assets not subject to amortization: Trade name 306 - Domain name 1,518 - Intangible assets subject to amortization: - Contract backlog 195 - Customer relationship 3,408 - Non-compete agreements 1,348 - Software technologies 322 - Cloud-computing based software platforms 1,458 - Other computer software 75 61 Intangible assets, cost 8,630 61 Less: accumulated amortization (479) (10)Intangible assets, net 8,151 51 F-33 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Trade name, Domain name, Contract backlog, Customer relationship, Non-compete agreements and Software technologies were acquired throughthe acquisition transactions described in Note 4. On July 1, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, and an individual who was not affiliated with the Companyformed a new company, Sheng Tian Network Technology (Hubei) Co., Ltd (“Sheng Tian Hubei”), which was 51% owned by Business OpportunityOnline Hubei and 49% owned by this individual. In addition, Business Opportunity Online Hubei, entered into a software platform and technologypurchase agreement with this individual. The agreement provides that the purchase price shall be based on a valuation of RMB18,200,000(approximately US$2,860,000), and Business Opportunity Online shall pay RMB9,282,000 (approximately US$1,458,000) and own 51% of thesesoftware platforms and the related technology accordingly. The agreement stipulates that the seller shall transfer all software platforms and therelated documentations to Sheng Tian Hubei and provide assistance for the registration of the software platforms and the related technology in thename of Sheng Tian Hubei. The agreement also provides that the seller shall dismiss all human resources for the business activities related to thesoftware platforms from the date of this agreement and provide assistance for Sheng Tian Hubei to re-employ the necessary technology staff from theseller upon establishment of Sheng Tian Hubei to ensure a smooth transitioning of the activities related to the software platforms. These softwareplatforms are all based on the cloud-computing technology and will be further consolidated and integrated into the Company’s advertising andmarketing platform and mainly, management tools platform and packed into different value-added services to be provided to its clients. Thesecloud-computing technology based software platforms were recorded at cost and amortized on a straight line basis for an estimated economic life often years. Amortization expenses in aggregate for the year ended December 31, 2011 and 2010 were approximately US$461,000 and US$10,000, respectively. Based on the carrying value of the finite-lived intangible assets recorded as of December 31, 2011, and assuming no subsequent impairment of theunderlying intangible assets, the estimated future amortization expenses is approximately US$1,014,000 per year through December 31, 2015 andapproximately US$975,000 for the year ended December 31, 2016. 15. Goodwill Amount US$(’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 16. Accrued payroll and other accruals As of December 31, 2011 2010 US$(’000) US$(’000) Accrued payroll and staff welfare 344 258 Accrued operating expenses 272 212 616 470 F-34 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. Due to equity investment affiliate As of December 31, 2011 2010 US$(’000) US$(’000) Zhao Shang Ke Hubei 220 - Zhao Shang Ke Hubei became an equity investment affiliate of the Company immediately after the deconsolidation (See Note 12). Amounts due toZhao Shang Ke Hubei as of December 31, 2011 was a temporary non-interest bearing working capital loan borrow by one of the Company’s VIEfrom Zhao Shang Ke Hubei. 18. Due to related parties As of December 31, 2011 2010 US$(’000) US$(’000) Shiji Huigu Technology Investment Co., Ltd - 91 Beijing Saimeiwei Food Equipments Technology Co., Ltd 4 3 Beijing Telijie Century Environmental Technology Co., Ltd. - 45 Due to legal (nominal) shareholders of Shanghai Jing Yang 157 152 161 291 The related parties listed above are directly or indirectly owned by the Control Group (See Note 9), the Company provided advertising services tothem. The advance payments listed above are received from these parties for advertising services will be provided in the future periods.Shanghai Jing Yang was incorporated in December 2009 by the Company’s senior management, prior to entering into the Contractual Agreementswith the Company (see Note 1), the legal shareholders contributed RMB1,000,000 (approximately US$157,000) as the original paid-in capital ofShanghai Jing Yang upon incorporation. This amount will be returned to the legal (nominal) shareholders of Shanghai Jing Yang in the first halfof 2012. 19. Due to Control Group As of December 31, 2011 2010 US$(’000) US$(’000) Due to Control Group - 81 F-35 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Due to Control Group represents the outstanding balance due to the Control Group for the costs and operating expenses paid by them on behalf ofthe Company. As of December 31, 2011, the Company had settled the balance to the Control Group. 20. Due to director As of December 31, 2011 2010 US$(’000) US$(’000) Due to director - 559 Due to director represents the operating expenses paid by director on behalf of the Company. As of December 31, 2011, the Company has settled thebalance to the director. 21. Payable for acquisition As of December 31, 2011 2010 US$(’000) US$(’000) Sou Yi Lian Mei 550 - Payable for acquisition represented the outstanding payment of RMB3,500,000 (approximately US$550,000) for the acquisition transaction of SouYi Lian Mei as of December 31, 2011. 22. 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 incometax. Following the Share Exchange, the Company became a holding company and does not conduct any substantial operations of its own. Noprovision for federal corporate income tax has been made in the financial statements as the Company has no assessable profits for the year endedDecember 31, 2011 and 2010, or any prior periods. The Company does not provide for U.S. taxes or foreign withholding taxes on undistributedearnings 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 onincome 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 profitstax has been made in the financial statements as China Net HK has no assessable profits for the year ended December 31, 2011 and 2010 or any priorperiods. 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 issubject to PRC enterprise income tax (“EIT”). Effective from January 1, 2008, the EIT rate of PRC was changed from 33% to 25%, and applies toboth domestic and foreign invested enterprises. F-36 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS l Rise King WFOE is a software company qualified by the related PRC governmental authorities and was approved by the local tax authoritiesof 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 theCompany. 