UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 TO
Form 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of Earliest Event Reported) January 18, 2000
CATHAYONLINE INC.
(Exact Name of Registrant as Specified in its Charter)
NEVADA 000-28705 88-0346952
- ---------------------------- --------- ------------
(State of other jurisdiction of (Commission (I.R.S. Employer
incorporation or organization Number) File Number) Identification
570 LEXINGTON AVENUE, 18TH FLOOR, NEW YORK, NEW YORK 10017
- ---------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(212) 888-6822
(Registrant's Executive Office Telephone Number)
LAZZARA FINANCIAL ASSET RECOVERY INC.
-------------------------------------
(Former name or former address, if changed since last report)
1
Certain statements contained in this Form 8-K constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and Section 21E of the Securities Exchange Act
of 1934 (the "Exchange Act"). These statements, identified by words such as
"will," "intend to," "plan to," "anticipate," "believe," "estimate,"
"should,""expect" and similar expressions, include our expectations and
objectives regarding our future financial position, operating results and
business strategy. These statements reflect the current views of management with
respect to future events and are subject to risks, uncertainties and other
factors that may cause our actual results, performance or achievements, or
industry results, to be materially different from those described in the
forward-looking statements. Such risks and uncertainties include those set forth
under the captions "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this Form 8-K.
We do not intend to update the forward-looking information to reflect actual
results or changes in the factors affecting such forward-looking information.
PRELIMINARY NOTE:
CURRENCY PRESENTATION
We publish our financial statements in United States dollars. In this
Form 8-K, any figure which is denominated, by contract or otherwise, in Canadian
dollars or Chinese Renminbi has been converted into US dollars at the exchange
rate on March 30, 2000. At March 30, 2000, CAN$1 was convertible into US$.68714
(so that CAN$1.3984 equals US$1) and one Chinese Renminbi was convertible into
US$.1208, based on a fixed exchange rate of RMN8.2788 for each US dollar. (All
Canadian currency information is based on exchange rates reported in the Wall
Street Journal on March 30, 2000.)
ITEM 1. CHANGES IN CONTROL OF REGISTRANT
On January 18, 2000, CathayOnline Inc. ("we" or "us") entered into an
Acquisition Agreement and Plan of Merger whereby we acquired all of the
outstanding shares of Lazzara Financial Asset Recovery, Inc., an inactive Nevada
corporation ("Lazzara"), in exchange for 25,000 shares of our common stock (the
"Merger"). We are the surviving entity in the merger. Lazzara was registered
under the Securities Exchange Act of 1934 (the "Exchange Act") and was required
to file reports under said Exchange Act. We elected to succeed to Lazzara's
reporting requirements under the Exchange Act, as permitted by Section 12g-3(b)
thereof, and as a result became a reporting company under the Exchange Act on
January 18, 2000. Accordingly, we now are required to file reports with the
Securities and Exchange Commission ("SEC") under the Exchange Act commencing
upon the filing of the Current Report on Form 8-K filed on January 18, 2000. As
a consequence of the merger and our election to succeed to Lazzara's reporting
requirements under the Exchange Act, our common stock remained eligible for
trading and continues to trade on the Over-the-Counter Electronic Bulletin
Board.
2
In connection with the merger, we issued to Donald J. Stoecklein
225,000 shares of Common Stock for services rendered in connection with the
Merger. The common stock issued Mr. Stoecklein was valued at $297,000.
DESCRIPTION OF BUSINESS.
OVERVIEW.
We are a Nevada corporation which, through our wholly-owned foreign
subsidiaries:
o provides operating, management and administrative services to
one of five currently operating Internet Service Providers
("ISP") licensed by the Province of Sichuan, The People's
Republic of China (the "PRC" or "China");
o provides Web based e-mail and messaging solutions on the
Internet for Chinese speaking customers mainly in China and
throughout the world;
o registers Internet domain names on a co-branded web site
through our relationship with register.com, inc.; and
O has entered into an agreement to develop and publish an
on-line version of China Market Journal, a monthly magazine
devoted to business and financial matters in China.
References in this Form 8-K to "we," "us" and "our" refer to
CathayOnline Inc. and its subsidiaries unless the context requires otherwise.
THE INTERNET.
We furnish consulting services, including operating, management and
administrative services, to an Internet service provider in the Province of
Sichuan, The People's Republic of China. An Internet service provider ("ISP")
permits people with personal computers and other devices fitted with computer
communications modems (an electronic device for converting between serial data
from a computer and an audio signal suitable for transmission over telephone
lines), now standard on most computers and available in other devices such as
television top Internet access devices, to access the Internet by dialing a
telephone number through a computer modem, dials the ISP access number and
interfaces with the ISP at a point of presence, thereby giving the user access
to the Internet. Users can then type in the Internet address or uniform resource
locator ("URL") and gain entry into the Internet site. Statistics evidence rapid
growth of the use of the Internet in China and we believe that such growth will
continue for the foreseeable future.
3
GROWTH OF THE INTERNET AND THE WORLD WIDE WEB (THE "WEB")
The Internet is a global collection of connected public and private
computer systems and networks that link millions of public and private computers
to form what is essentially the largest computer network in the world. The
Internet enables government agencies, educational institutions, commercial
organizations and individuals to communicate, access and share information,
provide entertainment and conduct business remotely. The Internet has
experienced rapid growth in recent years and is expected to continue to grow
based on estimated increases in the numbers of Web users, Web traffic and the
number of Web sites. International Data Corporation ("IDC") estimates that the
number of worldwide users of the Internet will increase from 97 million in 1998
to 502 million by the end of 2003. In a report issued in April 1998, the U.S.
Department of Commerce estimates that traffic on the Internet is doubling every
100 days. Additionally, Forrester Research estimates that the number of Web
sites in the United States will increase from approximately 450,000 in 1997 to
nearly four million in 2002.
We believe that several factors are contributing to the Internet's
growth on a worldwide basis, including the proliferation of lower cost personal
computers ("PCs"); advances in the performance and speed of PCs, modems and
networking components; improvements in network infrastructures, easier and more
competitive access to the Internet and the increasing use of the Internet by
businesses as a competitive tool. In addition, the emergence of a network of
servers and information called the World Wide Web, which is rich in content,
activities and services, has made the Internet more accessible in terms of
providing information, products and services that people can use on a daily
basis. A few examples of what is available on the Web include magazines, news
feeds, radio broadcasts, and corporate, product, educational, research, and
political information, as well as activities, including chat and Web communities
and customer services, including reservations, banking, games and discussion
groups. The rapid deployment of the Web has introduced fundamental changes in
the way information can be produced, distributed and consumed, lowering the cost
of publishing information and extending its potential reach. Companies from many
industries are publishing products and company information or advertising
materials and collecting customer feedback and demographic information
interactively. The structure of Web documents allows an organization to publish
significant quantities of information while simultaneously allowing each user to
view selected information that is of particular interest in a cost effective and
timely fashion.
Furthermore, the Internet has become an important global medium that
enables millions of people to obtain and share information and conduct business
electronically. In China, additional factors driving the growth of the Internet
include improving technological infrastructure, the increase in access to
personal computers (PCS) and a rapid increase of the quantity of Chinese content
driven by the government's on-line initiative and commercial enterprises, among
other factors described below.
INTERNET INFRASTRUCTURE IN CHINA
China's Internet network presently consists of four, largely separate
4
national networks: ChinaNet, the largest Internet access provider, is owned and
operated by the PRC government and is the only channel through which the
domestic PRC network can connect to the international Internet network; Golden
Bridge Network, a much smaller, commercial network; China Science and Technology
Network, the nation's high technology research network; and China Educational
and Research Network, linking China's academic and learning institutions from
grade school to post-graduate level. A fifth network, the China Multimedia
Services Network, is an asynchronous transfer mode, or ATM, network which relies
on ATM switches and routers (which are poorly suited to carrying Internet
protocol traffic, which results in inefficient use of network bandwidth), is
currently under development and is already available in a number of cities.
Until March 1997, these four networks had virtually no
interconnectivity so that all Internet traffic had to be routed via the United
States. Today, there is limited connectivity via low bandwidth (128K) leased
line connections among the four networks, though these connections are
completely saturated. As yet, there are no shared network access points or
peering relationships (which are agreements among Internet networks and service
providers which permit information to flow freely from one network to another)
to improve the efficiency of network traffic. The various networks have little
or no redundancy or back-up, and network flow is subject to frequent outages.
All ISPs in China are connected to nodes operated and maintained by the
Science and Technology Ministry of the PRC government. Nodes (the physical
equipment through which ISPs connect to China's Internet backbone and which
connect China to the international Internet) and routers (which send Internet
data to the proper destination) have been established in 31 of China's largest
cities such as Beijing, Guangzhou, Shanghai and Chengdu. Nodes located in
coastal cities such as Beijing, Shanghai and Guangzhou provide China with its
connection to the international Internet.
The majority of commercial users access ChinaNet via dial-up accounts
that support bandwidth speeds of up to 33.6Kbps, that is, the communications
line can accommodate a maximum of 33,600 bytes of information per second. A
bandwidth speed of 33.6Kbps currently represents the industry standard, though
higher speed connections are available in certain areas of the world via cable
and satellite, though such connections are not currently available in China.
ACCESSING THE INTERNET IN CHINA
In China, access to the Internet is accomplished primarily through the
government's backbone of separate national interconnecting networks that connect
with the international gateway to the Internet, which is owned and operated by
the PRC government and is the only channel through which the domestic PRC
network can connect to the international Internet network. Presently, almost all
access to the Internet is through ChinaNet, the PRC's primary commercial network
(operated by the Ministry of Information Industry), which is owned and operated
by the PRC government. Four other Internet access providers are operating at a
national level, albeit with small subscriber bases. Over the last several years,
the PRC government and individual provinces, consistent with the central
5
government's policies and initiatives to establish and construct a modern
telecommunications industry and information distribution system, have granted
licenses to private organizations to provide Internet access services to the
Internet's resources. In October 1999, there were estimated to be 150 private
ISPs operating in China. Access services in China generally are limited to
dial-up modem access whereby an individual's computer dials a number which
connects the user to a network owned and maintained by the ISP, which either has
access to the Internet backbone or is permanently connected to the Internet, and
through which the user is connected to the Internet. ISP's in China all rely on
the national telecommunications companies, such as China Telecom and China
Unicom, to provide Internet access lines and to maintain local
telecommunications lines.
In Beijing, it is possible for computer users to access the Internet by
dialing a four digit number and logging-on using a three digit password, which
is available to anyone. The only cost for the service is the telephone line
charge [users pay local phone charges of roughly 4 RMB (US$0.50) per hour] that
appears on the telephone line's monthly bill. The Golden Bridge Network,
described below, has a similar access system, charged through the purchase of a
pre-paid calling card, and is available in most major cities in China.
GROWTH OPPORTUNITIES IN CHINA
According to ChinaNIC ("CNNIC"), a department of the Chinese Academy of
Sciences, by July 1999, China officially had 4 million Internet users, up from
2.1 million users at the end of 1998. A study conducted by Maverick Research
Ltd., in conjunction with Virtual China Inc., estimates that the number of
Internet users in China could increase to 15 million persons by mid 2001
(measured by numbers of users accessing the Internet, not by the number of
computers connected to the Internet). IDC estimates that Web pages hosted in
China grew from 100 in 1994 to 250,000 in 1998. According to The Internet in
China, a study published in June 1999 by Strategis Group and BDA China, China is
the fastest-growing Internet market in Asia. The study estimates that by the end
of 1999, more than 6.7 million people in China will have Internet access, a
number projected to grow to 33 million or more by 2003. Some forecasts project
up to 100 million users by 2010, at which time China would surpass the United
States as the country with the most Internet users.
