Edgar Filing: ChinaNet Online Holdings, Inc.

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2010

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

For the transition period from ____ to _____

Commission File Number: 000-52672

ChinaNet Online Holdings, Inc.

(Exact name of registrant as specified in its charter)

Nevada	90-0617940
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

No.3 Min Zhuang Road, Building 6

Yu Quan Hui Gu Tuspark, Haidian District, Beijing, PRC 100195

(Address of principal executive offices) (Zip Code)

+86-10-51600828

(Registrant’s telephone number, including area code)

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

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

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

*The registrant has not yet been phased into the Interactive Data requirements.

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

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

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

As of November 12, 2010 the registrant had 17,078,720 shares of common stock outstanding.

TABLE OF CONTENTS

		PAGE

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

	Consolidated Balance Sheets	1-2

	Consolidated Statements of Income and Comprehensive Income	3-4

	Consolidated Statements of Cash Flows	5-6

	Notes to Consolidated Financial Statements	7-37

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		38-61

Item 3. Quantitative and Qualitative Disclosures About Market Risk		62

Item 4(T). Controls and Procedures		62

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		63

Item 1A. Risk Factors		63

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		63

Item 3. Defaults Upon Senior Securities		63

Item 4. Submission of Matters to a Vote of Security Holders		63

Item 5. Other Information		63

Item 6. Exhibits		63

Signatures		64

CHINANET ONLINE HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

	September 30,		December 31,
	2010		2009
	(US $)		(US $)
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	22,241	$	13,917
Accounts receivable, net		4,455		3,173
Other receivables		2,856		2,636
Prepayment and deposit to suppliers		4,221		4,111
Due from related parties		214		492
Inventories		2		2
Other current assets		174		30
Total current assets		34,163		24,361

Property and equipment, net		1,518		1,355
Intangible assets, net		59		-
Other long-term assets		31		48
TOTAL ASSETS	$	35,771	$	25,764

Liabilities and Equity
Current liabilities:
Accounts payable	$	374	$	290
Advances from customers		1,009		914
Other payables		22		27
Accrued payroll and other accruals		298		191
Due to related parties		-		24
Due to Control Group		416		1,142
Due to director		389		-
Taxes payable		2,010		1,978
Dividends payable		380		373
Total current liabilities		4,898		4,939

Long-term borrowing from director		131		128
Warrant liabilities		-		9,564

Commitments and contingencies		-		-

CHINANET ONLINE HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS (CONTINUED)

(In thousands, except for number of shares and per share data)

	September 30,		December 31,
	2010		2009
	(US $)		(US $)
	(Unaudited)

Equity:
Series A convertible preferred stock (US$0.001 par value; authorized-8,000,000 shares; issued and outstanding-2,918,600 and 4,121,600 shares at September 30, 2010 and December 31, 2009 respectively; aggregate liquidation preference amount: $7,677 and $10,677, accrued but unpaid dividends of $380 and $373, at September 30, 2010 and December 31, 2009, respectively.		3		4
Common stock (US$0.001 par value; authorized-50,000,000 shares; issued and outstanding-17,061,320 shares and 15,828,320 shares at September 30, 2010 and December 31, 2009 respectively)		17		16
Additional paid-in capital		18,454		10,574
Statutory reserves		372		372
Retained earnings		11,320		50
Accumulated other comprehensive income		559		117
Total ChinaNet’s Online Holdings, Inc.’s stockholders’ equity		30,725		11,133
Noncontrolling interest		17		-
Total equity		30,742		11,133

TOTAL LIABILITIES AND EQUITY	$	35,771	$	25,764

See notes to the consolidated financial statements

CHINANET ONLINE HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In thousands)

	For the nine months ended September 30,						For the three months ended September 30,
	2010			2009			2010		2009
	(US $)			(US $)			(US $)		(US $)
	(Unaudited)			(Unaudited)			(Unaudited)		(Unaudited)

Sales
To unrelated parties	$	30,304		$	25,320		$	8,631	$	7,604
To related parties		872			1,985			265		522
		31,176			27,305			8,896		8,126
Cost of sales		15,791			15,918			3,110		4,029
Gross margin		15,385			11,387			5,786		4,097

Operating expenses
Selling expenses		2,187			3,253			851		624
General and administrative expenses		2,410			1,530			815		614
Research and development expenses		605			347			276		133
		5,202			5,130			1,942		1,371

Income from operations		10,183			6,257			3,844		2,726

Other income (expenses):
Changes in fair value of warrants		1,861			(1,289	)		-		(1,289	)
Interest income		8			9			4		4
Other income		8			8			4		2
Other expenses		(1	)		(100	)		0		(99	)
		1,876			(1,372	)		8		(1,382	)

Income before income tax expense and noncontrolling interest		12,059			4,885			3,852		1,344
Income tax expense		304			1,653			25		696
Net income		11,755			3,232			3,827		648
Net loss attributable to noncontrolling interest		127			-			50		-
Net income attributable to ChinaNet Online Holdings, Inc.		11,882			3,232			3,877		648

Other comprehensive income
Foreign currency translation gain		442			13			365		8
Comprehensive income	$	12,197		$	3,245		$	4,192	$	656

CHINANET ONLINE HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME AND

COMPREHENSIVE INCOME （CONTINUED）

(In thousands, except for number of shares and per share data)

	For the nine months ended September 30,						For the three months ended September 30,
	2010			2009			2010			2009
	(US $)			(US $)			(US $)			(US $)
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net income attributable to ChinaNet Online Holdings, Inc.	$	11,882		$	3,232		$	3,877		$	648
Beneficial conversion feature of Series A convertible preferred stock		-			(5,898	)		-			(5,898	)
Dividend of Series A convertible preferred stock		(612	)		-			(190	)		-

Net income attributable to common shareholders of ChinaNet Online Holdings, Inc.	$	11,270		$	(2,666	)	$	3,687		$	(5,250	)

Earnings per share
Earnings per common share
Basic	$	0.68		$	(0.18	)	$	0.22		$	(0.33	)
Diluted	$	0.57		$	(0.18	)	$	0.19		$	(0.33	)

Weighted average number of common shares outstanding:
Basic		16,676,752			14,495,560			16,939,961			15,774,300
Diluted		20,905,796			14,495,560			20,916,463			15,774,300