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 year endedDecember 31, 2011 and 2010, the applicable income tax rate for Rise King WFOE was 12.5% and nil%, respectively. After fiscal year 2013,the applicable income tax rate for Rise King WFOE will be 25% under the current EIT law of PRC. l Business Opportunity Online was qualified as a High and New Technology Enterprise in Beijing High-Tech Zone in 2005 and was approvedby the local tax authorities of Beijing, the PRC, to be entitled to a three-year EIT exemption for fiscal year 2005 through fiscal year 2007 anda 50% reduction of its applicable EIT rate, which is 15% to 7.5% for the following three years for fiscal year 2008 through fiscal year2010. However, in March 2007, a new enterprise income tax law (the “New EIT”) in the PRC was enacted which was effective on January 1,2008. Subsequently, on April 14, 2008, relevant governmental regulatory authorities released new qualification criteria, applicationprocedures and assessment processes for “High and New Technology Enterprise” status under the New EIT which would entitle the re-qualified and approved entities to a favorable statutory tax rate of 15%. Business Opportunity Online re-applied its qualification for a Highand New Technology Enterprise in 2008 to the related PRC regulatory authorities. With an effective date of September 4, 2009, BusinessOpportunity Online obtained the approval of its reassessment of the qualification as a “High and New Technology Enterprise” under the NewEIT law and was approved again by the local tax authorities to be entitled to a favorable statutory tax rate of 15%. Under the previous EITlaws and regulations, High and New Technology Enterprises enjoyed a favorable tax rate of 15% and were exempted from income tax forthree years beginning with their first year of operations, and were entitled to a 50% tax reduction to 7.5% for the subsequent three years and15% thereafter. The current EIT Law provides grandfathering treatment for enterprises that were (1) qualified as High and New TechnologyEnterprises under the previous EIT laws, and (2) established before March 16, 2007, if they continue to meet the criteria for High and NewTechnology Enterprises under the current EIT Law. The grandfathering provision allows Business Opportunity Online to continue enjoyingtheir unexpired tax holidays provided by the previous EIT laws and regulations, as it was established in December 2004 and qualified as aHigh and New Technology Enterprises under the previous EIT laws in 2005. After the expiration of the current tax holiday as of December 31,2010, the applicable income tax rate of Business Opportunity Online increased to 15%, the standard preferential income tax rate for a Highand New Technology Enterprise. Therefore, for the year ended December 31, 2011 and 2010, the applicable income tax rate for BusinessOpportunity Online was 15% and 7.5%, respectively. Business Opportunity Online’s High and New Technology Enterprise certificate willexpire on September 4, 2012 and subject to an administrative review by the relevant PRC governmental regulatory authorities for obtainingthe renewed certificate. As confirmed with the local tax authorities, if Business Opportunity Online fails to pass the administrative review, theenacted tax rate will be increased to 25% starting from January 1, 2012. Business Opportunity Online assessed the situation and concludedthat more likely than not it will be able to pass this administrative review and continue to enjoy the 15% preferential income tax rate as aHigh and New Technology Enterprise. l Business Opportunity Online Hubei, Hubei CNET and Zhao Shang Ke Hubei were all incorporated in Xiaotian Industrial Park of XiaoganEconomic Development Zone in Xiaogan City, Hubei province of the PRC in 2011. These operating entities have been approved by therelated local government authorities to apply the deemed income tax method for its computation of income tax expense for the year endedDecember 31, 2011. Under the deemed income tax method, the deemed profit is calculated based on 10% of the total revenue and theapplicable income tax rate is 25%. Therefore, the income tax expenses under the deemed income tax method is calculated as 2.5% of the totalrevenue recognized for the year ended December 31, 2011 for each of these operating entities. In December 2011, the local tax authorities ofthese operating entities informed the Company, that they will cancel the current applicable deemed income tax method for computation ofincome tax expenses starting from January 1, 2012 for these entities, but may refund certain amount of the income tax paid by these operatingentities as an local subsidy to these entities. Therefore, the applicable income tax rate for these operating entities will be 25% starting fromJanuary 1, 2012. l The applicable income tax rate for other PRC operating entities of the Company is 25% for the years ended December 31, 2011 and 2010. F-37 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS l The New EIT also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holdingcompany outside China, which were exempted under the previous enterprise income tax law and rules. A lower withholding tax rate will beapplied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companiesin Hong Kong, for example, will be subject to a 5% rate. Rise King WFOE is invested by immediate holding company in Hong Kong and willbe entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company. All of the preferential income tax treatments enjoyed by the Company’s PRC subsidiary and VIEs were based on the current applicable laws andregulations of the PRC and approved by the related government regulatory authorities and local tax authorities where the Company’s respectivePRC subsidiary and VIEs operate. Rise King WFOE, Business Opportunity Online, Business Opportunity Online Hubei, Hubei CNET and ZhaoShang Ke Hubei were most affected by these preferential income tax treatments within the structure of the Company for the year ended December 31,2011 and 2010. The preferential income tax treatments are subject to change in accordance with the PRC government economic developmentpolicies and regulations. These preferential income tax treatments are mainly determined by the regulation and policies of the PRC government inthe context of the overall economic policy and strategy. As a result, the uncertainty of theses preferential income tax treatments are subject to, butnot limited to, the PRC government policy on supporting any specific industry’s development under the outlook and strategy of overallmacroeconomic development. 2) Business tax and relevant surcharges Revenue of advertisement services is subject to 5.5% business tax and 3% cultural industry development surcharge of the net service income afterdeducting amount paid to ending media promulgators. Revenue of internet technical support services is subjected to 5.5% business tax. Businesstax charged was included in cost of sales. 3) Value added tax As a general value-added tax payer, revenue from sales of software of Rise King WFOE is subjected to 17% value added tax. As of December 31, 2011 and 2010, taxes payable consists of: As of December 31, 2011 2010 US$(’000) US$(’000) Business tax payable 2,210 1,147 Culture industry development surcharge payable 2 5 Value added tax payable - 216 Enterprise income tax payable 2,770 759 Individual income tax payable 58 66 5,040 2,193 F-38 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A reconciliation of the provision for income taxes determined at the US federal corporate income tax rate to the Company’s effectiveincome tax rate is as follows: Year ended December 31, 2011 2010 US$(’000) US$(’000) Pre-tax income 4,035 16,727 US federal rate 35% 35% Income tax expense computed at U.S. federal rate 1,412 5,854 Reconciling items: Rate differential for domestic earnings (770) (1,601)Preferential tax treatments and tax holiday effects (1,552) (3,785)Valuation allowance on deferred tax assets 1,921 401 Loss not recognized as deferred tax assets - 109 Non-deductible expenses and non-taxable income 24 (626) Effective income