In addition to the factors described above, several specific elements are
contributing to the growth of the Internet in China, including: the increasing
familiarity, acceptance, and use of the Internet by the central and local
governments, businesses, and consumers; the growing number of PCs installed in
homes, offices, and public locations such as libraries and schools; the advent
of the television set-top box that requires only a television set and telephone
line for Internet access (at a cost significantly less than a PC and within the
budget of many more Chinese than a PC); the increased availability of PCs for
purchase through retail outlets in China; the decreasing cost of PCs and related
peripherals; significant improvements and upgrades in progress in
telecommunications network infrastructure, bandwidth, and connectivity; the
popularity of e-mail and messaging services; and the emphasis placed by the PRC
government on developing a national information infrastructure built, in part,
on Internet connectivity under its Torch Program and the initiation of the
6
Golden Projects, launched in 1994, designed to increase economic efficiency and
centralize the control of information.
Under the Torch Program, the PRC government has already invested more than
US$28 billion to install more than 100,000 km of optical fiber that now links
85% of the country. In addition, under the Golden Bridge Project, the PRC
commenced development of the infrastructure for "informationizing" the national
economy, which encompassed the construction of an infrastructure backbone over
which other information services run and included a hybrid network of satellite
and landline networks, which tie together the provincial and regional nodes. The
Golden Bridge Project has given rise to CERNET (the China Education and Research
Network, discussed above), which was intended to be China's entry into the
Internet.
The first direct fiberoptic link between China and the US - the US$1.2
billion China-US Cable Network project- is expected to be completed in the first
half of 2000. This link will provide an explosion of information available
within China. In order to make efficient and economical use of the coming flood
of information, the Chinese government is encouraging foreign investment and
assistance to develop its telecommunications and technology infrastructures.
Over the last several years, as a part of the Torch Program initiative,
China has taken steps to improve telecommunications for the masses by increasing
cable television and telephone installations, both of which can support Internet
access. As of the fourth quarter of 1999, cable television access was installed
in over 100 million households in China and there was more than one television
set for every eight people and one color television for each urban household.
Telephone penetration in China is expected to rise at an annual average rate of
2% in the next five years and reach 22% by 2003 from the current 12%, with the
focus placed on the rural and western part of the country, according to the
Minister of the Information Industry. By 2003, the number of customers using
fixed telephones will increase to 170 million from the current 100 million and
the number of persons using mobile telephones will increase to 100 million from
the current 36 million. In the Province of Sichuan, which has a population of
approximately 100 million people, there are estimated to be approximately 3.44
million fixed line telephone subscribers and 546,000 mobile telephone
subscribers. Though penetration of actual lines are low when expressed as a
percentage of the overall population, these percentages translate into an
enormous numbers of households when viewed in relation to the actual population.
The Maverick Research Ltd. report forecasts that PC sales in China are
expected to be 7 to 10 million units over the next two years. We believe that
the confluence of telephone and cable television line installations and PC sales
point to significantly increased Internet access use over the next several
years.
We do not believe that the economic downturn in Asia during 1998 and 1999
has effected or will impact the rate of Internet penetration in China or our
other target markets for the following reasons:
7
o Statistics evidence continued growth in use of the Internet;
o The PRC government has adopted policies and taken initiative
to develop the telecommunications infrastructure and to ensure
that the Internet continues to grow; and
o It appears that individual and business Internet users have
determined that Internet applications such as e-mail and Web
site advertising, offer lower cost substitutes for comparable
non-Internet alternatives.
E-COMMERCE IN CHINA
The Internet is dramatically affecting the methods by which consumers
and businesses are evaluating and buying goods and services, and the methods by
which businesses are providing customer service. The Internet provides online
merchants with the ability to reach a global audience and to operate with
minimal infrastructure, reduced overhead and greater economies of scale, while
providing consumers with a broad selection, increased price comparison power and
convenience. In the last several years, many companies have emerged that focus
solely on the Internet as the medium for selling products or delivering services
directly to purchasers, bypassing traditional wholesale and retail channels.
Furthermore, traditional businesses are implementing sophisticated Web sites and
extranets to effect electronic commerce initiatives that offer competitive
advantages.
These businesses are deploying an expanding variety of Internet-enabled
applications, ranging from Web site marketing and recruiting programs to on-line
customer interaction systems, integrated purchase order and "just-in-time"
inventory solutions for key customers and suppliers. These capabilities require
increasingly complex Web sites and support operations. In addition, advances in
on-line security and payment mechanisms are alleviating concerns associated with
conducting transactions in an open-platform environment, thus prompting more
consumers and businesses to use the Internet in conjunction with purchases and
more businesses to offer a greater breadth of electronic commerce services. IDC
estimates that the number of consumers buying goods and services on the Internet
will grow from 17.6 million in 1997 to over 128 million in 2002, and that the
total value of goods and services purchased over the Internet by consumers and
businesses will increase from approximately $12 billion in 1997 to over $425
billion by 2002.
The opportunities for e-commerce in emerging markets such as China are
magnified by the inefficiencies of existing product and service distribution
systems. Products are available sporadically, if at all, in certain locations
and at prices which do not reflect the world-wide competitive environment or
other market forces. Alternatively, e-commerce affords customers access to a
greater variety of products and services at prices consistent with world
markets. These factors are expected to be the primary driving forces behind the
projected explosive growth of e-commerce in China. In fact, China's President,
Jiang Zemin has described e-commerce as "the future of business" and called on
developed countries to provide less developed countries with the technology and
other assistance needed to promote it. This statement, made at such a high
8
level, reflects the emphasis China is beginning to put in the economic benefits
of having a wired nation.
Currently, e-commerce is not developed in Greater China nearly to the
extent it is in the United. The most cited obstacle to e-commerce in China is
the lack of a nation-wide credit card verification system. Although credit cards
such as MasterCard and Visa operate in China, these cards predominantly are
issued by individual banks and their use is limited because of the inability of
merchants to clear transactions with banks with which they do not have a
relationship. The PRC, as a part of its Golden Projects initiative, has proposed
the Golden Card project which has targeted the development of a nationwide,
inter-bank credit card clearing house by the year 2000. The development and
widespread issuance of credit cards would inaugurate the e-commerce era in
China. We believe that as this market matures, credit card use and additional
methods of making online payments will increase, and e-commerce will generate
significant retail revenue.
E-commerce is relatively prevalent among state sector and government
controlled businesses but is almost nonexistent among individual consumers. In
the summer of 1998, the Ministry of Foreign Trade and Economic Cooperation
(otherwise known as "MOFTEC") went on-line with its China Market Web site, the
country's first official export-oriented business-to-business e-commerce site.
One report suggests that this site was organized because the preponderance of
major business is conducted by state-sector and government controlled businesses
and that it will serve as the foundation for consumer oriented e-commerce.
However, by some estimates e-commerce is on the cusp of explosive growth.
According to BDA China/Strategis Group, China will have over 33 million Internet
users employing over 37 million computers by the end of 2003 and IDC predicts
that China's e-commerce market will burgeon to over $11 billion by 2004, up from
$43 million in 1999 (though no break-down between e-commerce derived from
business customers relative to individual consumers was provided in this study).
While e-commerce is in its infancy in China, companies such as
China.com Corporation and Sina.net, have rolled out fully diversified
sophisticated Web Portals to deliver content, products and services targeting
Chinese speaking people in China, Hong Kong and Taiwan. Similar Web sites have
been and will be developed and as they condition the Chinese market to the
possibilities of e-commerce for the masses, e-commerce will gain increasing
acceptance as a purchase medium for consumers and as an advertising tool for
businesses.
In a study conducted by CNNIC, the typical Internet user in China is a
young, college educated, urban male, who is technically oriented and accesses
the Internet via the Windows operating system. A very high percentage reside in
China's major cities. According to the report, 37% of users have annual incomes
between 400 and 1,000 Renminbi (the official Chinese unit of currency, valued,
by the PRC government, at RMB8.28 per US$1). These persons are influenced by
and, in essence, are a part of Western culture. We believe that this segment of
the population will be the driving force behind the first wave growth of
e-commerce in the future. We also believe that the prospect of engaging in
9
e-commerce, both from a consumer and business perspective, will be one of the
driving forces behind the growth of the Internet in China.
We believe that e-commerce will serve as one of the driving forces
behind the growth of the Internet in China and that all aspects of our business
will benefit from the growth of e-commerce. Businesses will develop Web sites to
attract e-commerce consumers and sell products and more consumers will access
the Internet to purchase goods and services over the Web. We believe that such
growth will benefit our company on many levels. First, as e-commerce and other
Internet and Web based services attract more consumers, Sichuan Guo Xun's user
base will grow and our revenues will increase accordingly. Second, as Internet
use and e-commerce grows in China, we plan to expand Sichuan Guo Xun's ISP
value-added services into e-commerce areas, which typically afford higher
margins than Internet access and e-mail/messaging services. Such value added
services include Web site design and maintenance consulting services;
co-location services, whereby we provide secure space to house customer-owned
Internet equipment; Web hosting services including shared and dedicated hosting
on our servers for customer Web sites as well as collocation hosting of customer
supplied servers in our facilities; and consulting services with respect to
connecting corporate networks to the Internet, use of the Internet as a revenue
generating tool and other services, which our clients may find useful. In
addition, we plan, as capital permits, to develop a content driven Web portal
through which we expect to offer content delivery services, such as search
engines, directories and local information all in the Chinese language and
directed specifically to users in China; community products such as chat and
message boards; online advertising and marketing solutions; and e-commerce
activities.
OUR ISP CONSULTING SERVICES.
We provide consulting services to ISP's in China. Our services include
consulting with respect to technical issues, management and administrative
services. Currently, we render our services to one ISP in China and we are
actively seeking other clients throughout China.
On September 9, 1999, our subsidiary, Sichuan CathayOnline Technologies
Co. Ltd., a foreign enterprise established under the laws of the PRC and
wholly-owned by us through CathayOnline Technologies (Hong Kong) Ltd., entered
into an Exclusive Management and Consulting Services Agreements with the Sichuan
Province ISP, Sichuan Guo Xun Xin Xi Chan Ye You Xian Gong Si ("Sichuan Guo
Xun"), which offers dial-up Internet access to consumers and businesses. Sichuan
Guo Xun is one of nine ISP's licensed by the Province of Sichuan to provide
Internet access to consumers and businesses in the Province, and one of only
five operating ISP's in Sichuan (this figure includes ISP's operated by the PRC
government or agencies thereof). Under the terms of this agreement we furnish to
Sichuan Guo Xun managerial and technical consulting services, including
o value added services with respect to planning, designing and
implementing computer networking and data processing
operations;
o services related to the development and implementation of
computer and electronic communications; and
10
o administrative services.
Owen Li, the General Manager of our subsidiary Sichuan CathayOnline
Technologies Co. Ltd., has approximately three years of experience operating an
ISP in China and is responsible for all of our operations in the Province of
Sichuan.
In consideration of the services we render to Sichuan Guo Xun, we
receive a fee equal to 90% of the net profits generated from Sichuan Guo Xun's
operations. The agreement with Sichuan Guo Xun extends through March 2003 and
automatically renews for three and one half years upon its expiration. At
October 31, 1999, Sichuan Guo Xun served approximately 2,500 subscribers in the
City of Chengdu, which has approximately 10 million residents.
In addition, we have agreed to fund the development and support of
Sichuan Guo Xun by infusing cash into our PRC subsidiary, Sichuan CathayOnline
Technologies Co., Ltd. To date, we have funded this entity with $700,000 which
has been used to purchase infrastructure, such as computer hardware and
software, and have invested in other supporting items and personnel. The
hardware and software that we have provided to date has allowed Sichuan Guo Xun
to increase the number of users it can accommodate from 2,500 persons to 25,000
persons. The equipment consists of (a) an intelligent voice/fax processing
platform with appropriate hardware and software; (b) 32 E1 fiber optical
connection channels (four of which are in service at this time) to the China
Telecom/Unicom PSTN systems; (c) 4 E1 DDN fiber optical point station to the
Internet backbone (only one E1 is in service now); (d) a power supply system
(can support up to 125A); (e) a 220V to 48V conversion battery UPS systems; and
(f) Local Area Network equipment (with Cisco routers, Compaq servers, IBM
servers). We will continue to invest in Sichuan Guo Xun to develop a world class
ISP.