Comprehensive Income
Net income		11,755			3,232			3,827			648
Foreign currency translation gain		442			13			365			8
		12,197			3,245			4,192			656
Comprehensive Income
Comprehensive income / (loss) attributable to noncontrolling interest		(127	)		-			(50	)		-
Comprehensive income attributable to ChinaNet’s Online Holdings, Inc.		12,324			3,245			4,242			656
		12,197			3,245			4,192			656

See notes to the consolidated financial statements

CHINANET ONLINE HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	For the nine months ended September 30,
	2010			2009
	(US $)			(US $)
	(Unaudited)			(Unaudited)

Cash flows from operating activities
Net income	$	11,755		$	3,232
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		275			134
Share-based compensation expenses		177			190
Changes in fair value of warrants		(1,861	)		1,289
Disposal of fixed assets		-			19
Changes in operating assets and liabilities
Accounts receivable		(1,195	)		(1,445	)
Other receivables		2,095			(166	)
Prepayments and deposit to suppliers		(24	)		9
Due from related parties		283			(154	)
Other current assets		(141	)		33
Accounts payable		77			117
Advances from customers		76			361
Accrued payroll and other accruals		104			134
Due to related parties		(24	)		(327	)
Due to director		389			-
Due to Control Group		(738	)		33
Other payables		(5	)		-
Taxes payable		(8	)		1,275
Net cash provided by operating activities		11,235			4,734

Cash flows from investing activities
Purchases of vehicles and office equipment		(385	)		(310	)
Purchases of intangible assets		(59	)		-
Purchases of other long-term assets		(4	)		(38	)
Net cash used in investing activities		(448	)		(348	)

CHINANET ONLINE HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(In thousands)

	For the nine months ended September 30,
	2010			2009
	(US $)			(US $)
	(Unaudited)			(Unaudited)

Cash flows from financing activities
Cash investment contributed by noncontrolling interest		144			-
Dividend paid to convertible preferred stockholders		(605	)		-
Increase of short-term loan to third parties		(2,257	)		(2,024	)
Decrease of short-term loan from directors		-			(13	)
Cancellation and retirement of common stock		-			(300	)
Proceeds from issuance of Series A convertible preferred stock and warrants (net of issuance cost of US$ 1,142)		-			9,162
Net cash (used in)/provided by financing activities		(2,718	)		6,825

Effect of exchange rate fluctuation on cash and cash equivalents		255			10

Net increase in cash and cash equivalents		8,324			11,221

Cash and cash equivalents at beginning of year		13,917			2,679
Cash and cash equivalents at end of period	$	22,241		$	13,900

Supplemental disclosure of cash flow information

Interest paid	$	-		$	-
Income tax paid	$	1,242		$	900

Non-cash transactions:

Warrant liability reclassify to additional paid in capital	$	7,703		$	-

See notes to the consolidated financial statements

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.	Organization and principal activities

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

On June 26, 2009, the Company entered into a Share Exchange Agreement (the “Exchange Agreement”), with (i) China Net Online Media Group Limited, a company organized under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s shareholders, Allglad Limited, a British Virgin Islands company (“Allglad”), Growgain Limited, a British Virgin Islands company ("Growgain"), Rise King Investments Limited, a British Virgin Islands company (“Rise King BVI”), Star (China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus Elegant Investment Limited, a British Virgin Islands company (“Surplus”), Clear Jolly Holdings Limited, a British Virgin Islands company (“Clear” and together with Allglad, Growgain, Rise King BVI, Star and Surplus, the “China Net BVI Shareholders”), who together owned shares constituting 100% of the issued and outstanding ordinary shares of China Net BVI (the “China Net BVI Shares”) and (iii) G. Edward Hancock, the principal stockholder of the Company at that time. Pursuant to the terms of the Exchange Agreement, the China Net BVI Shareholders transferred to the Company all of the China Net BVI Shares in exchange for the issuance of 13,790,800 shares (the “Exchange Shares”) 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”), which engages in providing advertising, marketing and communication services to small and medium companies in China through www.28.com (the portal website of the Company’s PRC Variable Interest 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, China Net BVI became the parent holding company of a group of companies comprised of CNET Online Technology Limited, a Hong Kong company (“China Net HK”), which established and is the parent company of Rise King Century Technology Development (Beijing) Co., Ltd., a wholly foreign-owned enterprise (“WFOE”) established in the PRC (“Rise King WFOE”). The Company refers to the transactions that resulted in China Net BVI becoming an indirect parent company of Rise King WFOE as the “Offshore Restructuring.” Through a series of contractual agreements, the Company operates its business in China primarily through Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”), Beijing CNET Online Advertising Co., Ltd. (“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. From time to time, we refer to them collectively as the “PRC Operating Entities.”

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

On June 24, 2010, one of the Company’s subsidiaries, Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”), together with three other individuals, who were not affiliated with the Company or any of its subsidiaries or Variable Interest Entities (“VIEs”), established a new company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). Shenzhen Mingshan is 51% owned by Business Opportunity Online and 49% owned by the other three individuals. Shenzhen Mingshan is located in Shenzhen City, Guangdong province of PRC and is primarily engaged in designing, developing and selling internet based software, developing online games, designing and developing the related websites and providing the related internet and information technology services necessary to operate such games and websites. As of September 30, 2010, Business Opportunity Online has invested approximately RMB 4,000,000 (approximately US$587,000) in Shenzhen Mingshan. Shenzhen Mingshan is currently in the start-up stage.

2.	Summary of significant accounting policies

a) Change of reporting entity and basis of presentation

As a result of the Share Exchange on June 26, 2009, the former China Net BVI shareholders became owners of a majority of the common stock of the Company. The transaction was regarded as a reverse acquisition whereby China Net BVI was considered to be the accounting acquirer as its shareholders retained control of the Company after the Share Exchange, although the Company is the legal parent company. The share exchange was treated as a recapitalization of the Company. As such, China Net BVI (and its historical financial statements) is the continuing entity for financial reporting purposes. Pursuant to the terms of the Share Exchange, Emazing Interactive, Inc. was delivered with zero assets and zero liabilities at time of closing. Following the Share Exchange, the company changed its name from Emazing Interactive, Inc. to ChinaNet Online Holdings, Inc. The financial statements have been prepared as if China Net BVI had always been the reporting company and then on the share exchange date, had changed its name and reorganized its capital stock.