tax expense 1,035 352 For the year ended December 31, 2011 and 2010, the Company’s income tax expense consisted of: Year ended December 31, 2011 2010 US$(’000) US$(’000) Current-PRC 1,008 352 Deferred-PRC 27 - 1,035 352 The Company’s deferred tax liabilities at December 31, 2011 and 2010 were as follows: Amount US$(’000) Balance as of January 1, 2011 - Tax effect of recognition of identifiable intangible assets acquired 1,751 Tax effect of gain on deconsolidation of subsidiaries 212 Reversal during the period (93)Exchange translation adjustment 23 Balance as of December 31, 2011 1,893 Deferred tax liabilities arose on the recognition of the identifiable intangible assets acquired from acquisition transactions described on Note 4. Deferred tax liabilities arose on the gain on deconsolidation of subsidiaries upon deconsolidation of Shenzhen Mingshan and Zhao Shang Ke Hubeion January 6, 2011 and December 29, 2011, respectively, which was calculated based on the respective deconsolidation gain recognized and therespective corresponding enacted tax rate that will be in effect in the period in which the differences are expected to reverse.Reversal during the year ended December 31, 2011 of approximately US$93,000, was due to the amortization of these acquired intangible assets. F-39 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company’s deferred tax assets at December 31, 2011 and 2010 were as follows: As of December 31, 2011 2010 US$(’000) US$(’000) Tax effect of net operating losses carried forward 1,975 602 Bad debts provision 651 - Valuation allowance (2,534) (602) 92 - The net operating losses carried forward incurred by the Company (excluding its PRC subsidiary and VIEs) were approximately US$5,381,000 andUS$1,719,000 at December 31, 2011 and 2010, respectively, which will expire in years through 2031. A full valuation allowance has been recordedbecause it is considered more likely than not that the deferred tax assets will not be realized through sufficient future earnings of the entity to whichthe operating losses relate.The net operating losses carried forward incurred by the Company’s PRC subsidiary and VIEs were approximately US$361,000 and US$nil atDecember 31, 2011 and 2010, respectively, which will expire in years through 2016. The related deferred tax assets was calculated based on therespective net operating losses incurred by each of the PRC subsidiary and VIEs and the respective corresponding enacted tax rate that will be ineffect in the period in which the differences are expected to reverse. No valuation allowance has been recorded because it is considered more likelythan not that the deferred tax assets will be realized through sufficient future earnings of the entities to which the operating losses relate.The bed debts provision recorded by the Company’s PRC subsidiary and VIEs were approximately US$2,583,000. A full valuation allowance hasbeen recorded because it is considered more likely than not that the deferred tax assets will not be realized through bad debts verification by thelocal tax authorities where the PRC subsidiary and VIEs operate. 23. Dividend payable As of December 31, 2011 2010 US$(’000) US$(’000) Dividend payable to Series A convertible stock holders 5 255 Dividend to Series A convertible preferred stockholders was accrued at the per annum rate of 10% and calculated based on US$2.5 per shareliquidation preference and the actual number of days of each share of the Series A convertible preferred stock outstanding for the year endedDecember 31, 2011 and 2010, respectively. For the years ended December 31, 2011 and 2010, the Company paid approximately US$657,000 andUS$912,000 dividends to its Series A convertible preferred stockholders, respectively. The outstanding dividend payable of approximatelyUS$5,000 as of December 31, 2011 was paid by the Company in February 2012. 24. Long-term borrowing from director As of December 31, 2011 2010 US$(’000) US$(’000) Long-term borrowing from director 137 132 Long-term borrowing from director was a non-interest bearing loan from a director of the Company relating to the original paid-in capitalcontribution in the Company’s wholly-owned subsidiary Rise King WFOE. F-40 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 25. Series A convertible preferred shares and Warrants On August 21, 2009, the Company entered into a securities purchase agreement (the “Purchase Agreement”), with several investors, includinginstitutional, accredited and non-US persons and entities (the “Investors”), pursuant to which the Company sold units, comprised of 10% Series AConvertible Preferred Stock, par value US$0.001 per share (the “Series A preferred stock”), and two series of warrants, for a purchase price of US$2.50 perunit (the “August 2009 Financing”). The Company sold 4,121,600 units in the aggregate, which included (i) 4,121,600 shares of Series A preferredstock, (ii) 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 (iii)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. Net proceeds wereapproximately US$9,162,000, net of issuance costs of approximately US$1,142,000. TriPoint Global Equities, LLC acted as placement agent andreceived (i) a placement fee in the amount equal to 8% of the gross proceeds and (ii) warrants to purchase up to 329,728 shares of common stock at anexercise 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”). Key terms of the Series A preferred stock sold by the Company in the August 2009 Financing are summarized as follows: Dividends Dividends on the Series A preferred stock shall accrue and be cumulative from and after the issuance date. For each outstanding share of Series Apreferred stock, dividends are payable at the per annum rate of 10% of the Liquidation Preference Amount of the Series A preferred stock. Dividends arepayable quarterly within thirty (30) days following the last Business Day of each August, November, February and May of each year (each, a “DividendPayment Date”), and continuing until such stock is fully converted. The Company shall have the right, at its sole and exclusive option, to pay all or anyportion of each and every quarterly dividend that is payable on each Dividend Payment Date, either (i) in cash, or (ii) by issuing to the holder of Series Apreferred stock such number of additional Conversion Shares which, when multiplied by US$2.5 would equal the amount of such quarterly dividend notpaid in cash. Liquidation Preference In the event of the liquidation, dissolution or winding up of the affairs of the Company, whether voluntary or involuntary (each, a “Liquidation”), theholders of the Series A preferred stock then outstanding shall be entitled to receive, out of the assets of the Company available for distribution to itsstockholders, an amount equal to US$2.5 per share of the Series A preferred stock, plus any accrued but unpaid dividends thereon, whether or notdeclared, together with any other dividends declared but unpaid thereon, as of the date of Liquidation (collectively, the “Series A Liquidation PreferenceAmount”) before any payment shall be made or any assets distributed to the holders of the common stock or any other junior stock. If upon theoccurrence of Liquidation, the assets thus distributed among the holders of the Series A shares shall be insufficient to permit the payment to such holdersof the full Series A Preference Amount, then the entire assets of the Company legally available for distribution shall be distributed ratably among theholders of the Series A preferred stock. Conversion