SICHUAN GUO XUN XUN XIN XI CHAN YE YOU XIAN GONG SI ISP
Sichuan Guo Xun was issued an ISP license by the PRC government on
September 8, 1999. Under the terms of the license, it may engage in the business
of operating computer information international networking, which includes
operation of an ISP and the right to provide e-mail and similar services.
Sichuan Guo Xun commenced ISP operations in September 1999. Its
principal offices and hardware facilities housing its infrastructure equipment
are located in Chengdu. Sichuan Guo Xun possesses limited hardware which allowed
it to service 2,500 subscribers, which has been augmented by the equipment and
support we have invested in our PRC subsidiary. Sichuan Guo Xun's leases one E1
line, having a bandwidth of 2.04 megabytes of data, to connect it with the
Internet node in Chengdu and three E1 lines for dial-up purposes. Sichuan Guo
Xun has the ability to expand to 32 dial-up lines at any time. Its network
capacity can accommodate 25,000 users and approximately 120 dial-up telephone
numbers through which a subscriber can enter the ISP. Over the next several
11
months, Sichuan Guo Xun will increase its bandwidth by leasing additional lines
to connect its facilities to the node in Chengdu and lease additional dial-up
lines to accommodate increased user demands. We have been advised that Sichuan
Guo Xun can increase the number of dial-up lines available to it to up 960
telephone numbers.
Sichuan Guo Xun is connected to the regional node maintained by the PRC
Ministry of Science and Technology located in Chengdu by telephone lines leased
from China Telecom and Unicom. Through this node, it is connected to China's
Internet backbone network, which permits it to route data to destinations,
including international sites, not on Sichuan Guo Xun's network.
We will continue to invest in the enhancement and expansion of Sichuan
Guo Xun's infrastructure to support customer growth and accommodate increased
customer usage. We will provide the hardware, software and technical assistance
necessary to create a reliable network to satisfy Sichuan Guo Xun's customers'
demands. We plan to provide Sichuan Guo Xun with additional capital in the next
year, as our financial position permits, to increase and support growth of the
subscriber base and to accommodate increased demands on the system.
Sichuan Guo Xun leases telephone lines on a monthly basis from the
PRC's telephone utilities, such as China Telecom and China Unicom, over which
users access the Internet. Internet line access is expensive and has BEEN CITED
AS THE PRIMARY IMPEDIMENT TO THE GROWTH OF THE INTERNET IN CHINA. Currently,
Sichuan Guo Xun leases the line that connects it to China's Internet backbone at
the node in Chengdu at a cost of approximately $18,116 per month. Sichuan Guo
Xun leases the lines through which its subscribers gain access to the Internet
at a cost of approximately $1,087 per line per month for an aggregate of
approximately $3,261 for the three lines it LEASES. We believe that with the
break-up of China Telecom, formerly the PRC's telephone monopoly, and the
ensuing competition among the resulting entities (which continue to be
government owned), that monthly line charges will continue to decrease. Internet
access line charges represent approximately 20% of Sichuan Guo Xun's total
operational costs and any reduction in these expenses will increase net revenues
and accrue to our benefit.
Sichuan Guo Xun presently provides Internet access services to
approximately 2,500 individual consumers and businesses located in the City of
Chengdu and anticipates expanding its service area to include other major CITIES
IN THE PROVINCE OF SICHUAN DURING THE NEXT 18 Months. Subscribers are provided
with software to load onto their computer which will allow their computer to
interface with the ISP and in which they will store the ISP access telephone
numbers. A computer modem (now standard on most computers), an electronic device
for converting between serial data from a computer and an audio signal suitable
for transmission over telephone lines, dials the ISP access number and
interfaces with the ISP at a point of presence, thereby giving the user access
to the Internet. Users can then type in the Internet address or uniform resource
locator ("URL") and gain entry into the Internet site. Users gain access to the
international Internet thought Sichuan Guo Xun. Some Internet sites are blocked
by the PRC government because of content offensive to the PRC and users will not
be able to gain access to these sites. In addition, Sichuan Guo Xun could be
12
subject to substantial fines and criminal penalties, including the loss of its
license, in the event users of its service gain access to proscribed sites or
content. See "Government Regulation."
Subscribers pay for Sichuan Guo Xun's services either through a debit
account, credit card or by way of "e-cash," (a payment method similar to a
checking account whereby a consumer either deposits funds with or maintains a
cash account with a financial institution and can direct payments to be made
from such account electronically, that is, over the Internet). We are exploring
the possibility of having local telecommunications carriers to bill the services
on the subscribers' monthly telephone bill.
THE PROVINCE OF SICHUAN
The Province of Sichuan is situated in the western section of China and
is bounded on the south and west by the Yangtze River. It is China's largest
province with 100 million residents, approximately 10 million of whom reside in
the capital, Chengdu. Sichuan is the fifth largest province in geographic area
and its gross domestic product, which was approximately $50 billion in 1998,
ranks fourth among China's provinces. Sichuan is characterized by dense
population, heavy industry and agricultural prosperity. Sichuan has
approximately 3.44 million fixed line telephone subscribers and 546,000 mobile
telephone subscribers, thereby giving them access to the Internet. Sichuan has
numerous universities, high-tech businesses and heavy industry, the primary
users of the Internet in China.
We believe that the small number of operating ISPs in Sichuan, its
demographic profile as well as the technological and physical infrastructure,
including telephone lines, are all positive factors which will permit Sichuan
Guo Xun's subscriber base to grow significantly over the next several years and
we have developed a marketing plan to effectuate such growth.
WEB BASED E-MAIL AND ADVANCED MESSAGING PRODUCTS AND SERVICES.
We provide, through our wholly-owned subsidiary TorchMail.com, Inc.,
Web based e-mail and messaging solutions on the Internet for Chinese speaking
consumers and Chinese businesses in China and throughout the world. Our e-mail
and messaging services are provided through the facilities of USA.NET, Inc., the
largest independent Web-based consumer e-mail service on the Internet, which
adapted and customized its professional messaging services and e-mail
applications to the Chinese language for us to employ in our product offerings
ELECTRONIC MAIL (E-MAIL)
The Internet is quickly becoming an important communications tool,
advertising medium and sales channel for both consumers and businesses
worldwide. IDC estimates that the number of Internet users worldwide will grow
from 97 million in 1998 to 502 million by the end of 2003, and that the number
of devices able to access the Internet will increase from 120 million in 1998 to
515 million by the end of 2002. Jupiter Communications estimates that online
advertising revenue will grow from approximately $1.9 billion in 1998 to
approximately $7.7 billion in 2002. We believe that e-mail and advanced
messaging services will continue to be key drivers of Internet usage and growth
because they are among the most popular Internet applications today. E-mail is a
13
powerful yet inexpensive means of handling a wide variety of
business-to-business, business-to-consumer and personal communications at any
time and from any location.
According to the CNNIC report, 94% of the Internet users cite e-mail as
a motive for accessing the Internet and almost 91% of Internet users cited
e-mail as the most frequently used service. A United States Embassy report on
the Internet in China indicates that over 9% of information carried by Internet
circuits in China is devoted to e-mail.
By way of comparison to United States e-mail trends, Forrester Research
reports that the number of e-mail users in the United States is expected to
increase from 75 million in 1998 to 135 million in 2001. In addition, IDC
estimates that the total number of e-mail messages sent per day in the United
States will increase from 2.1 billion in 1998 to 7.9 billion in 2002.
We believe that the growth in the use of e-mail is being driven by its
convenience, speed, relatively low cost and the ability to send multimedia
attachments, such as video clips, graphics files, audio files, documents and
spreadsheets. These products are available because of new industry wide e-mail
protocols. New Internet protocols enable a user to access messages from a
variety of devices. These protocols allow Internet servers to route mail from
the sender to a destination so that users with a Web browser, such as Netscape
Navigator or Microsoft Internet Explorer, to access their messages from any
computer, terminal or device that is connected to the Internet. These protocols
also allow users to sort messages, search for specific text in a message, and
manipulate folders and mailboxes while those files are still on the server host
instead of on the user's computer or alternative Internet access device. This is
particularly valuable for users who access their messages from different
computers with different e-mail software. In addition, these new protocols allow
users to have a common mailbox and customized folders and mailboxes that are not
specific to a particular computer or alternative access device.
The new Internet protocols are facilitating a convergence in messaging,
including e-mail, voice mail and fax communications onto a single platform with
a single standard. For example, these new standards will allow voice mail
messages to become audio attachments and faxes to become image attachments to
e-mail messages. As a result, users will be able to read, view, listen and
respond to different message types using a common interface that can be accessed
by traditional PCs or a variety of other Internet access devices, including
wireless telephones, network computers, pagers, personal digital assistants and
television set-top boxes. The multiplicity of products and uses for e-mail are
making it an essential communications medium and businesses and consumers expect
their e-mail service to be as reliable as their telephone service. To remain
competitive, businesses must be able to rapidly deploy an advanced e-mail
system, manage the system effectively and increase its capacity. As the number
of e-mail users grows and the volume and complexity of messages increases,
e-mail systems must be able to accommodate increasing user demand and rising
storage requirements.
Today, many businesses have implemented in-house e-mail systems that
require hardware, software and technical and administrative resources. Creative
Networks, an e-business consulting and research firm, estimates that to acquire,
14
deploy and operate an in-house messaging solution for 5,000 users, a business
must spend approximately $640 per user's mailbox per year. Even at this level of
investment, we believe many businesses still face significant downtime and
unreliable service. According to the Gartner Group, the percentage of large
businesses that expect to outsource at least some of their e-mail systems is
estimated to grow from 10% in 1998 to 25% in 2000. Additionally, Forrester
Research estimates that the amount spent on outsourced e-mail services will
increase from an estimated $8 million in 1997 to over $1 billion in 2002. We
believe that a growing number of businesses will outsource their messaging
services to ensure a more reliable, cost-effective and less resource-intensive
solution than their own in-house e-mail system.
WEB BASED E-MAIL AND MESSAGING AS A BUSINESS AND MARKETING TOOL
The Internet has emerged as an attractive new medium for advertisers.
The Internet allows advertisers to target desired demographic groups or
consumers in specific geographic locations. It also allows them to interact more
effectively with consumers and capture valuable data about buying patterns,
preferences and demands. The Internet allows advertisers to present messages to
specific, targeted audiences, and to enable users to interact with advertising
information presented in Web pages. This characteristic of the Internet also
permits advertisers to measure more precisely the number of impressions, or
times that an advertisement appears in page views downloaded by users, through
verification by an independent third-party auditor.
Advertisers can also measure the effectiveness of advertising in
generating "click throughs", or user requests for additional information made by
clicking on the advertiser's banner linking the user to the advertiser's Web
site. We also believe that technological developments may result in greater
ability to provide information and analysis about the effectiveness of Internet
advertising and the demographic profiles of users, as well as the ability of
advertisers to modify frequently and tailor more closely their messages. This
should result in more targeted, higher impact advertising opportunities, and
greater integration of Web-based advertising into the range of marketing
channels available to advertisers.
E-MAIL IN CHINA
According to the CNNIC report, 94% of the Internet users in China cite
e-mail as a motive for accessing the Internet and almost 91% of Internet users
cited e-mail as the most frequently used service. A United States Embassy report
on the Internet in China indicates that over 9% of information carried by
Internet circuits in China is devoted to e-mail. By way of comparison to United
States e-mail trends, Forrester Research reports that the number of e-mail users
in the United States is expected to increase from 75 million in 1998 to 135
million in 2001. In addition, IDC estimates that the total number of e-mail
messages sent per day in the United States will increase from 2.1 billion in
1998 to 7.9 billion in 2002. We expect that e-mail in China will continue to
grow as the number of Internet users increases.
15
OUR AGREEMENT WITH USA.NET
On July 1, 1999, our whooly-owned subsidiary TorchMail.com Inc. entered
into a Reseller Agreement with USA.NET, Inc. which entitles us to offer its Web
based e-mail and messaging services to our customers. USA.NET is the largest
independent Web-based consumer e-mail service on the Internet and presently
services approximately 12 million business and consumer mailboxes. We began
full-scale marketing of our suite of e-mail products in early January 2000.