The accompanying unaudited interim consolidated financial statements include the accounts of the Company, and its subsidiaries and VIEs, China Net BVI, China Net HK, Rise King WFOE, Beijing CNET Online and Business Opportunity Online and Shenzhen Mingshan. According to the agreements between Beijing CNET Online and Shanghai Borongdingsi, although Beijing CNET Online legally owns 51% of Shanghai Borongdingsi’s interests, Beijing CNET Online only controls the assets and liabilities related to the bank kiosk business, which has been included in the financial statements of Beijing CNET Online, but does not control the other assets of Shanghai Borongdingsi, thus, Shanghai Borongdingsi’s financial statements were not consolidated by the Company.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, as promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes required by US GAAP for annual financial statements. However, management believes that the disclosures are adequate to ensure the information presented is not misleading.

In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring entries, which are necessary for a fair presentation of the results for the interim periods presented. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2009 filed with the SEC on March 31, 2010. The results of operations for the interim periods presented are not indicative of the operating results to be expected for the Company’s fiscal year ending December 31, 2010.

b) Principles of Consolidation

The consolidated financial statements include the financial statements of all the subsidiaries and VIEs of the Company. All transactions and balances between the Company and its subsidiaries and VIEs have been eliminated upon consolidation.

c) Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure of contingent assets and liabilities at the date of these consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Management bases these estimates on historical experiences and the best information available at the time the estimates are made; however, actual results could differ from those estimates. US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, contingencies and results of operations. While management has based their assumptions and estimates on the facts and circumstances existing as of September 30, 2010, final amounts may differ from these estimates.

d) Foreign currency translation and transactions

The functional currency of the Company is United States dollars (“US$”), and the functional currency of China Net HK is Hong Kong dollars (“HK$”). The functional currency of the Company’s PRC operating entities is Renminbi (“RMB”), and PRC is the primary economic environment in which the Company operates.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

For financial reporting purposes, the financial statements of the Company’s PRC operating entities, which are prepared using the RMB, are translated into the Company’s reporting currency, the US$. Assets and liabilities are translated using the exchange rate at each balance sheet date. Revenue and expenses are translated using average rates prevailing during each reporting period, and stockholders’ equity is translated at historical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulated other comprehensive income in stockholders’ equity.

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. The resulting exchange differences are included in the determination of net income of the consolidated financial statements for the respective periods.

The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows:

	September 30, 2010		December 31, 2009

Balance sheet items, except for equity accounts		6.6981		6.8372

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009

Items in the statements of income and comprehensive income, and the statements of cash flows		6.8164		6.8425		6.7803		6.8411

No representation is made that the RMB amounts could have been, or could be converted into US$ at the above rates.

e) Cash and cash equivalents

Cash and cash equivalents consist of cash on hand and bank deposits, which are unrestricted as to withdrawal and use. The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

f) Accounts receivable, net

Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts as needed. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on aging data, historical collection experience, customer specific facts and economic conditions. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company did not have any off-balance-sheet credit exposure relating to its customers, suppliers or others.

g) Inventories

Inventories, consisting mainly of low value consumable articles are stated at the lower of cost or market value. Inventories are charged to expense when being withdrawn.

h) Property and equipment, net

Property and equipment are recorded at cost less accumulated depreciation. Depreciation is calculated on the straight-line method after taking into account their respective estimated residual values over the following estimated useful lives:

Vehicles		5 years
Office equipment		3-10 years
Electronic devices		5 years

Depreciation expenses are included in selling expenses, general and administrative expenses and research and development expenses.

When property and equipment are retired or otherwise disposed of, resulting gain or loss is included in net income or loss in the year of disposition for the difference between the net book value and proceeds received thereon. Maintenance and repairs which do not improve or extend the expected useful lives of the assets are charged to expenses as incurred.

i) Intangible assets, net

Purchased software is initially recorded at costs and amortized on a straight-line basis over the estimated useful economic life of 3 years.

j) Impairment of long-lived assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recognized for the difference between the carrying amount of the asset and its fair value. There were no impairment losses incurred for the nine and three months ended September 30, 2010 and 2009.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

k) Fair Value

Accounting Standard Codification™ (“ASC”) Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

Level 1 -

Quoted prices in active markets for identical assets or liabilities.

Level 2 -

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 -

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.

The carrying values of cash and cash equivalents, trade and other receivables, prepayments, payables and other liabilities approximate fair values due to their short maturities.

Assets and liabilities measured at fair value on a non-recurring basis are summarized as follows:

Fair value measurement using inputs

Level 1

Level 2

Level 3

Carrying amount as of

December 31, 2009

Financial instruments

US$(’000)

Warrant liabilities

9,564

Due to lack of the liquidity of the Company’s underlying stock and other factors, the Company estimated the fair value of the warrant liabilities based upon observable inputs such as quoted prices for similar securities, quoted price in markets that are not active or other inputs that are observable to determine the fair value of the warrant liabilities.

Warrant liabilities measured at fair value as of December 31, 2009 was related to the investor and placement agent warrants that were issued as a result of the Company’s August 2009 Financing contained a “Down-round protection provision” whereby for a period of twelve (12) months following December 31, 2009 (the effective date of the Registration Statement) in the event the Company issued any additional shares of Common Stock or securities exercisable, convertible or exchangeable for Common Stock at a price per share less than the exercise price then in effect or without consideration. As described in Note 17 and 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 lead to the Warrants to fail to be qualified as indexed to the Company’s own stock and then fail to meet the scope exceptions of ASC Topic 815. Therefore, the Company accounted for the Warrants as derivative liabilities 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 fair value recorded in earnings at each reporting period.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

On March 29, 2010, the Company and the holders of the Warrants entered into agreements to amend certain provisions of the Warrants. The amendment to the investor and placement agent warrants removes the “Down-round protection” rights that were applicable if the Company were to issue new shares of common stock or common stock equivalents at a price per share less than the exercise price of the Warrants. In addition, the amendment 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 new issuance 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 this amendment, the Warrants issued in the August 2009 financing were qualified as indexed to the Company’s own stock and then met the scope exceptions of ASC Topic 815, and were eligible to be reclassified as equity. In accordance to ASC Topic 815, the classification of a contract should be reassessed at each balance sheet 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 the event 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 at fair value during the period that the contract was classified as an asset or a liability should not be reversed. 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 during the period that the Warrants were classified as a derivative liability, which was approximately US$ 1,861,000 was recorded in earnings for the nine month period ended September 30, 2010.

There was no asset or liability measured at fair value on a non-recurring basis as of September 30, 2010.

l) Revenue recognition

The Company's revenue recognition policies are in compliance with ASC Topic 605 “Revenue Recognition”. In accordance with ASC Topic 605, revenues are recognized when the four of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the service has been rendered, (iii) the fees are fixed or determinable, and (iv) collectability is reasonably assured.