Rights Voluntary Conversion: At any time on or after the date of the initial issuance of the Series A preferred stock, the holder of any such shares of Series A preferred stock may, at suchholder’s option, subject to the limitations described below in “Conversion Restriction”, elect to convert all or portion of the shares of Series A preferredstock held by such person into a number of fully paid and non-assessable shares of common stock equal to the quotient of Liquidation preferenceamount of the Series A preferred stock divided by the initial conversion price of US$2.5. The initial conversion price may be adjusted for stock splits andcombinations, dividend and distributions, reclassification, exchange or substitution, reorganization, merger, consolidation or sales of assets, issuance ofadditional shares of common stock or equivalents with lower price or without considerations etc, as stimulated in the Certification of Designation. F-41 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Mandatory Conversion: All outstanding shares of the Series A preferred stock shall automatically convert into shares of Common Stock, subject to the limitations describedbelow in “Conversion Restriction”, at the earlier to occur of (i) twenty-four month anniversary of the Closing Date, and (ii) at such time that the VolumeWeighted Average Price of the Company’s common stock is no less than US$5.00 for a period of ten (10) consecutive trading days with the daily volumeof the common stock of at least 50,000 shares per day. On August 21, 2011, 2,367,792 shares of the Company’s outstanding Series A preferred stock, which has not been voluntarily converted into theCompany’s common shares, were fully converted to the Company’s common shares under the Mandatory Conversion clause described above. Registration Rights Agreement In connection with the Financing, the Company entered into a registration rights agreement (the “RRA”) with the Investors in which the Companyagreed to file a registration statement (the “Registration Statement”) with the Securities and Exchange Commission to register the shares of commonstock underlying the Series A preferred stock (the “Conversion Shares”) and the Warrants (the “Warrant Shares”), thirty (30) days after the closing of theFinancing. The Company agreed to use its best efforts to have the Registration Statement declared effective within 150 calendar days after filing, or 180calendar days after filing in the event the Registration Statement is subject to a “full review” by the SEC. The Company is required to keep the Registration Statement continuously effective under the Securities Act until such date as is the earlier of the datewhen all of the securities covered by that registration statement have been sold or the date on which such securities may be sold without any restrictionpursuant to Rule 144 (the “Financing Effectiveness Period”). The Company will pay liquidated damages of 2% of each holder’s initial investment in theUnits sold in the Financing per month, payable in cash, up to a maximum of 10%, if the Registration Statement is not filed or declared effective withinthe foregoing time periods or ceases to be effective prior to the expiration of the Financing Effectiveness Period. However, no liquidated damages shallbe paid with respect to any securities being registered that the Company are not permitted to include in the Financing Registration Statement due to theSEC’s application of Rule 415. The Company evaluated the contingent obligation related to the RRA liquidated damages in accordance with “ASC Topic 825 “Financial Instruments”subtopic 20, which required the contingent obligation to make future payments or otherwise transfer consideration under a registration paymentarrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement be separately recognized andmeasured in accordance with “ASC Topic 450” “Contingencies”. The shares of common stock underlying the Series A preferred stock (the “ConversionShares”) and the Warrants (the “Warrant Shares”) have been successfully registered by the Company as of December 31, 2009 and remained effective asof December 31, 2011. Therefore, the Company concluded that such obligation was not probable to incur and no contingent obligation related to theRRA liquidated damages needs to be recognized for the years ended December 31, 2011 and 2010. Security Escrow Agreement The Company entered into a securities escrow agreement with the Investors (the “Escrow Agreement”), pursuant to which Rise King Investment Limited,a British Virgin Islands company (the “Principal Stockholder”), initially placed 2,558,160 shares of Common Stock (the “Escrow Shares”) into an escrowaccount. Of the Escrow Shares, 1,279,080 shares (equivalent to 50% of the Escrow Shares) were being held as security for the achievement of audited netincome equal to or greater than $7.7 million for the fiscal year 2009 (the “2009 Performance Threshold”) and the remaining 1,279,080 of the EscrowShares are being held as security for the achievement of audited net income equal to or greater than $14 million for the fiscal year 2010 (the “2010Performance Threshold”). If the Company achieves at least 95% of the applicable Performance Threshold, all of the Escrow Shares for the corresponding fiscal year shall bereturned to the Principal Stockholder. If the Company achieves less than 95% of the applicable Performance Threshold, the Investors shall receive in theaggregate, on a pro rata basis (based upon the number of shares of Series A preferred stock or conversion shares owned by each such Investor as of thedate of distribution of the Escrow Shares), 63,954 shares of the Escrow Shares for each percentage by which the applicable Performance Threshold wasnot achieved up to the total number of Escrow Shares for the applicable fiscal year. Any Escrow Shares not delivered to any investor because suchinvestor no longer holds shares of Series A preferred stock or conversion shares shall be returned to the Principal Stockholder. F-42 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the purposes of the Escrow Agreement, net income is defined in accordance with US GAAP and reported by the Company in its audited financialstatements for each of the fiscal years ended 2009 and 2010; provided, however, that net income for each of fiscal years ended 2009 and 2010 shall beincreased by any non-cash charges incurred (i) as a result of the Financing , including without limitation, as a result of the issuance and/or conversion ofthe Series A Preferred Stock, and the issuance and/or exercise of the Warrants, (ii) as a result of the release of the Escrow Shares to the PrincipalStockholder and/or the investors, as applicable, pursuant to the terms of the Escrow Agreement, (iii) as a result of the issuance of ordinary shares of thePrincipal Stockholder to Messrs. Handong Cheng and Xuanfu Liu and Ms. Li Sun (the “PRC Shareholders”), upon the exercise of options granted to thePRC Shareholders by the Principal Stockholder, (iv) as a result of the issuance of warrants to any placement agent and its designees in connection withthe Financing, (v) the exercise of any warrants to purchase common stock outstanding and (vi) the issuance under any performance based equityincentive plan that the Company adopts. Because both the 2009 and 2010 performance threshold had been met, the Escrow Shares were released to the Principal Stockholder in the middle of2010 and 2011, respectively. In accordance with ASC Topic 718 and ASU No. 2010-05—Compensation—Stock Compensation: Escrowed Share Arrangements and the Presumptionof Compensation. The Company evaluated the substance of this arrangement and whether the presumption of compensation has been overcome.According to the Security Escrow Agreement signed between the Company and its investors, the release of these escrow shares to the PrincipalStockholder was not contingent on continue employment, and this arrangement is in substance an inducement made to facilitate the financingtransaction on behalf of the Company, rather than as compensatory. Therefore, the Company has accounted for the escrowed share arrangementaccording to its nature, and therefore did not recognize any non-cash compensation charge as a result of the Company satisfying both the 2009 and 2010performance thresholds. 