We will offer to our individual and business customers, through
USA.NET's infrastructure, a variety of Web based consumer e-mail services and
commercial messaging services as well as comprehensive message outsourcing
services. We believe that USA.NET offers messaging solutions on highly reliable
and scalable, or expandable, technology that include advanced features,
universal accessibility and a high level of security. We also believe that we
can leverage USA.NET's strong and respected brand recognition to grow our e-mail
subscriber base.
Our agreement with USA.NET provides that we will have "First to Market
Protection" within a territory comprising the PRC, Hong Kong, Singapore, Taiwan,
and the Philippine Islands (the "Territory") for a specified period after we
accepted delivery of the Chinese language version of USA.NET's e-mail and
advanced messaging products (December 1, 1999). During this period, USA.NET may
not form competing relationships with other resellers in the same industry in
the Territory. This protection will afford us the opportunity to effectively
market, advertise, support and resell the customized services in the Territory
during such period. After the expiration of this period, USA.NET will be
entitled to enter into relationships with other entities to identify, register
and support customers and provide the services that we will offer.
The Reseller Agreement includes monthly sales quotas that require us to
sell a certain number of "seats" (defined as an electronic mailbox created
within a customer's account) during each month of our agreement with USA.NET and
a specified number of seats during the first year. If we are able to meet the
minimum annual quota, USA.NET will grant to us a right of first refusal to serve
as its exclusive reseller within the Territory for the initial term (one year)
and for each successive term of the agreement, if it is renewed by each of us
thereafter. It is our intention, if funds become available, to purchase the
minimum number of seats required to meet the first year's annual quota during
the period in which we have First to Market Protection which will allow us to
solidify our competitive position and develop our marketing techniques to ensure
that we can thereafter continue to be the sole provider of USA.NET's Web based
e-mail and messaging services in the Territory. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Our agreement with USA.NET provides that it will handle customer
support with respect to all seats, however, given that the inquiries will be in
the Chinese language and given further that USA.NET's support services are
limited to responses in English, we will establish e-mail/messaging services
support operations and maintain a customer service department staffed by Chinese
16
speaking employees and implement support procedures to respond to customer
support questions and ensure that our subscribers receive reliable service.
Ultimately, we will be responsible for handling customer support for our
Chinese-speaking customers but will have the benefit of relying upon USA.NET for
answers to questions or responses to problems which we cannot solve ourselves.
As yet, we have not established customer support operations nor have we engaged
any personnel to staff the customer support center.
WEB BASED E-MAIL AND MESSAGING PRODUCTS
We believe that the market for Web based e-mail and messaging products
can be divided among business and corporate users, on the one hand, and
individual consumers, on the other. Business and corporate users can use Web
based e-mail/messaging products and services both as an intra-corporate
communications device as well as a marketing and advertising tool to reach
millions of potential customers. Individual consumers tend to rely on e-mail as
a communications device. We have developed marketing strategies directed to each
of these groups and offer distinct products and services to satisfy each group's
demands.
We will offer our basic Web based e-mail services to individual consumers
free of charge and charge individuals for additional premium services. We will
charge business customers fees for the TorchMail premium messaging services.
Business customers may select from a wide range of products and services that
will be priced based upon the services selected. Service charges will be payable
by subscribers via "e-cash," debit or credit card.
We accepted delivery of the Chinese version of USA.NET's Web based e-mail
and messaging suite of products on December 1, 1999 and recently commenced
full-scale marketing of these products. As of the date hereof, our subscriber
base is nominal.
In return for providing basic messaging services to individual users
free-of-charge, we may integrate revenue-producing advertising on the TorchMail
Web site (e.g., banner ads, clickthrough links, and direct delivery content). We
hope to generate revenue from advertising on our TorchMail Web site as well as
from the promotion of opt-in content delivery, which is marketing information
and special offers from advertisers that users can choose to receive. We will
seek to develop and maintain up-to-date demographic profiles and information
about our customers, by studying their clickthrough preferences, to permit
advertisers to target groups with pinpoint advertisements. We may be able to
sell such demographic information (except as to Hong Kong residents where the
distribution of such information is illegal) for a profit.
Although advertising naturally segues with our Web based e-mail and
messaging services and is a practice followed by most similarly situated Western
Internet companies, we have focused our attention on organizational activities
such as securing agreements with Sichuan Guo Xun and USA.NET, and only recently
have begun to explore the possibilities of advertising by way of our TorchMail
Web site.
We have entered into a letter of intent with an entity which will permit
17
TorchMail to develop a financial Web site and offer to our customers us real
time stock quotes from exchanges around the world and financial news services as
provided by Standard & Poor's Corporation (through a duly licensed provider of
such services based in Canada), and grants to us a right of first refusal to
offer Web based e-mail and messaging services to any other entities which feed
this supplier's live stock quotes through their Web sites. We have not entered
into a final agreement for the services which are the subject of the letter of
intent and no assurance can be given that any such agreement ever will be
finalized.
We intend to implement our Web based e-mail and messaging services in two
phases. Phase One, which currently is underway, encompasses the offering of Web
based e-mail and messaging services to individuals and business customer within
the Territory. In Phase Two we will make available television set top boxes
through which a user may access and send e-mail and browse the Web and develop
and offer new products consistent with technological advances.
Users of our Web based e-mail and messaging services will receive a
permanent e-mail address of their choice with a "torchmail.com" domain name
(e.g. username@torchmail.com). We provide the basic service free of charge. The
user's e-mail address does not change regardless of how often the user switches
employers, schools or Internet service providers. Users can send or retrieve
e-mail through our TorchMail Web site (www.torchmail.com) from any computer
connected to the Internet with a standard Web browser. Since our system is
Web-based, users do not need to download or install special software to access
the service, but if they desire, they can view their messages through popular
software programs such as Netscape Messenger or Microsoft Outlook.
All of our users can use TorchMail's set of free basic features to:
o Store up to five megabytes of data (additional storage space
is available at a nominal charge);
o Consolidate messages from multiple Post Office Protocol;
o Compliant mailboxes into one mailbox;
o Block unwanted messages;
o Attach large, complex files to their messages;
o Store frequently used e-mail addresses in an address book;
o Spell check messages;
o Organize and archive messages in customized folders;
o Add customized signatures to their messages; and
18
o Create automatic replies to incoming messages.
Our subscribers will have the advantage of advanced privacy and security
features. Each user has an account that the user can access only after entering
a unique user name and an individually selected password. Users accessing their
accounts via a public computer or other access device can choose to disable the
memory cache, meaning that viewed pages are expired rather than stored in the
browser's memory so that subsequent users of the public computer or other access
device will not be able to read the user's messages. Users can also subscribe to
several fee-based premium services, including virus scanning, pager
notification, e-mail forwarding and Post Office Protocol access. Users pay for
these premium services on a monthly or annual basis.
We will offer a wide variety of fee based, tiered packages of commercial
Web based e-mail and advanced messaging services including:
o Professional Messaging: A branded Web-based e-mail account to
be offered on a fee basis to individual companies, small
businesses, and value-added retailers ("VARs"). Companies are
provided with a full-featured branded e-mail address (e.g., _
HYPERLINK mailto:ownername@companyname.com) and a suite of
branded e-mailboxes for employees (e.g.,
employeename@companyname.com). Each e-mailbox is Web-based,
making it accessible from any location in the world that
provides Web access. Professional Messaging is offered on a
tiered-subscription basis, with fees based on the number of
e-mailboxes included in a suite and the types of optional
value-added services selected. Optional value-added premium
services, if not included in a particular subscription bundle,
include spam blocking, read receipt notification, e-mail
collecting and forwarding, signature verification, mail
management (e.g., user management, alias management, etc.),
pager notification, and other such services.
o Enterprise Messaging: Represents a fee-based feature-rich and
reliable Web-based e-mail services and e-mail management
services for businesses, including VARs, that desire an e-mail
system but prefer to avoid the expense, time and resource
consumption, and the inconvenience of installing, operating,
and supporting a proprietary in-house system. Enterprise
Messaging is customized to meet the specific needs of a
business, and is offered on a tiered-subscription basis, with
fees based on the types and levels of services requested.
Optional value-added premium services, if not included in a
particular subscription bundle, include junk mail blocking,
read receipt notification, e-mail collecting and forwarding,
signature verification, customized interface and
administrative reports, pager notification, and other such
services.
o Web Messaging for Portals-- A combination of free and
fee-based web-based e-mail, messaging, and other services that
portal operators can provide to their portal site visitors and
customers. Free services include message storage, mail
19
collection, spam blocking, file attachment, address book,
company directory, spell checking, and folder and message
management. Services available to portal operators on a
tiered- or custom-contract basis include most of the specialty
services offered in the Carrier Messaging for Service
Providers program; assistance with setting up, managing,
maintaining, and upgrading a branded Webmail site; and mail
management features that let a portal operator maintain
account-level control. We believe that when these services are
combined, they provide a Web portal operator with the
opportunity to build a loyal customer base, increase
advertising revenue through its own advertising sources and
through shared revenues from ads provided through its
affiliation with us, and improve the effectiveness of its
customer communications. Our Web Messaging for Portals program
is structured to offer portal operators services similar to
those that USA.NET provides to customers such as American
Express(R)and Netscape(R)Netcenter.
Today, many businesses have implemented in-house e-mail systems that
require hardware, software and technical and administrative resources. Creative
Networks, an e-business consulting and research firm, estimates that for United
States based companies to acquire, deploy and operate an in-house messaging
solution for 5,000 users, a business must spend approximately $640 per user's
mailbox per year. Even at this level of investment, we believe many businesses
still face significant downtime and unreliable service. According to the Gartner
Group, the percentage of large businesses in the United States that expect to
outsource at least some of their e-mail systems is estimated to grow from 10% in
1998 to 25% in 2000. Additionally, Forrester Research estimates that the amount
spent on outsourced e-mail services by United States based entities will
increase from an estimated $8 million in 1997 to over $1 billion in 2002. While
these figures represent trends in the United States and there is no comparable
information for China, we believe that a growing number of businesses, both in
the United States and China, will elect to outsource their messaging services to
ensure a more reliable, cost-effective and less resource-intensive solution than
their own in-house e-mail system. Consequently, we believe that outsourcing of
Web base e-mail and messaging services for businesses will continue to grow in
China.
During Phase Two, we will complete our roll out of the Chinese-language
version of TorchMail.com and begin to offer new products and services as
developed by USA.NET and others and as PRC laws permit. These products will be
developed on an in-house basis and through strategic alliances with a number of
different companies based in China and other parts of Asia and the world.
In addition during Phase Two, we intend to commence offering an
Internet television set top box that will permit anyone with a television set
and a telephone line to send and receive e-mail and browse the Internet. The
Company intends to make its Internet TVTopBox available for purchase through
retail outlets, which will provide sales revenue, and to bundle the set-top
boxes with value-added subscriptions to TorchMail.com services, as well as
subscriptions to Sichuan Guo Xun's Internet access service. We envision that the
typical purchaser of the TVTopBox will never have owned a PC and will have had
little to no experience operating computers, may have less than a college
education and be somewhat intimidated by technology. Given these assumptions, we
20
believe that the TVTopBox is an attractive alternative to the PC for the
following reasons:
o Low price; computer (and consequently Internet) penetration is
limited by the cost of PCs, which are beyond the reach of the
average consumer financially, whereas the TVTopBox will be
significantly less expensive; and
o Ease of use; TVTopBoxes will be simpler to use than PCs as
these devices will be "plug-and play" ready.
The TVTopBox relies on existing technology and can be manufactured in
China at a cost which will allow us to sell the product at a price point which
we believe may be in the range of many Chinese families.
TERMS OF OUR ACQUISITION OF TORCHMAIL
By agreement dated July 2, 1999, we acquired all of the outstanding
shares of the capital stock of TorchMail.com Inc., a corporation organized under
the laws of the Turks and Caicos Islands, British West Indies, from the sole
holder of all such shares. TorchMail.com Inc. had, on July 1, 1999, entered into
an agreement with USA.NET, Inc. to develop the Chinese language version of its
Web based e-mail and messaging services in the Chinese language and appointed
TorchMail.com Inc. as its First Right to Market the Web based e-mail and
advanced messaging services and products described above.