Sales

Sales include revenues from reselling of advertising time purchased from TV stations and internet advertising, reselling of internet advertising spaces and other advertisement related resources. No revenue from advertising-for-advertising barter transactions was recognized because the transactions did not meet the criteria for recognition in ASC Topic 605, subtopic 20. Advertising contracts establish the fixed price and advertising services to be provided. Pursuant to advertising contracts, the Company provides advertisement placements in different formats, including but not limited to banners, links, logos, buttons, rich media and content integration. Revenue is recognized ratably over the period the advertising is provided and, as such, the Company considers the services to have been delivered. The Company treats all elements of advertising contracts as a single unit of accounting for revenue recognition purposes. Based upon the Company’s credit assessments of its customers prior to entering into contracts, the Company determines if collectability is reasonably assured. In situations where collectability is not deemed to be reasonably assured, the Company recognizes revenue upon receipt of cash from customers, only after services have been provided and all other criteria for revenue recognition have been met.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

m) Cost of sales

Cost of sales primarily includes the cost of media advertising time, internet advertisement related resources and other technical services purchased from third parties, labor cost and benefits and PRC business tax.

n) Advertising costs

Advertising costs for the Company’s own brand building are not includable in cost of sales, they are expensed when incurred and are included in “selling expenses” in the statement of income and comprehensive income. For the nine month period ended September 30, 2010 and 2009, advertising expenses for the Company’s own brand building were approximately US$1,534,000 and US$2,330,000, respectively. For the three month period ended September 30, 2010 and 2009, advertising expenses for the Company’s own brand building were approximately US$585,000 and US$353,000, respectively.

o) Research and development expenses

Research and development costs are charged to expense when incurred. Expenses for research and development for the nine month period ended September 30, 2010 and 2009 were approximately US$605,000 and US$347,000 respectively. For the three month period ended September 30, 2010 and 2009, expenses for research and development were approximately US$275,000 and 133,000, respectively.

p) Income taxes

The Company adopts ASC Topic 740 “Income Taxes” and uses liability method to accounts for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between of the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in income statement in the period that includes the enactment date. The Company had no deferred tax assets and liabilities recognized for the nine month period ended September 30, 2010 and for the year ended December 31, 2009.

q) Uncertain tax positions

The Company adopts ASC Topic 740-10-25-5 through 740-10-25-7 and 740-10-25-13, “Accounting for Uncertainty in Income Taxes”), which prescribes a more likely than not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. For the nine month period ended September 30, 2010 and 2009, the Company did not have any interest and penalties associated with tax positions and did not have any significant unrecognized uncertain tax positions.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

r) Share-based Compensation

The Company accounted for share-based compensation in accordance with ASC Topic 718, which requires that share-based payment transactions be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period, or vesting period.

s) Comprehensive income

The Company accounts for comprehensive income in accordance with ASC Topic 220, Comprehensive Income, which establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Accumulated other comprehensive income, as presented on the accompanying consolidated balance sheets are the cumulative foreign currency translation adjustments.

t) Noncontrolling interest

The Company accounts for noncontrolling interest in accordance with ASC Topic 810-10-65, which requires the Company to present noncontrolling interests (previously referred to as minority interests) as a separate component of total shareholders’ equity on the consolidated balance sheet and the consolidated net income attributable to the parent and the noncontrolling interest be clearly identified and presented on the face of the consolidated income and comprehensive income statement.

Noncontrolling interest on the consolidated balance sheet as of September 30, 2010 represents the noncontrolling interest shareholders’ proportionate share of the equity of the Company’s consolidated majority-owned subsidiary Shenzhen Mingshan. Net loss attributable to noncontrolling interest on the consolidated income and comprehensive income statement represents the noncontrolling interest shareholders’ proportionate share of the net loss incurred for the three and nine months ended September 30, 2010 of Shenzhen Minshan.

u) Earnings per share

Earnings per share are calculated in accordance with ASC Topic 260, “Earnings Per Share”. Basic earnings per share is computed by dividing income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Common shares issuable upon the conversion of the convertible preferred shares are included in the computation of diluted earnings per share on an “if-converted” basis when the impact is dilutive. The dilutive effect of outstanding common stock warrants is reflected in the diluted earnings per share by application of the treasury stock method when the impact is dilutive.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

v) Commitments and contingencies

The Company has adopted ASC 450 subtopic 20, “Loss Contingencies” in determining its accruals and disclosures with respect to loss contingencies. Accordingly, estimated losses from loss contingencies are accrued by a charge to income when information available prior to issuance of the financial statements indicates that it is probable that a liability have been incurred and the amount of the loss can be reasonably estimated. Legal expenses associated with the contingency are expensed as incurred. If a loss contingency is not probable or reasonably estimable, disclosure of the loss contingency is made in the financial statements when it is at least reasonably possible that a material loss could be incurred.

w) Recent accounting pronouncements

In July 2010, the FASB issued Accounting Standard Update (“ASU”) 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. This ASU amends Topic 310 to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. Except for the expanded disclosure requirements, the adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s Consolidated Financial Statements upon adoption.

3. Cash and cash equivalents

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Cash		36		616
Deposits with short-term maturities		22,205		13,301
		22,241		13,917

4. Accounts receivable

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Accounts receivable		4,527		3,244
Less: Allowance for doubtful debts		72		71
Accounts receivable, net		4,455		3,173

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

All of the accounts receivable are non-interest bearing. As of November 15, 2010, approximately US$1,070,000 of Accounts receivable had been subsequently collected. Management believes that there will not be any collectability issue about these accounts receivable, therefore additional allowance for doubtful accounts is not required for the nine and three months ended September 30, 2010.

5. Other receivables

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Advance deposits for TV advertisement bidding		-		2,261
Short-term loan to third parties		2,298		-
Staff advances for normal business purpose		558		375
		2,856		2,636

Advance deposits for TV advertisement bidding were deposits made by the Company to participate in the biddings for TV advertisement time of 2010 in several TV stations, and had been all subsequently collected in the first quarter of fiscal year 2010. Short-term loan to third parties were temporary loans, unsecured, no interest bearing and approximately US$1,493,000 had been collected in October 2010. Management believes no allowance for doubtful accounts is required for these other receivables for the nine and three month period ended September 30, 2010.