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’scommon stock (the “Shares”) through a warrant for share exchange. The Company issued the Shares in exchange for the Warrants in accordance with thefollowing 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-1Warrant 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-2Warrant 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 theterms 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 termsof 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 tenderedin exchange for approximately 35,680 Shares, for a total of 1,775,600 Warrants exchanged for approximately 106,620 Shares. The Company hadaccepted for exchange all of the Warrants validly tendered and not withdrawn. Warrants issued and outstanding at December 31, 2011 and changes during the year then ended are as follows: Warrants Outstanding Warrants Exercisable Number ofunderlyingshares WeightedAverageExercisePrice AverageRemainingContractualLife (years) Number ofunderlyingshares WeightedAverageExercisePrice AverageRemainingContractualLife (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) (1,775,600) Balance, December 31, 2011 3,005,456 $3.41 2.21 3,005,456 $3.41 2.21 As the Offer related solely to warrants that were sold by the Company to investors in its August 2009 Financing and was accounted for as equityinstrument since March 29, 2010 upon removal of the “Down-round protection” as described in Note 26. Therefore, this Offer for warrants exchange forcommon shares was accounted for as an equity transaction with no changes in fair value of instruments resulted from the exchange recognized in thestatement of income and comprehensive income. The capital stock account has been adjusted to reflect the new issuance of the common shares with acorresponding decrease of additional paid-in capital account. F-43 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 26. Changes in fair value of WarrantThe Company analyzed the Warrants issued in the August 2009 Financing in accordance to ASC Topic 815 “Derivatives and Hedging” to determinewhether the Warrants meet the definition of a derivative under ASC Topic 815 and if so, whether the Warrants meet the scope exception of ASC Topic815, which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equityshall not be considered to be derivative instruments for purposes of ASC Topic 815. The Company adopted the provisions of ASC Topic 815 subtopic40, which applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by ASC Topic815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. As a result of adopting ASC Topic 815subtopic 40, the Company originally concluded that the Warrants issued in the August 2009 financing should be treated as a derivative liability,because the Warrants were entitled to a price adjustment provision to allow the exercise price to be reduced, in the event the Company would issue orsell any additional shares of common stock at a price per share less than the then-applicable exercise price or without consideration, which is typicallyreferred to as a “Down-round protection” or “anti-dilution” provision. According to ASC Topic 815 subtopic 40, the “Down-round protection”provision is not considered to be an input to the fair value of a fixed-for-fixed option on equity shares which leads the Warrants fail to be qualified asindexed to the Company’s own stock and then to fail to meet the scope exceptions of ASC Topic 815. Therefore, the Company originally accounted forthe Warrants as derivative liabilities under ASC Topic 815. Pursuant to ASC Topic 815, derivatives should be measured at fair value and re-measured atfair value with changes in fair value recorded in earnings at each reporting period.On March 29, 2010, the Company and the holders of the Warrants entered into agreements to amend certain provisions of the Warrants. The amendmentto the investor and placement agent warrants removes the “Down-round protection” rights that were applicable if the Company were to issue new sharesof common stock or common stock equivalents at a price per share less than the exercise price of the Warrants. In addition, the amendment to thewarrants added a provision to grant the holders of a majority of the warrants an approval right until December 31, 2010, over any new issuance of sharesof common stock or common stock equivalents at a price per share less than the exercise price of the warrants.As a result of this amendment, the Warrants issued in the August 2009 Financing were qualified as indexed to the Company’s own stock and then met thescope exceptions of ASC Topic 815, and were eligible to be reclassified as equity. In accordance to ASC Topic 815, the classification of a contractshould be reassessed at each balance sheet date. If the classification required under this ASC changes as a result of events during the period, the contractshould be reclassified as of the date of the event that caused the reclassification. If a contract is reclassified from an asset or a liability to equity, gains orlosses recorded to account for the contract at fair value during the period that the contract was classified as an asset or a liability should not bereversed. Therefore, the Company re-measured the fair value of the Warrants as of March 29, 2010, the date of the event that caused the classification,which was approximately US$7,703,000 and reclassified the amount to equity as additional paid-in capital. The gain of the changes in fair value duringthe period that the Warrants were classified as a derivative liability, which was approximately US$1,861,000 was recorded in earnings for the year endedDecember 31, 2010. As the Warrants have been reclassified to equity on March 29, 2010, no gain or loss of changes in fair value of the Warrants wouldbe recorded thereafter. The following table summarized the above transactions: As ofMarch 29,2010 As ofDecember 31,2009 Changes inFair Value(Gain)/Loss US$’000 US$’000 US$’000 Fair value of the Warrants: Series A-1 warrant 3,606 4,513 (907)Series A-2 warrant 3,256 4,019 (763)Placement agent warrants 841 1,032 (191) 7,703 9,564 (1,861) F-44 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 27. Restricted Net AssetsAs most of the Company’s operations are conducted through its PRC subsidiary and VIEs, the Company’s ability to pay dividends is primarilydependent on receiving distributions of funds from its PRC subsidiary and VIEs. Relevant PRC statutory laws and regulations permit payments ofdividends by its PRC subsidiary and VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards andregulations and after it has met the PRC requirements for appropriation to statutory reserves. Paid in capital of the PRC subsidiary and VIEs included inthe 