Pursuant to our agreement with the sole shareholder of TorchMail.com
Inc., we paid US$10,000 and we issued 2,500,000 shares of our Common Stock upon
the closing of the agreement. We also have agreed to pay additional
consideration to the seller of the TorchMail.com shares as follows:
o upon the resale of 360,000 seats, we will issue an additional
2,500,000 shares of our Common Stock;
o upon the resale of 500,000 seats, we will issue an additional
1,250,000 shares of our Common Stock;
o upon the resale 700,000 seats, we will issue an additional
1,250,000 shares of our Common Stock;
o upon the resale of 35,000 seats and up to the resale of 99,999
seats, we will pay a fee equal to $.01 per seat per month;
o upon the resale of 100,000 seats and up to the resale of
199,999 seats, we will pay a fee equal to $.03 per seat per
month;
21
o upon the resale of 200,000 seats and up to the resale of
299,999 seats, we will pay a fee equal to $.05 per seat per
month;
o upon the resale of 300,000 seats and up to the resale of
399,999 seats, we will pay a fee equal to $.07 per seat per
month; and
o upon the resale of 400,000 seats and above, we will pay a fee
equal to $.10 per seat per month.
We believe that we will generate sufficient income from each seat
resold by us to support the payments to the seller of TorchMail.com Inc. as
required pursuant to this agreement. See "Management's and Discussion and
Analysis of Financial Condition and Results of Operations."
TOP LEVEL DOMAIN NAME REGISTRATION.
As the Internet and e-commerce grow in China, we anticipate that more
and more businesses and individuals will seek to establish a presence on the Web
by organizing and maintaining Web sites which incorporate their name or other
identifying mark. Each Web site must have a unique title. This title or name is
registered with Internet Corporation for Assigned Names and Numbers ("ICANN")
and the U.S. Department of Commerce, thereby foreclosing that name from use by
others.
We have entered into an agreement with register.com, inc. which
entitles us to offer to our TorchMail customers Internet top level domain name
registration of their Web sites. Top level domain name registration includes
registration of generic top level domain names such as sites which end with
.com, .net and .org and various country top level domains such as .fm, .md and
.dk. (all of which refer to specific countries.
register.com's services include:
o verification of domain name availability;
o confirmation of end-user intent to register the name;
o procedures by which the end-user or Web site registrant must
login to create or re-use domain registration profile;
o billing of the end-user; and
o entering the end-user's domain name in appropriate registrar
data bases.
Torchmail customers click hot link text or graphics on the TorchMail Web
site which, when clicked, automatically accesses the TorchMail/register.com
co-branded Web site titled TorchMail.register.com. At our co-branded Web site,
22
our customers furnish certain required information which permit register.com to
complete the domain name registration. Domain name registration is completed
immediately upon receipt of the application and payment of the fee and
verification of availability of the domain name. Our customers pay register.com
a fees of from $70 for two year for top level domains and up to $250 per domain
name registration for top level country domain names for a period of two years.
In accordance with our agreement with register.com, we receive a
commission for each domain name registered by our customers. Our commission is
based upon the number of domain names registered per month and is calculated as
a percentage of the fees paid to register.com for each domain name registration.
As the number of generic top level domain names registered in each month
increases, the percentage of fees payable to us a commission increases. We will
receive commissions equal to from 10% to 30% of register.com's net fees for top
level generic domain name registration. We will receive a fee equal to 10% of
each country code top level domain name registered by register.com.
Our agreement with register.com extends for a period of three years and
automatically renews for additional one-year terms unless written notice of a
party's intention to cancel the agreement is furnished within ninety days of the
scheduled expiration date.
FINANCIAL CONTENT INTERNET SITE.
The liberalization over the last several years of many of China's
long-held social and economic policies have impacted the way business and
investment is conducted in China. Businesses compete on a global level for
customers and capital and individuals have begun to realize disposable income, a
portion of which they invest locally and worldwide. Business and financial
publications have experienced corresponding growth which mirror society's
transformation. We believe that there are few comprehensive Web sites devoted to
Chinese business, financial and investment information. We will seek to address
the deficiency we perceive in the market for business, financial and investment
information on the Web by developing an Internet content provider dedicated to
these disciplines.
Toward that end, we have entered into an agreement to purchase a 62.5%
interest in CMD Capital Limited, a Hong Kong corporation, which, through its 70%
owned subsidiary, owns all of the outstanding capital stock of CHINA INVESTMENT,
a monthly journal duly registered in the PRC and currently in registration in
Hong Kong. CHINA INVESTMENT, currently printed only in traditional Chinese
characters (which are understood predominantly in Hong Kong and Taiwain and
sparingly in China), provides analysis and reports on important economic,
business and financial issues and activities throughout China. Its current
subscription base comprises approximately 35,000 BUSINESS EXECUTIVES. CHINA
INVESTMENT'S primary assets, insofar as the development of a Web site is
concerned, are the relationships it currently maintains or is developing with
government sanctioned news providers. We believe that the news from these
sources, both in quality and quantity, can serve as the basis for a financial
Web site devoted to Chinese business, financial and economic issues.
23
We intend to develop a web site that tracks a china investment's
journal format as well as adding the timely, up to the minute information that
can be made available only on the Internet. When complete, we expect that the
Web site will provide:
o THE FULL CONTENT OF THE CURRENT ISSUE OF CHINA INVESTMENT;
o weekly reviews and summaries of important information;
o KEY TOPICS FROM THE NEXT ISSUE OF CHINA INVESTMENT;
o SELECTED REPORTS FROM PREVIOUS ISSUES OF CHINA INVESTMENT;
o daily updates of important business information presented on a
region by region basis;
o a search engine for text and keywords in a document;
o a database of economic and demographic data relating to China;
o real-time video news, interviews and chat;
o fee based services, including research reports; and
o opportunities for e-commerce.
We intend to implement the development of the Web site in stages in the
order presented in the foregoing list. We expect to inaugurate the Web site with
several of the above-described features and to add additional features in time,
as funds permit and a may be warranted by usage. We expect that we can have the
Web site operational as to the initial basic features completed within four
months after development is commenced. We expect to commence development of the
site in early May 2000.
We estimate that the fixed costs to develop the Web site will approach
$250,000, which will include hardware (servers and other computer equipment),
software, Web site development, initial translation costs and other
miscellaneous expenses. Additional funds will be required as we add more
sophisticated services such as real-time feeds and fee services. Monthly
maintenance of the site should aggregate approximately $50,000 and cover staff
salaries (approximately 16 persons, including management, trained financial
personnel, technical staff [Web developers and database administrators],
translators, and administrative staff ), telephone line charges and other
miscellaneous expenses. In addition we will engage a person to monitor the
content exhibited on this site to ensure compliance with China's strict Internet
content laws.
We are required to obtain certain government approvals and permits to
initiate our financial information Internet content provider, including an
24
Internet content provider license for which our partner, China Invest, currently
is making application. We have been advised that such license and all other
government and regulatory approvals will be granted imminently.
GROWTH STRATEGY.
Our long-term goal is to become a fully integrated and fully
diversified Internet company that provides the complete range of Internet
services and solutions to our clients. Our immediate focus will be to build
revenues from our existing core activities. We will concentrate on increasing
our subscriber base for Sichuan Guo Xun's Internet access services and for our
e-mail/advanced messaging services, which will generate revenues from
subscription fees for premium services and advertising revenues generated
through our TorchMail Web site, and to introduce the TVTopBox. We believe that
these product offerings, when bundled in attractive multi-service packages, will
drive sales for the next 18 to 24 months, and income generated from these
activities will constitute the vast majority of our revenues during this period.
We will seek to develop with relationships with other ISPs in China to
offer consulting services similar to those we offer to Sichuan Guo Xun. We
believe that success in building Sichuan Guo Xun's business will serve as a
basis for us to advertise our ISP consulting services and can result in
additional business and revenues from this business segment.
We also will focus on the development of our financial information
Internet content provider in an effort to launch that site during September
2000. We believe that our acquisition of a majority interest in CHINA INVESTMENT
journal will afford us the quality and quantity of business, financial and
economic information to develop a first-class Web site. Our desire is to be the
first Web site that Chinese-speaking people worldwide log-on to when seeking
information about the Chinese business and economic climate. We also believe
that the experience we gain from developing this Web site will prepare us in our
efforts to develop a full content Web portal.
At such time as we have established our organizational competencies and
have created and implemented sustainable growth models within each of our core
areas, which may require 1 to 2 years of development, we will proceed with the
expansion of our business into the potentially more lucrative area of developing
a general content driven Web portal which we project to offer:
o content delivery services, such as search engines, directories
and local information all in the Chinese language and directed
specifically to users in China;
o community products such as chat and message boards;
o online advertising and marketing solutions; and
o e-commerce activities.
25
According to BDA China/Strategis Group, China will have over 33 million
Internet users employing over 37 million computers by the end of 2003. IDC
predicts that China's e-commerce market will burgeon to over $11 billion by
2004, up from $43 million in 1999. These figures present a compelling rationale
to proceed with the development of a content driven Web portal.
We believe that Internet companies will need to offer customers a
variety of value-added solutions to take full advantage of the Internet's
capabilities. Eventually, as capital permits, we plan to expand Sichuan Guo
Xun's ISP value-added services by adding appropriate hardware, software and
human resources to provide such services. Such value added services typically
provide higher margins than Internet access and e-mail/advanced messaging
services. We believe that, worldwide, value-added services are among the fastest
growing segments of the Internet marketplace. We will focus our efforts on
developing corporate clients. We will stress to potential corporate customers
that in order to realize the opportunities of the Internet, companies must
develop an attractive Internet presence using a "Web site" that is easily
accessible to potential customers. Since few businesses in China have neither
experience creating and developing nor the corporate resources (cash and
Internet expertise) to cost-effectively develop, maintain an Internet presence
and continually upgrade network facilities, we will develop consulting and
technical capabilities that will allow us to offer a full range of services to
businesses including the following:
o Web site design and maintenance consulting services;
o co-location services, whereby we provide secure space to house
customer-owned Internet equipment;
o Web hosting services including shared and dedicated hosting on
our servers for customer Web sites as well as collocation
hosting of customer supplied servers in our facilities; and
o consulting services with respect to connecting corporate
networks to the Internet, use of the Internet as a revenue
generating tool and other services, which our clients may find
useful.
We will stress the benefits of outsourcing these services emphasizing
that customers will be able to easily and more cost-effectively address their
Internet needs without developing solutions internally or assembling services
from multiple vendors, including resellers, other Internet service providers and
information technology service providers. These arrangements will allow
enterprises to focus on their core operations, enhance the reliability and
performance of their Web sites and reduce their Internet-related operating
expenses. We propose to offer these services in customized bundles through a
single network connection and to provide our customers with technical support
and management expertise.
We are actively seeking to establish relationships with ISPs in other
Provinces of the PRC and hope to enter into arrangements with such entities as
26
that which exists between Sichuan Guo Xun and us.
We believe that our current services are and our future services, if we
are able to develop them, will be complimentary, as sales of TVTopBoxes will
benefit customer growth in our Internet access business that will benefit our
e-mail business. Ultimately, once we have completed the development of our Web
portal, consumers could use our TVTopBoxes to send and receive e-mail through
Sichuan Guo Xun's Internet access service and transact e-commerce, conduct Web
searches and engage in personal activities, such as information retrieval, chat
groups and online hobby organizations through our Web portal. We also can create
important synergies between our Internet access and e-mail advanced messaging
services by creating a default mechanism that directs Internet access customers
to our Web portal home page. If we can successfully capture these synergies, we
can distinguish our services from our competitors and gain a competitive
advantage that will benefit consumers and advertisers.