6. Prepayment and deposit to suppliers

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Contract execution guarantee to TV advertisement and internet resources providers		3,259		3,086
Prepayments to TV advertisement and internet resources providers		390		991
Prepayment for purchase of bank kiosk equipment		540		-
Other deposits and prepayments		32		34
		4,221		4,111

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Contract execution guarantee to TV advertisement and internet resources providers are paid as a contractual deposit to the Company’s service providers. These amounts will be used to offset the service fee needs to be paid to the service providers in the last month of each contract period.

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

Therefore, management believes that there will not be any collectability issue about these deposits and prepayments, and no allowance for doubtful accounts is required for the nine and three months ended September 30, 2010.

7. Due from related parties

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Beijing Hongfujiali Information Technology Co., Ltd.		-		439
Beijing Saimeiwei Food Equipment Technology Co., Ltd.		-		53
Beijing Fengshangyinli Technology Co., Ltd.		45
Beijing Telijie Century Environmental Technology Co., Ltd.		26		-
Soyilianmei Advertising Co., Ltd.		143		-
		214		492

These related parties are directly or indirectly owned by the Control Group (see note 12) or the management of the Company. Amount due from Beijing Hongfujiali Information Technology Co., Ltd. as of December 31, 2009, which amounted to approximately US$439,000 was an advance deposit for participating in year 2010 advertising resources bidding and had been collected in January 2010. Amount due from Soyilianmei Advertising Co., Ltd. as of September 30, 2010, which amounted to approximately US$143,000 was related to the internet advertising resources purchased by the Company on behalf this related party. The rest of the related party balances as of September 30, 2010 were outstanding payments for advertising services the Company provided to these related parties.

8. Property and equipment

Property and equipment consist of the following:

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Vehicles		577		423
Office equipment		1,080		816
Electronic devices		447		438
Total property and equipment		2,104		1,677
Less: accumulated depreciation		586		322
Total property and equipment, net		1,518		1,355

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Depreciation expenses in aggregate for the nine months ended September 30, 2010 and 2009 were approximately US$253,000 and $134,000, respectively. For the three months ended September 30, 2010 and 2009, depreciation expenses in aggregate were approximately US$90,000 and US$49,000, respectively.

9. Intangible assets, net

	September 30,			December 31,
	2010			2009
	US$(’000)			US$(’000)
	(Unaudited)

Computer software		60			-
Less: accumulated amortization		(1	)		-
Total intangible assets, net		59			-

Amortization expenses in aggregate for the nine and three months ended September 30, 2010 and 2009 were approximately US$1,000 and nil, respectively.

10. Accrued payroll and other accrues

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Accrued payroll and staff welfare		252		131
Accrued operating expenses		46		60
		298		191

11. Due to related parties

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Beijing Saimeiwei Food Equipments Technology Co., Ltd		-		14
Beijing Telijie Century Environmental Technology Co., Ltd.		-		10
		-		24

The related parties listed above are directly or indirectly owned by the Control Group (see note 12) and the Company provided advertising services to them. The advance payments listed above were received from these parties for advertising services that will be provided in the future.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

12. Due to Control Group

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Due to Control Group		416		1,142

Mr. Handong Cheng, Mr. Xuanfu Liu and Ms. Li Sun, the owners of the Company’s PRC VIEs, Business Opportunities Online, and Beijing CNET Online before the Offshore Restructuring, are collectively referred to as the “Control Group”.

Due to Control Group were amounts paid by Control Group individuals on behalf of the Company which mainly included staff salary, performance bonus and cost of resources purchased.

During the three months ended September 30, 2010, the Company repaid the Control Group approximately US$738,000.

13. Due to director

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Due to director		389		-

Due to director represents the operating expenses paid by director on behalf of the Company.

14. Taxation

1)Income tax

i). The Company is incorporated in the state of Nevada. Under the current law of Nevada, the Company is not subject to state corporation income tax. The Company became a holding company and does not conduct any substantial operations of its own after the Share Exchange. No provision for federal corporate income tax has been made in the financial statements as the Company has no taxable income for the nine month period ended September 30, 2010.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

ii). China Net BVI was incorporated in the British Virgin Islands (“BVI”). Under the current law of the BVI, the Company is not subject to tax on income or capital gains. Additionally, upon payments of dividends by China Net 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 income tax has been made in the financial statements as China Net HK has no taxable income for the nine month period ended September 30, 2010. Additionally, upon payment of dividends by China Net HK to its shareholders, no Hong Kong withholding tax will be imposed.

iv). The Company’s PRC operating entities, being incorporated in the PRC, are governed by the income tax laws of the PRC and are subject to PRC enterprise income tax (“EIT”). Effective from January 1, 2008, the EIT rate of PRC was changed from 33% to 25%, and applies to both domestic and foreign invested enterprises.

Rise King WFOE is a software company qualified by the related PRC governmental authorities and was entitled to a two-year EIT exemption from its first profitable year and a 50% reduction of its applicable EIT rate, which is 25% of its taxable income for the following three years. Rise King WFOE had a net loss for the year ended December 31, 2008 and its first profitable year is fiscal year 2009 which has been verified by the local tax bureau by accepting the application filed by the Company. Therefore, it was 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.

Business Opportunity Online was qualified as a High and New Technology Enterprise in Beijing High-Tech Zone in 2005 and was entitled to a three-year EIT exemption for fiscal year 2005 through fiscal year 2007 and a 50% reduction of its applicable EIT rate for the following three years for fiscal year 2008 through fiscal year 2010. 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, application procedures 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%. With an effective date of September 4, 2009, Business Opportunity Online obtained the approval of its reassessment of the qualification as a “High and New Technology Enterprise” under the New EIT law and was entitled to a favorable statutory 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% for the subsequent three years and 15% thereafter. The current EIT Law provides grandfathering treatment for enterprises that were (1) qualified as High and New Technology Enterprises under the previous EIT laws, and (2) established before March 16, 2007, if they continue to meet the criteria for High and New Technology Enterprises under the current EIT Law. The grandfathering provision allows Business Opportunity Online to continue enjoying their unexpired tax holidays provided by the previous EIT laws and regulations. Therefore, its income tax was computed using a tax rate of 7.5% for the nine and three month period ended September 30, 2010 and the year ended December 31, 2009 due to its unexpired tax holidays for the year 2009 through year 2010. For the nine and three month period ended September 30, 2009, since Business Opportunity Online had not obtained the approval of its qualification as a “High and New Technology Enterprise” under the New EIT law, it estimated and calculated its income tax based on the income tax rate of 25%, the difference of the income tax expenses between the estimated and the actual income tax expenses for the nine and three month periods ended September 30, 2009 was approximately US$1,136,000 and US$487,000 respectively.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The applicable income tax rate for Beijing CNET Online was 25% for the nine month periods ended September 30, 2010 and 2009.