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 statutoryreserves, namely general reserve fund, the enterprise expansion fund and staff welfare and bonus fund which are appropriated from net profit as reportedin 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 suchreserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. Appropriations to the enterprise expansion fund andstaff 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 notdistributable as cash dividends. Rise King WFOE is subject to the above mandated restrictions on distributable profits. Additionally, in accordance withthe 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 untilsuch reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to providefor a discretionary surplus reserve, at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and arenot 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 netassets to the Company. As of December 31, 2011 and 2010, net assets restricted in the aggregate, which includes paid-in capital and statutory reservefunds of the Company’s PRC subsidiary and VIEs that are included in the Company’s consolidated net assets, was approximately US$4.7 million andUS$3.4 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 dividendsdistributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous EIT law. A lowerwithholding 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 HongKong 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 inapplicable 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, interestpayments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation ofinvestments and investments in securities outside of China, unless the prior approval of the State Administration of Foerign Exchange (the “SAFE”) isobtained and prior registration with the SAFE is made. Foreign-invested enterprises like Rise King WFOE that need foreign exchange for the distributionof profits to its shareholders may effect payment from their foreign exchange accounts or purchase and pay foreign exchange rates at the designatedforeign exchange banks to their foreign shareholders by producing board resolutions for such profit distribution. Based on their needs, foreign-investedenterprises are permitted to open foreign exchange settlement accounts for current account receipts and payments of foreign exchange along withspecialized accounts for capital account receipts and payments of foreign exchange at certain designated foreign exchange banks. F-45 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Although the current Exchange Rules allow the convertibility of Chinese Renminbi into foreign currency for current account items, conversion ofChinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of SAFE, which isunder the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign currency conversion. TheCompany cannot be sure that it will be able to obtain all required conversion approvals for its operations or the Chinese regulatory authorities will notimpose greater restrictions on the convertibility of Chinese Renminbi in the future. Currently, most of the Company’s retained earnings are generated inRenminbi. Any future restrictions on currency exchanges may limit the Company’s ability to use its retained earnings generated in Renminbi to makedividends or other payments in U.S. dollars or fund possible business activities outside China.As of December 31, 2011 and 2010, there was approximately US$34.0 million and US$26.8 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$2.2million and US$1.6 million statutory reserve funds as of December 31, 2011 and 2010, respectively, that may be affected by increased restrictions oncurrency exchanges in the future and accordingly may further limit the Company’s PRC subsidiary’ and VIEs’ ability to make dividends or otherpayments in U.S. dollars to the Company, in addition to the approximately US$4.7 million and US$3.4 million restricted net assets as of December 31,2011 and 2010, respectively, as discussed above. 28. Related party transactions Revenue from related parties: Year ended December 31, 2011 2010 US$(’000) US$(’000) -Beijing Saimeiwei Food Equipment Technology Co., Ltd, 85 278 -Beijing Fengshangyinli Technology Co., Ltd. 307 478 -Beijing Xiyue Technology Co., Ltd - 51 -Beijing Telijie Century Environmental Technology Co., Ltd. 234 357 626 1,164 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 investmentaffiliates for approximately US$36,000, the profit from this transaction which was included in the Company’s consolidated earnings was approximatelyUS$3,000. 29. 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 pensionbenefits, medical care, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require that the PRCsubsidiaries of the Company make contributions to the government for these benefits based on certain percentages of the employees’ salaries. TheCompany has no legal obligation for the benefits beyond the contributions made. The total amounts for such employee benefits, which were expensed asincurred, were approximately US$381,000 and US$245,000 for the years ended December 31, 2011 and 2010, respectively. 30. 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, 2011 and 2010, substantially all of the Company’scash and cash equivalents were held by major financial institutions located in the PRC and Hong Kong, which management believes are of high creditquality. F-46 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, andother risks and uncertainties inherent in the PRC. Among other risks, the Company’s operations in the PRC are subject to the risks of restrictions ontransfer 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 exchangetransactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange ratesquoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requiressubmitting a payment application form together with suppliers’ invoices and signed contracts. These exchange control measures imposed by the PRCgovernment 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 Supplier For the year ended December 31, 2011, two suppliers individually accounted for 36% and 24% of the Company’s cost of sales, respectively. For the yearended December 31, 2010, three suppliers individually accounted for 20%, 20% and 11% of the Company’s cost of sales, respectively. Except for theafore-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 31,2011 and 2010, respectively. 31. Commitments The following table sets forth the Company’s contractual obligations as of December 31, 2011: Server hosting andboard-band lease Purchase of TVadvertisement time Total US$(’000) US$(’000) US$(’000) Year ended December 31, -2012 110 32,941 33,051 -Thereafter - - - Total 110 32,941 33,051 32. Segment reporting The Company follows FASB ASC Topic 280, Segment Reporting, which requires that companies disclose segment data based on how managementmakes decisions about allocating resources to segments and evaluating their performance. Reportable operating segments include components of anentity 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. Beginning on January 1, 2011, the Company combined the Internet Advertisement Resources Reselling segment and the Internet InformationManagement (“IIM”) segment with the Internet Advertisement segment, due to the fact that the relative percentages of these two combined segments’financial performances were immaterial and will be immaterial to the Company’s consolidated financial results for each of the reporting period. Certainprior period amounts have been regrouped to conform to