In order to realize our potential, we will enter into strategic
alliances or make strategic acquisitions, as necessary, to strengthen our
business, and as liquidity permits. We also plan to actively pursue strategic
investments. This will allow us to capture value in other Internet-related
businesses, both within China (as PRC law permits) and otherwise, including
those that exist today and those that will develop in the future. We are
prepared to adapt our businesses in all of our core competencies and future
endeavors in order to better serve our customers and to gain a competitive
advantage.
The descriptions in this registration statement regarding our planned
product and service offerings and the anticipated features of those planned
product and service offerings are forward-looking statements. Actual products,
services and features could differ materially from those projected as a result
of a variety of factors, some or all of which may be out of our control.
MARKETING AND BRAND AWARENESS.
Our marketing efforts are designed to help implement our strategy to
build a totally integrated Internet services company in China and to provide
Internet related services to Chinese speaking people throughout the world. In
order to accomplish our goals, we will pursue the following strategies:
Build Our Brands. Given the low penetration of the Internet in Sichuan
and China, generally, and the paucity of market participants in the region (we
are one of nine private ISPs licensed by, and one of only five privately owned
ISPs operating in, the Province of Sichuan), we believe that we have an
opportunity to develop a brand name within Sichuan for the entire range of our
products and to develop a loyal consumer base among Chinese speaking
e-mail/advanced messaging users throughout the world. Our relationship with
USA.NET, which allows us to offer the same products and services it provides to
its customers and to avail ourselves of USA.NET's high quality customer
services, ensures that we offer a high quality, reliable and state-of-the art
product which we hope will promote loyalty among our customer base. In the
province of Sichuan, as e-mail/advanced messaging subscribers become aware of
our other services and products, such as the Internet accesses services provided
27
by Sichuan Guo Xun and our TVTopBox, we will offer them attractive incentives,
such as bundling the products at reduced prices, to become consumers of these
products. Once we have developed brand loyalty among one of our products, we
believe that we can attract consumers to other products.
We believe that building our ISP brands is essential to attract, retain
and obtain revenue from our potential user base. We will use advertising to
build our ISP brands. Our campaigns will include online advertising, public
billboards, public transportation, radio and newspapers. We will arrange
seminars on university campuses directed at students, who represent the highest
concentration of Internet users in China. We will offer lectures and seminars to
business leaders and trade groups, such as librarians and other professional
organizations, which have a national presence and whose recommendations will be
a valuable source of word of mouth advertising. We hope to leverage our existing
Internet access and e-mail/advanced messaging subscriber base by offering
incentives to register new subscribers to these services. Our advertising will
focus on the benefits customers can derive from using the Internet, such as
easily locating useful information, and the ease with which the Internet can be
used and will demonstrate that our services are within the budget of the average
person.
We will undertake an aggressive advertising campaign of our existing
products. We will start by focusing on our free e-mail services. We will stress
the benefits of communicating via e-mail/advanced messaging to individuals and
corporate users and emphasize our dedicated customer support, which will be
available 24 hours per day, seven days per week. We initially will focus our
advertising in the City of Chengdu where approximately 10 million persons reside
(representing 10% of Sichuan's population), including the wealthiest and most
educated segment of the population. We believe that business customers will be
particularly interested in our Web based e-mail/advanced messaging services. In
advertising our Web based e-mail and advanced messaging services to business
customers, we will focus on the fact that our services:
o eliminate the need to incur significant hardware, software and
ongoing operational support costs;
o can be rapidly deployed, upgraded and expanded to
meet growth in business and message volume;
o are reliable and offer a high degree of security;
o can be customized to meet branding requirements and
ensure a "look and feel" that is consistent with
their corporate image;
o are compatible with software platforms such as
Netscape Messenger and Microsoft Outlook;
o offer specialized applications and value added
features that allow strategic business-to-business
and/or business-to-consumer communications; and
28
o provide sophisticated and accessible customer service
and technical support.
o expand Our ISP Customer Base. We will take action to
expand our ISP customer base. Some of these steps are
designed to lower barriers to Internet use:
o by making the Internet easier to access, and
o by lowering our customers' start-up costs.
We offer our software in easy-to-use Internet connection kits. We believe
that our software will be useful in encouraging inexperienced and first-time
users to sign on to the Internet and to use our ISP products. We will offer
these types of kits to our Internet subscribers at no additional cost. We
believe that this will encourage potential customers to use our Internet access
service rather than those of our competitors.
We will work hard to retain existing customers and stimulate usage. We will
continue to work hard to build customer loyalty and encourage increased Internet
usage. In order to retain our existing customers we will take action to ensure
that our product offerings are the most competitive in the marketplace. We will
strive to offer our ISP customers the highest quality and fastest service to
enhance their Internet experience. Market research among Internet users in China
indicates that fast and reliable Internet access is essential to retaining
users. We therefore will work to provide our customers with a low call failure
rate, fast login time and high connection speed. We also will offer, for a fee,
specialty training seminars to individuals and businesses covering and
introduction to the Internet, Web site and Web page design, networking, data
base development, systems administration, making money through the Internet and
connectivity of internal networks to the Internet. These seminars will serve to
introduce customers to the services we offer, establish us as a reputable
provider of these services and develop brand awareness.
GOVERNMENT REGULATION.
REGULATION OF FOREIGN PARTICIPATION IN THE OPERATION AND MANAGEMENT OF
TELECOMMUNICATIONS SERVICES
In 1995, the PRC introduced the Interim Regulations Directing Foreign
Investment, which classified foreign investment in all economic sectors in the
PRC into four categories; encouraged; permitted; restricted and prohibited. To
these regulations were appended the Industrial Catalogue (as revised on January
1, 1998), which clearly provides that the operation and management of
telecommunication services falls within the prohibited category. In addition,
Article 6 of the Interim Telecom Procedures also expressly prohibits foreign
nationals and entities (and wholly owned subsidiaries of such foreign nationals
or entities) from investing in, operating/managing or participating in
telecommunications businesses. Thus, foreign investors are legally barred from
participating in the operation and management of telecommunications services in
the PRC. ISPs are deemed to fall within this category and such regulations are
29
supported by other laws specifically relating to the Internet in the PRC.
The above described law has prompted us to enter into the consulting
agreement with Sichuan Guo Xun which provides that we will furnish, to the
extent such activities are not proscribed by PRC law, management, consulting and
technical assistance services, including value added services with respect to
planning, designing and implementing computer networking and data processing
operations; services related to the development and implementation of computer
and electronic communications; and administrative services. The penalties, which
we might incur if we are, for any reason, deemed to be in violation of any of
the PRC laws regarding foreign participation in an ISP, are unclear. Such
penalties may include the revocation of Sichuan Guo Xun Xun's license or our
suspension or termination from operating within the ISP industry in the PRC, as
well as potential fines. Any ruling, which limits or prohibits our ISP
operations in the PRC would negatively impact our business and our potential
results of operations.
We have obtained an opinion of the Beijing Sage Law Firm of Beijing,
PRC, which advises that our ISP operations are in compliance with all relevant
laws in China.
INTERNET CONTENT REGULATION
Under the Administrative Measures on Security Protection for
International Connections to Computer Information Networks, any use of the PRC
Internet infrastructure which results in a breach of the public security or the
provision of socially destabilizing content is a violation of Chinese law. A
breach of public security includes: (i) a breach of national security or
disclosure of State secrets; (ii) infringement on State, social or collective
interests or the legal rights and interests of citizens; or (iii) illegal or
criminal activities. "Socially destabilizing content" is broadly construed to
include any violation of PRC laws or the PRC Constitution; which incites
subversion of State power; incites national division; fabricates or distorts the
truth, spreads rumors or disrupts social order; spreads feudal superstition,
involves obscenities, pornography, gambling, violence; or damages the reputation
of any State organ; among other destabilizing content. Web sites, which do not
comply with such regulation, can be and are blocked from the PRC Internet
infrastructure by the PRC Public Security at the source at which the
international Internet enters the PRC. Web sites, which violate this law,
intentionally or otherwise, are subject to criminal penalties, loss of licenses,
and blocking of the site by the PRC, among other punishments.
If we are able to develop a Web portal that provides content services
within the PRC, we will have to ensure that the content respects the laws of the
PRC. We likely would have to engage an organization to provide regulatory advice
to us to ensure compliance by our portal network with PRC regulatory
requirements.
CURRENCY REPATRIATION
We expect to realize a significant portion of our revenues from the
30
operations of Sichuan CathayOnline Technologies Co., Ltd., a foreign investment
enterprise ("FIE") organized pursuant to the laws of the PRC. These revenues
will be generated in the form of Renminbi. A portion of the revenues that we
generate from our relationship with Sichuan Guo Xun will be used to pay our PRC
employees, for marketing and other working capital in connection with our PRC
operations. Though we intend to repatriate as much of the revenue generated from
these operations to the US parent company, we will be restricted from converting
all revenues earned from these operations into foreign currency for repatriation
to our United States operations.
Prior to 1996, FIEs were severely restricted in their ability to
convert Renminbi into foreign currency for use outside of China, including for
payments to foreign third parties for payments for services rendered or good
sold or repatriation to foreign parent corporations. On July 1, 1996,
regulations were enacted which allow all FIEs throughout China to purchase and
sell foreign exchange at designated banks. In accordance with these regulations,
all domestic entities, including FIEs, can buy foreign exchanges at designated
foreign exchange banks for the purposes of current account payments by
submitting documents which prove that the commercial transactions are real.
Under the regulations, in order to buy foreign currencies for current account
payments, FIEs are required to present commercial documents to the designated
foreign exchange bank. Under the regulations, with certain exceptions, all
current account foreign exchange earnings of a domestic entity (including an
FIE) must be sold to designated foreign exchange banks. Current account earnings
include foreign exchange earnings deriving from export, transportation assets
(including intangible assets, transfer, leasing and services. A significant
exception to these rules is that FIEs are permitted to retain certain amount of
foreign exchange within a designated ceiling set by the PRC government. FIEs can
open foreign exchange primary accounts for current account purposes and special
purpose foreign exchange accounts for capital items.
While we will not able to repatriate all revenues earned in Renminbi,
we will be able to repatriate the profit earned from our China operations, which
is a current account item, and to repatriate those funds we have invested and
will invest in our PRC subsidiary upon termination of our operations in China.
To make profit distribution to its foreign parent company, the FIE will have to
submit to the designated foreign exchange bank, among other things, its board
resolution regarding such profit distribution. While the 1996 laws offer some
flexibility to foreign investment enterprises such as our PRC subsidiary, the
laws continue to regulate the purposes for which and the amount of funds which
can be repatriated to the United States parent corporation.
EFFECT OF RECENT ACCORD BETWEEN THE UNITED STATES AND CHINA
On November 15, 1999, the United States and the PRC reached a trade
agreement whereby China agreed to reduce tariffs on various industrial and
agricultural products and lift many of the barriers that prevent US companies
from doing business in China. Under the agreement, China agreed, among other
things, to permit:
o foreign entities to invest in Chinese Internet businesses;
31
o foreign entities to own up to 49% of Chinese telephone service
providers, which would increase to 50% in two years;
o foreign entities to establish their own product distribution
systems and sell directly to Chinese customers;
o foreign banks and insurance companies to offer services to
Chinese customers in two years;
o foreign entities to own up to 33% of other financial service
provider, which percent would increase to 49% at some time in
the future.
The United States agreed that in return for these concessions, that it
would support China's entry into the World Trade Organization, the group that
sets the rule for international commerce. Entry into the WTO would give China
access to international economic protections, such as protection from unfair
trade practices abroad, but also would impose a body of rules on China's
internal economy and put China under the jurisdiction of international courts
that enforce the World Organization's rules. The agreement is subject to
approval by the United States Congress.
The PRC also must negotiate trade agreements with each of the European
Union and Japan in order to gain the support of these groups to China's entry
into the WTO.
It is impossible to predict what effect China's entry into the WTO will
have on our business. Clearly, by becoming a member of the WTO, China will have
to open its boarders to international competition, which generally will have a
beneficial effect on most international entities doing business in China. If the
US Congress does not approve the November 15, 1999 agreement, there could be
serious repercussions on US-Chinese relations and a possible backlash against US
owned businesses operating in China, including the adoption of new laws that
severely restrict how US businesses operate in China and their ownership of
Chinese businesses.