The New EIT also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous enterprise income tax law and rules. A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate. Rise King WFOE is invested by immediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company.

2) Business tax and relevant surcharges

Revenue of advertisement services is subject to a 5.5% business tax and 3% cultural industry development surcharge of the net service income after deducting amount paid to ending media promulgators. Revenue of internet technical support services is subjected to a 5% to 5.5% business tax. Business tax charged was included in cost of sales.

3) Value added tax

As a small-scale value added taxpayer, revenue from sales of self-developed software of Rise King WFOE is subject to a 3% value added tax.

As of September 30, 2010 and December 31, 2009, taxes payable consist of:

	September 30,			December 31,
	2010			2009
	US$(’000)			US$(’000)
	(Unaudited)

Business tax payable		1,082			1,003
Culture industry development surcharge payable		2			27
Value added tax payable		(26	)		8
Enterprise income tax payable		897			886
Individual income tax payable		55			54
		2,010			1,978

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

15. Dividend payable

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Dividend payable to Series A convertible preferred stockholders		380		373

Dividend to Series A convertible stockholders was accrued at the per annum rate of 10% and calculated based on US$2.5 per share liquidation preference and the actual number of days of each share of the Series A convertible stock outstanding for each of the respectively reporting period.

During the nine months ended September 30, 2010, the Company paid approximately US$605,000 dividends to its Series A convertible stockholders.

16. Long-term borrowing from director

	September 30,		December 31,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)

Long-term borrowing from director		131		128

Long-term borrowing from director was a non-interest bearing loan from a director of the Company relating to the long-term investment in the Company’s wholly-owned subsidiary Rise King WFOE.

17. Warrant liabilities

On August 21, 2009 (the “Closing Date”), the Company 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 the Company sold units, comprised of 10% Series A Convertible 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 per unit (the “August 2009 Financing”). The Company sold 4,121,600 units in the aggregate, which included (i) 4,121,600 shares of Series A preferred stock, (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 were approximately US$9,162,000, net of issuance costs of approximately US$1,142,000. TriPoint Global Equities, LLC acted as placement agent and received (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 an exercise price of US$2.50, 164,864 shares at an exercise price of US$3.00 and 164,864 shares at an exercise price of US$3.75 respectively, with a five-year term (“Placement agent warrants” and together with the Series A-1 Warrant and Series A-2 Warrant, the “Warrants”).

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Warrants have an initial exercise price which is subject to adjustments in certain circumstances for stock splits, combinations, dividends and distributions, reclassification, exchange or substitution, reorganization, merger, consolidation or sales of assets, issuance of additional shares of common stock or equivalents. The Warrants may not be exercised if it would result in the holder beneficially owning more than 9.99% of the Company’s outstanding common shares. That limitation may be waived to the warrant holders by sending a written notice to the Company not less than 61 days prior to the date that they would like to have the limitation waived.

Accounting for warrants

As described in Note 2 k), the Company analyzed the Warrants in accordance to ASC Topic 815 “Derivatives and Hedging” to determine whether the Warrants meet the definition of a derivative under ASC Topic 815 and if so, whether the Warrants meet the scope exception of ASC Topic 815, 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’ equity shall not be considered to be derivative instruments for purposes of ASC Topic 815. The Company adopted the provisions of ASC Topic 815 subtopic 40, which applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by ASC Topic 815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. As a result of adopting ASC Topic 815 subtopic 40, the Company concluded that the Warrants issued in the August 2009 financing should be treated as a derivative liability, because the Warrants are entitled to a price adjustment provision to allow the exercise price to be reduced, in the event the Company issues or sells any additional shares of common stock at a price per share less than the then-applicable exercise price or without consideration, which is typically referred 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 as indexed to the Company’s own stock and then to fail to meet the scope exceptions of ASC Topic 815. Therefore, the Company accounted for the Warrants as derivative liabilities under ASC Topic 815. Pursuant to ASC Topic 815, derivatives should be measured at fair value and re-measured at fair value with changes in fair value recorded in earnings at each reporting period.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarized the above transactions:

	As of March 29, 2010		As of December 31, 2009		Changes in Fair 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	)

Placement agent warrants

In accordance with ASC Topic 340 subtopic 10 section S99-1, “specific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering.” In accordance with the SEC accounting and reporting manual “cost of issuing equity securities are charged directly to equity as deduction of the fair value assigned to share issued.” Accordingly, the Company concluded that the warrants issued to the placement agents are directly attributable to the August 2009 financing. If the Company had not issued the warrants to the placement agent, the Company would have had to pay the same amount of cash as the fair value. Therefore, the Company deducted the total fair value of the Placement agent warrants as of the Commitment Date which was approximately US$733,000 as a deduction of the fair value assigned to the Series A preferred stock.

The Placement Agent Warrants were also entitled to the benefits of the “Down-round protection” provision upon issuance and subsequently removed on March 29, 2010 as described above. Therefore, it was reclassified to equity on March 29, 2010. The changes in fair value of the placement agent warrants before the reclassification had been recorded in earnings for each respective reporting period.

18. Series A convertible preferred shares

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 A preferred stock, dividends are payable at the per annum rate of 10% of the Liquidation Preference Amount of the Series A preferred stock. Dividends are payable quarterly within thirty (30) days following the last Business Day of each August, November, February and May of each year (each, a “Dividend Payment 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 any portion 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 A preferred stock such number of additional Conversion Shares which, when multiplied by US$2.5 would equal the amount of such quarterly dividend not paid in cash.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Voting Rights

The Series A preferred stock holders are entitled to vote separately as a class on matters affecting the Series A Preferred Stock and with regard to certain corporate matters set forth in the Series A Certificate of Designation, so long as any shares of the Series A preferred stock remain outstanding. Holders of the Series A Preferred Stock are not, however, entitled to vote on general matters along with holders of common stock.