the current period presentation. As a result of the acquisition of Quanzhou Zhi Yuan, QuanzhouTianxi Shun He and the launch of Zhao Shang Ke Hubei, the Company also now operates in one more reportable business segment, Brand Managementand Sales Channel Building. F-47 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended December 31, 2011 InternetAd. TVAd. Bankkiosk Brandmanagementand saleschannelbuilding Others Inter-segment andreconcilingitem 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 Including: Depreciation and amortizationexpense 263 76 191 387 95 - 1,012 Operating income(loss) 6,860 199 219 475 (4,591) - 3,162 Changes in fair value of contingentconsideration receivables - - - (70) - - (70)Gain on deconsolidation of subsidiaries - - - 693 232 - 925 Share of earnings (losses) in equity investmentaffiliates - 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 61,741 15,954 800 6,369 16,305 (43,887) 57,282 *Including approximate US$2,900,000 share-based compensation expenses. Year ended December 31, 2010 InternetAd. TVAd. Bankkiosk Brandmanagementand saleschannelbuilding Others Inter-segment andreconcilingitem Total US$(‘000) US$(‘000) US$(‘000) US$(‘000) US$(‘000) US$(‘000) US$(‘000) Revenue 28,563 12,493 531 - 596 (596) 41,587 Cost of sales 6,879 11,974 45 - 72 - 18,970 Total operating expenses 4,980 459 232 - 2,695* (596) 7,770 Including: Depreciation and amortizationexpense 169 121 111 - 64 - 465 Operating income(loss) 16,704 60 254 - (2,171) - 14,847 Changes in fair value of warrants - - - - 1,861 - 1,861 Expenditure for long-term assets 287 5 503 - 266 - 1,061 Net income (loss) 16,363 58 254 - (300) - 16,375 Total assets 32,103 5,864 774 - 19,231 (15,976) 41,996 *Including approximate US$337,000 share-based compensation expenses. F-48 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 33. Earnings per share Basic and diluted earnings per share for each of the periods presented are calculated as follows: Year ended December 31, 2011 2010 US$(’000) US$(’000) (Amount in thousands except forthe number of shares and per share data) Net income attributable to ChinaNet Online Holdings, Inc. $2,995 $16,589 Dividend for Series A convertible preferred stock (407) (794)Net income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for basic earningsper share) 2,588 15,795 Dividend for Series A convertible preferred stock -(1) 794 Net income attributable to common shareholders of ChinaNet Online Holdings, Inc. (numerator for dilutedearnings per share) 2,588 16,589 Weighted average number of common shares outstanding - Basic 18,545,609 16,778,176 Effect of diluted securities: Series A Convertible preferred stock -(1) 3,178,402 Warrants 213,631 939,483 Weighted average number of common shares outstanding -Diluted 18,759,240 20,896,061 Earnings per share-Basic $0.14 $0.94 Earnings per share-Diluted $0.14 $0.79 (1) The diluted earnings per share calculation for the year ended December 31, 2011 did not include the effect of the 1,625,526 incremental sharesresulted from assumed conversion of the convertible preferred stock, because their effect were anti-dilutive. 34. Share-based compensation expensesOn June 17, 2009, the Company entered into a one-year agreement to engage J and M Group, LLC (“J&M”) to provide investor relations services. Asadditional compensation, the Company issued J&M 120,000 shares of the Company’s common stock. The shares were issued in accordance with theexemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involvingany public offering. These shares were valued at $0.15 per share, the closing bid price of the Company’s common stock on the date of grant and therelated compensation expenses were amortized over the requisite service period. Total compensation expenses recognized for the year ended December31, 2011 and 2010 was US$nil and US$9,000, respectively.On July 1, 2009, the Company entered into a one-year agreement to engage Hayden Communications International, Inc. (“HCI”) to provide investorrelations services. As additional compensation, the Company issued HCI 80,000 shares of the Company’s common stock. The shares were issued inaccordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act forissuances not involving any public offering. These shares were valued at $1.75 per share, the closing bid price of the Company’s common stock on thedate of grant and the related compensation expenses were amortized over the requisite service period. Total compensation expenses recognized for theyear ended December 31, 2011 and 2010 was US$nil and US$70,000, respectively.On July 1, 2010, the Company entered into a six-month agreement to engage Chesapeake Group Inc. (“Chesapeake”) to provide investor relationsservices. As compensation, the Company issued Chesapeake 30,000 restricted shares of the Company’s common stock. The shares were issued inaccordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act forissuances not involving any public offering. These shares were valued at $3.70 per share, the closing bid price of the Company’s common stock on thedate of grant and the related compensation expenses were amortized over the requisite service period. Total compensation expenses recognized for theyear ended December 31, 2011 and 2010 was US$nil and US$111,000, respectively. F-49 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On July 12, 2010, the Company renewed the investor relations service contract with Hayden Communications International, Inc. (“HCI”) for an18-monthservice contract commencing July 12, 2010. As additional compensation, the Company issued HCI 60,000 restricted shares of the Company’s commonstock. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided bySection 4(2) of such Act for issuances not involving any public offering. These shares were valued at $3.80 per share, the closing bid price of theCompany’s common stock on the date of grant and the related compensation expense were amortized over the requisite service period. Totalcompensation expenses recognized for the year ended December 31, 2011 and 2010 was US$152,000 and US$70,000, respectively.On November 30, 2009, the Company granted one 5-year options to each of its three independent directors, Mr. Douglas MacLellan, Mr. MototakaWatanabe 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. However, upon a change of control, the option shall automatically become fully vested and exercisable as of thedate of such changes of control. The company utilized Black-Scholes option pricing model to gauge the grant date fair value of these options. Therelated compensation expenses were amortized over its vesting period. Total compensation expenses recognized for these options for the year endedDecember 31, 2011 and 2010 was US$141,480 and US$77,220, respectively.The Company estimated the fair value of these common stock options granted on November 30, 2009 using the Black-Scholes option pricing modelbased on the following assumptions:Underlying stock price$5.00Expected term (years)3.00Risk-free interest rate1.10%Dividend yield-Expected Volatility150%Exercise price of the option$5.00Value per option$4.05Underlying 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 Companydeveloped a weighted-average expected term at 3 years based on analysis of the vesting schedule and exercise assumptions. The risk-free interest rate isbased 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 underlyingstock. 