It is impossible to predict how entry into the World Trade Organization
would affect China's economy or the manner in which it conducts business
domestically and internationally.
COMPETITION.
We face intense competition in both of our primary businesses, ISP
services in Sichuan and Web based e-mail and advanced messaging services and
products provided to Chinese nationals and Chinese speaking people worldwide.
ISP SERVICES
In the PRC, there are the five national ISPs owned and operated by the
national government (or ministries of the national government). There are in
32
excess of 150 private ISPs licensed to operate in various provinces. In the
Province of Sichuan, there are nine licensed ISPs, five of which currently are
operating, including ISP's owned and operated by the PRC or its ministries and
agencies.
The Internet in China is in its infancy. Local and national licensing
requirements limit the number of ISPs which currently operate and which will be
permitted to operate in China. Further, according to commentary in the September
18, 1999 China Commercial News (as described in an October 1998 United States
Embassy Report emanating from Beijing), high net access fees collected by the
government telecommunications monopolies limit the development of the Internet.
Line rates represent the largest single expenditure incurred by private ISPs in
China, costing approximately $18,116 per line per month. According to a US
Embassy Report in Beijing, private ISPs in the PRC pay 80% of their income in
Internet access fees (line charges). The recent break-up of China Telecom and
the establishment of other nationally owned telephone companies such as China
Unicom, have ushered in a somewhat competitive environment.
We believe that our primary ISP competitor in Sichuan is ChinaNet,
which is owned and operated by the PRC government. As an arm of the PRC
government, ChinaNet is well funded and politically protected. Most importantly,
ChinaNet obtains telephone lines from government owned telephone companies such
as China Telecom and Unicom, at rates that we believe are substantially less
than rates paid by private ISPs. In addition, ChinaNet offers its Internet
access services nationwide. Consequently, ChinaNet can offer its Internet access
services at rates substantially less than private ISPs. For example, ChinaNet
account holders dial the same number throughout China and have several choices
of payment plans. ChinaNet's cheapest plan offers three hours of monthly access
for just 20RMB (US$2.50). Users can also get 75 hours a month for 300 RMB
(US$36). In addition, users must pay local phone charges of roughly 4 RMB
(US$0.50) per hour.
We believe that the privately owned ISPs operating in Sichuan and
elsewhere in China currently are small operations with negligible subscriber
bases. As the Internet industry matures in the PRC and as telephone line rates
for Internet access decrease, more entities will be granted national and local
licenses to offer ISP services and more individuals will register with private
ISPs because private ISPs will offer faster connections to the Internet, have
lower user to telephone line ratios and can provide services in addition to
Internet access. Many existing and potential future ISPs in Sichuan and the PRC
generally, will possess significantly greater capital and human resources then
we do and have the potential to be factors in the PRC ISP industry.
We believe that our competitive advantage arises because of our
position as one of the first ISPs in Sichuan. We believe that if we can provide
reliable Internet access at reasonable rates, we can build name recognition and
establish our self as the premier private ISP in Sichuan. In addition, when we
offer our ISP services bundled with our Web based e-mail and advanced messaging
products, we believe that we can provide a comprehensive product offering which
is not otherwise available in Sichuan. Further, as we develop and add to our
existing product line with our TVTopBox and our Web portal, we can build brand
33
recognition and a loyal customer base and remain ahead of our competitors at the
forefront of the ISP and Internet market in Sichuan.
On November 15, 1999, the PRC and the United States reached an
agreement that would facilitate the PRC's entry into the World Trade
Organization. As a part of the accord, the PRC agreed to lift barriers that have
prohibited American companies from doing business in China. The accord is
subject to approval by the United State Congress. If the US Congress approves
the accord, we are unable to predict the effect opening China's restrictive
economy to foreign businesses will have on our business.
WEB BASED E-MAIL AND MESSAGING SERVICES
PRC law provides generally that all providers of Internet services,
including e-mail and related services, must be licensed at the national level.
Presently, we believe that there are only a few entities that have been granted
the official licenses to provide e-mail and related services in the PRC.
However, e-mail services can be provided to people in China from remote
locations. We are aware of several other entities offering e-mail services to
Chinese speaking people throughout the world and that these e-mail services are
directed to individuals and not business or corporate users. We believe that
none of the other entities offering e-mail services in China offer the range of
Web based e-mail and messaging services that we offer. Most of these entities
are substantially larger, have significantly greater subscriber bases and
possess greater financial and human resource than we do.
We believe that our association with USA.NET, which allows us to offer
the same extensive suite of Web based e-mail/messaging services and products as
it offers to its US customers, affords us a competitive advantage over other
entities providing similar services to Chinese speaking persons and business in
the PRC and around the world. USA.NET is committed to developing and
implementing innovative products and services that will keep it at the forefront
of the Web based e-mail/messaging industry. As the Internet matures in China and
users become more familiar with and begin employing the complete range of
services we offer, they will further appreciate our product offerings and we
have the opportunity to become the e-mail/messaging service provider of choice
in the PRC and throughout the Chinese-speaking world.
CORPORATE HISTORY.
CathayOnline was incorporated in the State of Nevada on September 20,
1995 under the name Kyocera Management, Ltd. The corporation was inactive from
its inception through the December 1998. In December 1998, we sold 5,785,500
shares of our common stock to a group of individuals, including members of
current Board of Directors, in consideration of $57,850 in cash and services
rendered. The then Board of Directors resigned and appointed Brian Ransom as a
Director. We then commenced our Internet services business. In April 1998, we
changed our name to CathayOnline Inc.
34
Prior to December 1999, we had been engaged in the sale of PRC national
lottery tickets to the general public through 10 electronic lottery kiosks
located in the City of Guangzhou, Guandong Province, PRC. We did not believe
that this business segment was consistent with our mission to become a
diversified Internet service provider and we transferred the kiosks to a
wholly-owned subsidiary. We entered into an agreement with Moorgate Management
Inc., an unaffiliated third party, to sell the subsidiary for a price of
$150,000, subject to Moorgate's completion of a satisfactory due diligence of
the corporation and the business. We expect Moorgate to complete its due
diligence investigation of the kiosk operations in the coming weeks and to
consummate the sale of the subsidiary at such time.
In February1999, our Board of Directors and shareholders approved an
amendment to our Articles of Incorporation which authorizes us to issue 30
million of shares of "blank check preferred stock." We have not yet amended our
Articles of Incorporation to add the class of preferred stock.
We are contemplating affecting a reverse split of the outstanding
shares of our common stock but will make such determination based upon market
and other conditions during the first quarter of 2000.
CORPORATE STRUCTURE.
CathayOnline Inc. was incorporated in 1995. We conduct business through
our subsidiaries, all of which are wholly-owned, except for CMD Capital Limited
(in which we hold a 62.5% interest), or wholly-owned subsidiaries of our direct
subsidiaries. Our corporate structure is depicted below, with the name of each
entity, the location of its principal office and its jurisdiction of
incorporation set forth below the corporate name in parentheses:
CathayOnline Inc./New York
(Nevada)
Lazzara Financial CathayOnline Ltd./Hong Kong
Asset Recovery, Inc.(Nevada) (British Virgin Islands)
TorchMail.com, Inc./Hong Kong CathayOnline (Hong Kong)
(Turks and Caicos Islands) Technologies Ltd./Hong Kong
(Hong Kong)
Sichuan CathayOnline CMD Capital Limited
Technologies Co. Ltd./ Hong Kong
Chengdu (PRC)
China Investments
Publishing House
(PRC)
35
EMPLOYEES
As of March 31, 2000, we had 45 full-time employees, 6 of whom are
located in North America and 39 of whom are located in the PRC. Our employees
include 17 persons engaged in technical support and development, 11 in marketing
and sales, and 10 in administration and support, and 7 persons engaged in
management.
From time-to-time, we also employ consultants and independent
contractors to support our sales, marketing and administrative efforts. Our
employees are not represented by any collective bargaining agreements and we
have not experienced any work stopages.
FACILITIES.
We maintain our principal executive office at 570 Lexington Avenue,
18th Floor, New York, New York where we sublease approximately 1,000 square feet
of office space at a cost of $3,000 per month through July 2000. We lease
approximately 4,200 square of feet of office space at 543 Granville Street,
Vancouver, British Columbia, Canada. We have leased this space for a term of
five years through April 2005 at a monthly rent of $3,925.73. Our Chinese
operations are run from a 12,100 square foot office located in the City of
Chengdu, Sichuan Province. We have leased this space through August 2004. We
have entered an agreement to lease approximately 331 square meters of office
space at No. 6, Ritian Road, Chao Yang District, Beijing, from which we will
launch our financial information Web site and develop other business in Beijing.
We take possession of this space on May 1, 2000 for a period of two years. We
have the right to extend the lease for five one-year periods on terms to be
agreed upon by the parties prior to each extension.
We believe that our offices in New York and Vancouver are sufficient
for our present and future needs and expect to relocate these offices over the
next several months. Should additional space be required, we believe that
additional space is available in each of these geographic areas at competitive
prices. If our business grows as we anticipate, we expect to require additional
office space in Chengdu. We are confident that sufficient additional office
space is available in Chengdu on commercially reasonable terms.
REMAINDER OF PAGE INTENTIONALLY LEFT BLANK
RISK FACTORS.
36
Set forth below are certain risks and uncertainties relating to our
business. These are not the only risks and uncertainties we face. Additional
risks and uncertainties not presently known to us or that we currently deem
immaterial may also impair our business. If any of the following risks actually
occur, our business, operating results or financial condition could be
materially adversely affected.
RISKS RELATING TO OUR BUSINESS
IT IS DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS BECAUSE WE HAVE A LIMITED
OPERATING HISTORY
We began exploring the possibility of entering into the Internet
business in China in January 1999 and reached an agreement with Sichuan Guo Xun
in September 1999 to render the consulting services described in the agreement
between us. We accepted delivery of the Chinese language version of USA.NET's
Web based e-mail and advanced messaging on December 1, 1999 and have commenced
full-scale marketing of these products and services. We have not yet launched
our financial information Web site and expect to do so in September 2000.
Accordingly, we have only a very limited operating history upon which you can
evaluate our business and prospects. As a young company, we face risks and
uncertainties relating to our ability to successfully implement our business
plan. You should consider the risks, expenses and difficulties encountered by
companies in their early stages of development, particularly companies, such as
ours, which is doing business in the new and rapidly evolving markets in China,
including, but not limited to:
o building a subscriber base for the Internet services offered
by Sichuan Guo Xun;
o successfully marketing our Web based e-mail and advanced
messaging services;
o successfully developing and marketing our financial
information Web site; and
o promptly address the challenges faced by early stage companies
which do not have an experience or performance base upon which
to draw.
If we do not successfully address these risks and uncertainties, our business,
operating results and financial condition will be materially adversely affected.
WE HAVE A HISTORY OF LOSSES, WE EXPECT TO LOSE MONEY IN THE FUTURE AND WE MAY
NOT ACHIEVE OR SUSTAIN PROFITABILITY
We have not generated any/MEANINGFUL??? revenues from our current
business operations and our current monthly operating costs exceed the revenues
we generate in each month. We expect to continue to lose money at least through
the end of fiscal year 2001. We incurred net losses from operations of
approximately $1,015,000 (unaudited) for the six months ended December 31, 1999,
and $322,038 for fiscal 1999. We have an accumulated deficit from operations of
approximately $1,340,000 since commencing our current business. We may never
37
generate revenues sufficient to offset expenses and we may never become
profitable. Even if we do achieve profitability, we may not sustain or increase
profitability on a quarterly or annual basis in the future. We have not
generated sufficient revenues to cover the substantial sums we have spent to
create, launch and enhance our services or to continue operating as we currently
do. Our operating costs have exceeded our revenues for all quarters during which
we have been engaged in the Internet services and Web base e-mail businesses. We
have historically funded our operations by selling stock and not by generating
income from our business. We may have to continue financing our operations from
the sale of equity or debt securities and if we are unsuccessful in obtaining
such financing, we will have to rely on revenues generated from operations to
fund our future growth. We may not be able to generate sufficient revenues from
operations to fund our further growth. Please see our financial statements for
further information regarding our financial history.