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”), the holders of the Series A preferred stock then outstanding shall be entitled to receive, out of the assets of the Company available for distribution to its stockholders, an amount equal to US$2.5 per share of the Series A preferred stock, plus any accrued but unpaid dividends thereon, whether or not declared, together with any other dividends declared but unpaid thereon, as of the date of Liquidation (collectively, the “Series A Liquidation Preference Amount”) before any payment shall be made or any assets distributed to the holders of the common stock or any other junior stock. If upon the occurrence of Liquidation, the assets thus distributed among the holders of the Series A shares shall be insufficient to permit the payment to such holders of the full Series A Preference Amount, then the entire assets of the Company legally available for distribution shall be distributed ratably among the holders 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 such holder’s option, subject to the limitations described below in “Conversion Restriction”, elect to convert all or portion of the shares of Series A preferred stock held by such person in a number of fully paid and non-assessable shares of common stock equal to the quotient of Liquidation preference amount 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 and combinations, dividend and distributions, reclassification, exchange or substitution, reorganization, merger, consolidation or sales of assets, issuance of additional shares of common stock or equivalents with lower price or without considerations etc, as stimulated in the Certification of Designation.

Mandatory Conversion:

All outstanding shares of the Series A preferred stock shall automatically convert into shares of Common Stock, subject to the limitations described below 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 Volume Weighted 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 volume of the Common Stock of at least 50,000 shares per day.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Conversion Restriction

Holders of the Series A preferred stock may not convert the preferred stock to common shares if the conversion would result in the holder beneficially owning more than 9.99% of the Company’s outstanding common shares. That limitation may be waived by a holder of the Series A preferred stock by sending a written notice to the Company on not less than 61 days prior to the date that they would like to waive the limitation.

Registration Rights Agreement

In connection with the Financing, the Company entered into a registration rights agreement (the “RRA”) with the Investors in which the Company agreed to file a registration statement (the “Registration Statement”) with the Securities and Exchange Commission to register the shares of Common Stock underlying the Series A Preferred Stock (the “Conversion Shares”) and the Warrants (the “Warrant Shares”), thirty (30) days after the closing of the Financing. The Company has agreed to use its best efforts to have the Registration Statement declared effective within 150 calendar days after filing, or 180 calendar 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 date when all 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 to Rule 144 (the “Financing Effectiveness Period”). The Company will pay liquidated damages of 2% of each holder’s initial investment in the Units 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 within the foregoing time periods or ceases to be effective prior to the expiration of the Financing Effectiveness Period. However, no liquidated damages shall be paid with respect to any securities being registered that the Company are not permitted to include in the Financing Registration Statement due to the SEC’s application of Rule 415.

The Company evaluated the contingent obligation related to the RRA liquidated damages in accordance to ASC Topic 825 “Financial Instruments” subtopic 20, which required the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement be separately recognized and measured in accordance with ASC Topic 450 “Contingencies”. The shares of common stock underlying the Series A preferred stock (the “Conversion Shares”) and the Warrants (the “Warrant Shares”) have been successfully registered by the Company. Therefore, the Company concluded that such obligation was not probable to incur and no contingent obligation related to the RRA liquidated damages needs to be recognized.

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 escrow account. Of the Escrow 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 greater than $7.7 million for the fiscal year 2009 (the “2009 Performance Threshold”) and the remaining 1,279,080 of the Escrow Shares 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 “2010 Performance Threshold”).

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

If the Company achieves at least 95% of the applicable Performance Threshold, all of the Escrow Shares for the corresponding fiscal year shall be returned to the Principal Stockholder. If the Company achieves less than 95% of the applicable Performance Threshold, the Investors shall receive in the aggregate, 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 the date of distribution of the Escrow Shares), 63,954 shares of the Escrow Shares for each percentage by which the applicable Performance Threshold was not achieved up to the total number of Escrow Shares for the applicable fiscal year. Any Escrow Shares not delivered to any investor because such investor no longer holds shares of Series A preferred stock or conversion shares shall be returned to the Principal Stockholder.

For the purposes of the Escrow Agreement, net income is defined in accordance with US GAAP and reported by the Company in its audited financial statements 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 be increased 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 the 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 Principal Stockholder 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 the Principal Stockholder to Messrs. Handong Cheng and Xuanfu Liu and Ms. Li Sun (the “PRC Shareholders”), upon the exercise of 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 designees in connection with the Financing, (v) the exercise of any warrants to purchase common stock outstanding and (vi) the issuance under any performance based equity incentive plan that the Company adopts.

Because the 2009 performance threshold has been met, 1,279,080 Shares (50% of the Escrow Shares) were released to the Principal Stockholder.

In accordance to ASC Topic 718 and ASU No. 2010-05—Compensation—Stock Compensation: Escrowed Share Arrangements and the Presumption of 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 Principal Stockholder or distributed to the investors without regard to the continued employment of any of the Company’s directors or officers, and this arrangement is in substance an inducement made to facilitate the financing transaction on behalf of the Company, rather than as compensatory. Therefore, the Company concluded that this arrangement should be recognized and measured according to its nature and reflects as a deduction of the proceeds allocated to the newly issued securities with no compensation expenses recorded in earnings.

Fair Value of the Series A preferred stock:

Fair value is generally based on independent sources such as quoted market prices or dealer price quotations. To the extent certain financial instruments trade infrequently or are non-marketable securities, they may not have readily determinable fair values. The Company estimated the fair value of the Warrants and Series A preferred stock using various pricing models and available information that management deems most relevant. Among the factors considered in determining the fair value of financial instruments are discounted anticipated cash flows, the cost, terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of similar traded securities, and other factors generally pertinent to the valuation of financial instruments.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Accounting for the Series A preferred stock

The Series A preferred stock has been classified as permanent equity as there was no redemption provision at the option of the holders that not within the control the Company on or after an agreed upon date. The Company evaluated the embedded conversion feature in its Series A preferred stock to determine if there was an embedded derivative requiring bifurcation. The Company concluded that the embedded conversion feature of the Series A preferred stock does not required to be bifurcated because the conversion feature is clearly and closely related to the host instrument.