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 annualmeeting held on June 15, 2011, the Company issued its management, employees and directors in the aggregate of 2,000,000 restricted shares of theCompany’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-monthperiod. 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 closingprice of the Company's common stock equals or exceeds $2.50 for five consecutive trading days, and (ii) November 30, 2013. In addition, the restrictedstock is subject to forfeiture upon an employee's cessation of employment at the discretion of the Company. The restricted stock was fully vested uponissuance 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 costrecognized for the year ended December 31, 2011 was US$2,280,000. F-50 CHINANET ONLINE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On November 30, 2011, under the Company’s 2011 Omnibus Securities and Incentive Plan, the Company also issued its management, employees anddirectors 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 ofthe 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 thefollowing assumptions:Adjusted underlying stock price$1.037Expected term (years)5.00Risk-free interest rate0.95%Dividend yield-Expected Volatility46.73%Exercise price of the option$1.20Value per option$0.37Adjusted underlying stock price is based on the closing bid price of the Company common stock on the grant date, after adjustment for the 2,000,000restricted shares award issued on November 30, 2011. Expected tenor are used when estimates of the expected lives of the options, based on vestingschedule and exercise assumptions, which has taken into account of early exercise behavior of the option holders. Yield-to-maturities in continuouscompounding 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 therisk-free rate. Average/median of industry annualized historical stock price volatility from an appropriate index as at the grant date is deemed to beappropriate to serve as the expected volatility of the stock price of the Company. The dividend yield is calculated based on management’s estimate ofdividends 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, 2011 and their movements during the year then ended are as follows: Option Outstanding Option Exercisable Number ofunderlyingshares WeightedAverageRemainingContractualLife (Years) WeightedAverageExercisePrice Number ofunderlyingshares WeightedAverageRemainingContractualLife (Years) WeightedAverageExercisePrice 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 Other information relative to option activity during the years ended December 31, 2011 and 2010 is as follows (in thousands, except weighted averagegrant date fair value): Year ended December 31, 2011 2010 Weighted average grant date fair value of stock options granted $0.37 $4.05 Aggregate grant date fair value of stock options vested 437 109 Aggregate intrinsic value for options granted - - Aggregate intrinsic value for options exercisable - - The aggregate unrecognized share-based compensation expenses as of December 31, 2011 and 2010 is approximately US$6,000 and US$299,000,respectively. F-51Exhibit 23.1 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM’S CONSENTWe consent to the incorporation by reference in the Registration Statement of ChinaNet Online Holdings, Inc. (the “Company”) on Form S-8 (file No. 333-178269) of our report dated April 16, 2012, with respect to our audit of the consolidated financial statements of the Company as of December 31, 2011 andfor the year ended December 31, 2011, which report is included in this Annual Report on Form 10-K of the Company for the year ended December 31, 2011./s/ Marcum Bernstein & Pinchuk llpMarcum Bernstein & Pinchuk llpNew York, New YorkApril 16, 2012 Exhibit 23.2 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM’S CONSENTWe consent to the incorporation by reference in the Registration Statement of ChinaNet Online Holdings, Inc. (the “Company”) on Form S-8 (file No. 333-178269) of our report dated March 31, 2011, except for revised disclosures in Note 1, 2, 22, 27 and 28, which was dated February 29, 2012, with respect toour audit of the consolidated financial statements of the Company as of December 31, 2010 and for the year ended December 31, 2010, which report isincluded in this Annual Report on Form 10-K of the Company for the year ended December 31, 2011./s/ Bernstein & Pinchuk llpBernstein & Pinchuk llpNew York, New YorkApril 16, 2012 Exhibit 31.1 CERTIFICATION I, Handong Cheng, the Chief Executive Officer of the registrant, certify that: (1) I have reviewed this Annual Report on Form 10-K of ChinaNet Online Holdings, Inc., for the fiscal year ended December 31, 2011. (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; (3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; (4) The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15a-15(f)) for the registrant and have:a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries and VIEs, is made known to us by otherswithin those entities, particularly during the period in which this report is being prepared;b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designedunder our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles:c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions aboutthe effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’sfourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and (5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financialreporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’sinternal control over financial reporting. Date: April 16, 2012 By: /s/ Handong ChengName: Handong ChengTitle: Chief Executive OfficerExhibit 31.2 CERTIFICATION I, Zhige Zhang, the Chief Financial Officer of the registrant, certify that: (1) I have reviewed this Annual Report on Form 10-K of ChinaNet Online Holdings, Inc., for the fiscal year ended December 31, 2011. (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; (3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; (4) The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15a-15(f)) for the registrant and have:a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries and VIEs, is made known to us by otherswithin those entities, particularly during the period in which this report is being prepared;b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designedunder our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles:c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions aboutthe effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’sfourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and (5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financialreporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb. any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal control over financial reporting. Date: April 16, 2012 By: /s/ Zhige ZhangName: Zhige ZhangTitle: Chief Financial Officer Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 In connection with the Annual Report of ChinaNet Online Holdings, Inc. (the “Company”), on Form 10-K for the year ended December 31, 2011 asfiled with the Securities and Exchange Commission (“SEC”) on the date hereof (the “Report”), each of the undersigned of the Company, certifies, pursuant to18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Report fully complies, in all material respects, with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany. By: /s/ Handong ChengName: Handong ChengTitle: Chief Executive OfficerApril 16, 2012 By: /s/ Zhige ZhangName: Zhige ZhangTitle: Chief Financial OfficerApril 16, 2012

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