Allocation of the proceeds at commitment date and calculation of beneficial conversion feature

The following table summarized the allocation of proceeds to the Series A preferred stock and the Warrants:

	Gross proceeds Allocated		Number of Instruments		Allocated value per instrument
	US$ (’000)				US$

Series A-1 Warrant		2,236		2,060,800		1.08
Series A-2 Warrant		2,170		2,060,800		1.05
Series A preferred stock		5,898		4,121,600		1.43
Total		10,304

The Company then evaluated whether a beneficial conversion feature exists by comparing the operable conversion price of Series A preferred stock with the fair value of the common stock at the commitment date. The Company concluded that the fair value of common stock was greater than the operable conversion price of Series A preferred stock at the commitment date and the intrinsic value of the beneficial conversion feature is greater than the proceeds allocated to the Series A preferred stock. In accordance to ASC Topic 470 subtopic 20, if the intrinsic value of beneficial conversion feature is greater than the proceeds allocated to the Series A preferred stock, the amount of the discount assigned to the beneficial conversion feature is limited to the amount of the proceeds allocated to the Series A preferred stock. Accordingly, the total proceeds allocated to Series A preferred stock were allocated to the beneficial conversion feature with a credit to Additional paid-in capital upon the issuance of the Series A preferred stock. Since the Series A preferred stock may convert to the Company’s common stock at any time on or after the initial issuing date, all discount was immediately recognized as a deemed dividend and a reduction to net income attributable to common shareholders.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

According to Staff Accounting Bulletin Topic 5.A: “Miscellaneous Accounting-Expenses of offering” (“ASC Topic 340 subtopic 10 section S99-1”), “specific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering”. And in accordance with the SEC accounting and reporting manual “cost of issuing equity securities are charged directly to equity as deduction of the fair value assigned to share issued”. Accordingly, the Company deducted the direct issuing cost paid in cash which were approximately US$1,142,000 from the assigned fair value to the Series A preferred stock.

19. Related party transactions

	Nine months ended September 30,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)		(Unaudited)

Advertising revenue from related parties:
-Beijing Saimeiwei Food Equipment Technology Co., Ltd.		276		1,232
-Beijing Xiyue Technology Co., Ltd.		10		-
-Beijing Fengshangyinli Technology Co., Ltd.		315		72
-Soyilianmei Advertising Co., Ltd.		-		539
-Beijing Telijie Cleaning Technology Co., Ltd.		-		15
-Beijing Telijie Century Environmental Technology Co., Ltd.		271		127
		872		1,985

	Three months ended September 30,
	2010		2009
	US$(’000)		US$(’000)
	(Unaudited)		(Unaudited)

Advertising revenue from related parties:
-Beijing Saimeiwei Food Equipment Technology Co., Ltd.		11		345
-Beijing Xiyue Technology Co., Ltd.		-		-
-Beijing Fengshangyinli Technology Co., Ltd.		138		11
-Soyilianmei Advertising Co., Ltd.		-		111
- Beijing Telijie Century Environmental Technology Co., Ltd.		116		55
		265		522

20. Employee defined contribution plan

Full time employees of the Company in the PRC participate in a government mandated defined contribution plan, pursuant to which certain pension benefits, medical care, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require that the PRC subsidiaries of the Company make contributions to the government for these benefits based on certain percentages of the employees’ salaries. The Company has no legal obligation for the benefits beyond the contributions made. The total amounts for such employee benefits, which were expensed as incurred, were approximately US$155,000 and US$118,000 for the nine months ended September 30, 2010 and 2009, respectively. For the three months ended September 30, 2010 and 2009, total expenses for employee benefits were approximately US$59,000 and US$44,000, respectively.

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

21. 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, and prepayments and other current assets. As of September 30, 2010 and December 31, 2009 substantially all of the Company’s cash and cash equivalents which amounting approximately US$22,241,000 and US$13,917,000, respectively (equal to approximately 62% and 54% of the Company’s total assets, respectively) were held by major financial institutions located in the PRC and Hong Kong, which management believes are of high credit quality.

Risk arising from operations in foreign countries

All of the Company’s operations are conducted within the PRC. The Company’s operations in the PRC are subject to various political, economic, and other risks and uncertainties inherent in the PRC. Among other risks, the Company’s operations in the PRC are subject to the risks of restrictions on transfer of funds, changing taxation policies, foreign exchange restrictions; and political conditions and governmental regulations.

Currency convertibility risk

Significant part of the Company’s businesses is transacted in RMB, which is not freely convertible into foreign currencies. All foreign exchange transactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requires submitting a payment application form together with suppliers’ invoices and signed contracts. These exchange control measures imposed by the PRC government authorities may restrict the ability of the Company’s PRC subsidiary and VIEs to transfer its net assets, which to the Company through loans, advances or cash dividends.

22. Commitments

The following table sets forth the Company’s contractual obligations as of September 30, 2010:

	Rental Payments		Server hosting and board- band lease payments		Internet resources and TV advertisement purchase payments		Total
	US$(’000)		US$(’000)		US$(’000)		US$(’000)

Three months ended December 31, 2010		66		-		8,811		8,877
Year ended December 31,
-2011		267		15		112		394
-Thereafter		-		-		-		-
Total		333		15		8,923		9,271

CHINANET ONLINE HOLDINGS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The contractual obligations of TV advertisement and internet resources purchase payments represent the contracts signed by the Company with TV stations for purchasing the TV advertisement time and with the internet resources providers for purchasing internet advertisement resources. The Company will update these contracts with the related counterparties based on its actual needs if necessary.

23. Segment reporting

Based on the criteria established by ASC Topic 280 “Segment report”, as of September 30, 2010, the Company mainly operated in five principal segments: internet advertising, TV advertising, bank kiosk advertising, internet advertising resources resell and internet information management. Internet information management is a new product and business segment of the Company, which was officially launched in August 2009. It is an intelligence software that is based on our proprietary search engine optimization technology which helps our clients gain an early warning in order to identify and respond to potential negative exposure on the internet. The following tables present summarized information by segments.

	Nine months ended September 30, 2010 (Unaudited)
	Internet Ad.		TV Ad.			Bank kiosk		Internet Ad. resources resell		IIM		Others			Inter- segment and reconciling item			Total
	US$ (‘000)		US$ (‘000)			US$ (‘000)		US$ (‘000)		US$ (‘000)		US$ (‘000)			US$ (‘000)			US$ (‘000)

Revenue		19,478		11,044			396		93		165		593			(593	)		31,176
Cost of sales		4,907		10,709			34		84		9		48			-			15,791
Total operating expenses		3,777		379			63		-		-		1,576	*		(593	)		5,202
Including: Depreciation and amortization expense		92		58			63		-		-		62						275
Operating income(loss)		10,794		(44	)		299		9		156		(1,031	)		-			10,183

Changes in fair value of warrants		-		-			-		-		-		1,861			-			1,861
Expenditure for long-term assets		264		-			-		-		-		184			-			448
Net income (loss)		10,496		(42	)		299		9		156