WE REQUIRE ADDITIONAL FUNDS TO IMPLEMENT OUR CURRENT PLANS AND FINANCE FUTURE
GROWTH
Our business model assumes that we will have substantial additional
funds to implement the full range of products and services we plan to offer. We
require funds for the following purposes:
o To continue providing hardware and technical assistance to
Sichuan Guo Xun;
o To implement our marketing strategy and attract subscribers to
both our e-mail/advanced messaging services and the Internet
access services offered by Sichuan Guo Xun, including hiring
additional persons;
o To implement a customer service department in China to assist
subscribers both with respect to our e-mail/advanced messaging
services and Internet services;
o To respond to unanticipated developments or competitive
pressures;
o To develop our future products such as the TVTopBox and our
proposed Web portal;
o To develop our financial information Web site;
o To develop our full content Web portal; and
o To take advantage of unanticipated opportunities, such as
major strategic alliances or other special marketing
opportunities and acquisitions of complementary businesses or
assets.
We will seek to obtain additional funds through sales of equity and/or
debt securities, or other external financing in order to fund our current
operations and to achieve our business plan. We cannot assure that any
additional capital resources will be available to us, or, if available, will be
38
on terms that will be acceptable to us. Any additional equity financing will
dilute the equity interests of existing security holders. If adequate funds are
not available or are not available on acceptable terms, our ability to execute
our business plan and our business could be materially and adversely affected.
OUR MANAGEMENT HAS LIMITED EXPERIENCE OPERATING A PUBLIC COMPANY
Only our Chief Financial Officer has served as a director of a public
company. No other members of our current management team have ever operated a
public company. We must develop the skills and knowledge required to operate
effectively as a public company and there can be no assurance that we will be
able to do so. If we are not successful in developing these skills or do not
retain individuals who have significant experience operating a public company,
we may never be able to implement all or any portion of our business plan and
our business could be materially and adversely affected. Please see the
biographies of our management under "DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS
AND CONTROL PERSONS."
WE MAY FACE RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS, INVESTMENTS, STRATEGIC
PARTNERSHIPS OR OTHER VENTURES, INCLUDING WHETHER SUCH TRANSACTIONS CAN BE
LOCATED, COMPLETED AND THE OTHER PARTY INTEGRATED WITH OUR BUSINESS ON FAVORABLE
TERMS
As part of our long-term growth strategy, we may seek to acquire or
make investments in complementary businesses, technologies, services or products
or enter into strategic relationships with parties who can provide access to
those assets, if appropriate opportunities arise. From time to time, we may
enter into discussions and negotiations with companies regarding our acquiring,
investing in, or partnering with their businesses, products, services or
technologies. We may not identify suitable acquisition, investment or strategic
partnership candidates, or if we do identify suitable candidates, we may not
complete those transactions on commercially acceptable terms or at all.
Acquisitions often involve a number of special risks, including, without
limitation, the following:
o we may experience difficulty integrating acquired operations,
products, services and personnel;
o we may be unable to retain acquired subscribers;
o the acquisition may disrupt our ongoing business;
o we may not be able to successfully incorporate acquired
technology and rights into our service offerings and maintain
uniform standards, controls, procedures, and policies;
o we may not be able to retain the key personnel of the acquired
company;
o the businesses we acquire may fail to achieve the revenues and
earnings we anticipated;
o we may ultimately be liable for contingent and other
39
liabilities, not previously disclosed to us, of the companies
that we acquire; and
o we may have to devote limited resources to manage the
absorption of newly acquired assts and companies.
We may not successfully overcome problems encountered in connection
with potential future acquisitions. In addition, an acquisition could materially
adversely affect our operating results by:
o diluting your ownership interest;
o causing us to incur additional debt; and
o forcing us to amortize expenses related to goodwill and other
intangible assets.
Any of these factors could have a material adverse effect on our
business. These difficulties could disrupt our ongoing business, distract our
management and employees and increase our expenses. Furthermore, we may have to
incur indebtedness or issue equity securities to pay for any future
acquisitions.
THE FAILURE OF THE UNITED STATES CONGRESS TO RATIFY THE RECENT AGREEMENT BETWEEN
THE US AND CHINA, WHICH WILL CLEAR THE WAY FOR CHINA'S ENTRY INTO THE WORLD
TRADE ORGANIZATION MAY HAVE A NEGATIVE IMPACT ON OUR BUSINESS
On November 15, 1999, the United States and the PRC reached a trade
agreement whereby China agreed to reduce tariffs on various industrial and
agricultural products and lift many of the barriers that prevent US companies
from doing business in China. Under the agreement, China agreed, among other
things, to permit:
o foreign entities to invest in Chinese Internet businesses;
o foreign entities to own up to 49% of Chinese telephone service
providers, which would increase to 50% in two years;
o foreign entities to establish their own product distribution
systems and sell directly to Chinese customers;
o foreign banks and insurance companies to offer services to
Chinese customers in two years; and
o foreign entities to own up to 33% of other financial service
provider, which percent would increase to 49% at some time in
the future.
The United States agreed that in return for these concessions, that it
40
would support China's entry into the World Trade Organization, the group that
sets the rule for international commerce. Entry into the WTO would give China
access to certain international legal protections, such as protection from
unfair trade practices abroad, but also would impose a body of rules on China's
internal economy and subject China to the jurisdiction of international courts,
which enforce the World Trade Organization's rules. The agreement is subject to
approval by the United States Congress.
If the US Congress does not approve the trade agreement, there could be
serious repercussions on US-Chinese relations and a possible backlash against
US-owned businesses operating in China, including the adoption of new laws that
severely restrict how US businesses operate in China and their ownership of
Chinese businesses. Any failure to approve the agreement could have a material
negative impact on all aspects of our business and our results or operations.
In addition, China must negotiate and enter trade pacts with the
European Union and other WTO member countries in order to gain their support to
entry into the WTO and we cannot be certain that China will be successful in
concluding treaties with either of them.
It is impossible to predict how entry into the World Trade Organization
would affect China's economy or the manner in China conducts business
domestically and internationally.
WE DEPEND ON OUR RELATIONSHIPS WITH USA.NET AND SICHUAN GUO XUN TO GENERATE
REVENUES AND OUR BUSINESS COULD SUFFER IF THESE RELATIONSHIPS ARE TERMINATED
Our agreement with Sichuan Guo Xun extends through March 2003 and our
initial agreement with USA.NET is for a period of one year expiring on July 2,
2000. These agreements may be terminated early in certain circumstances,
including our failure, in the case of Sichuan Guo Xun, to support its
operations, and in the case of USA.NET, to reach certain minimum sales quotas
and provide certain service and support levels. Even we are able to meet our
sales quotas, USA.NET may not renew our agreement at the conclusion of the term
thereof. If either of these relationships is terminated early, we will be unable
to recover the costs and expenses associated with building our operations in
these markets. If Sichuan Guo Xun terminates our relationship prior to or upon
the expiration of our agreement with it, it is unlikely that we could reach an
agreement with an existing private ISP in China and our business would be
materially adversely affected. If USA.NET does not renew this relationship and
if we do not replace it with another full service Web based e-mail/advanced
messaging strategic partner, then our business, operating results and financial
condition would be materially adversely affected.
IF WE FAIL TO EFFECTIVELY MANAGE OUR GROWTH, OUR BUSINESS WILL SUFFER
41
If the Internet and Web based e-mail and messaging becomes as widely
used in China as we expect and as estimates suggest and our business grows
correspondingly, this rapid growth will place a significant strain on our
managerial, operational, financial and information systems resources. To
accommodate any significant increase in our size and manage our growth, we must
implement and improve these systems and attract, train, manage and retain
qualified employees. These demands will require us to add new management
personnel and develop new expertise. If we fail to successfully manage our
growth, our ability to maintain and increase our subscriber base will be
impaired and our business will suffer.
RELIANCE ON USA.NET TO PROVIDE SOFTWARE AND OTHER THIRD PARTIES TO PROVIDE
HARDWARE TO KEEP PACE WITH TECHNOLOGICAL CHANGE AND EVOLVING INDUSTRY STANDARDS
AND REMAIN COMPETITIVE
Both the Internet services market and Web based e-mail and advanced
messaging market are characterized by rapidly changing technology, evolving
industry standards, changes in subscriber needs and frequent new services and
product introductions. We will rely on USA.NET to provide us with new products
and services to enhance our Web based e-mail and advanced messaging services and
no assurance can be given that USA.NET will develop or offer to us these new
services.
In addition, we depend on certain suppliers of hardware and software
components to build Sichuan Guo Xun's ISP business. We acquire a majority of our
networking service components, including terminal servers and high-performance
routers, from only a few companies, including Cisco Systems, Sun Microsystems
and Hewlett Packard, all of which are located in the United States. The
expansion of Internet networks worldwide may place a significant demand on these
suppliers, some of which have limited production capacity. We may experience
delays in delivery of new modems, terminal servers and other equipment. If
delays are severe, all of Sichuan Guo Xun's incoming modem lines may become full
during peak times, resulting in busy signals for subscribers who are trying to
connect to Sichuan Guo Xun. If our suppliers cannot meet increased demand and we
are not able to develop alternative sources of supply, we could experience
delays and increased costs in expanding our network, difficulty in providing our
services and the loss of dissatisfied customers.
Our future success depends, in part, on our ability to:
o use leading technologies to develop our technical expertise;
o enhance our existing services;
o develop or gain the right to offer new services that meet
changing member needs on a timely and cost-effective basis;
and
o develop new products which are attractive to our subscribers
and which may generate additional subscribers.
42
In particular, we must provide subscribers with the appropriate
products, services and guidance to best take advantage of the rapidly evolving
Internet and Web based e-mail and advanced messaging market. Our failure to
respond in a timely and effective manner to new and evolving technologies could
have a negative impact on our business. We may not succeed in adapting our
Internet access business or Web based e-mail and advanced messaging services to
new and faster access devices.
ANY DECLINE IN OUR SUBSCRIBER RETENTION LEVELS WILL ADVERSELY AFFECT US
Our new subscriber acquisition costs, both with respect to the Internet
access services provided by Sichuan Guo Xun and the Web based e-mail and
advanced messaging services that we provide, will be substantial relative to the
monthly fees we charge. Accordingly, our long-term success largely depends on
our retention of existing members. While we have invested and will continue to
invest significant resources in our infrastructure and technical and member
support capabilities, it is relatively easy for Internet users and Web based
e-mail/advanced messaging customers to switch to competing providers.
Consequently, our investments may not help member retention. Any significant
loss of members will substantially decrease our revenue and cause our business
to suffer.
WE MAY BE SUBJECT TO LIABILITY AND OUR REPUTATION MAY SUFFER BECAUSE OF
SPAMMING, LOST OR MISDIRECTED MESSAGES OR OTHER PROBLEMS
We may be subject to risks from claims resulting from unsolicited
e-mail (or spamming), lost or misdirected messages, illegal or fraudulent use of
e-mail or interruptions or delays in service. Even to the extent these claims do
not result in liability, we could incur significant costs in investigating or
defending against these claims, or in implementing measures to reduce our
exposure to such liability. These types of claims may also hurt our reputation
which is crucial to our business. Any imposition of liability coverage could
materially adversely affect our business, financial condition and operating
results.
DISRUPTIONS CAUSED BY SYSTEM FAILURES OF OUR SERVICE PROVIDERS SUCH AS SICHUAN
GUO XUN, USA.NET OR CHINA'S NATIONAL TELECOMMUNICATIONS CARRIERS OR CAUSED BY
NATURAL DISASTERS COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS
We expect to derive the vast majority of our revenues for the
foreseeable future from our relationship with Sichuan Guo Xun, which provides
Internet access services to residents of Sichuan Province, China, and the Web
based e-mail and advanced messaging services provided to our subscribers through
the infrastructure of USA.NET. These services are provided over
telecommunications lines leased from China's national telecommunications
monopolies such as China Telecom and China Unicom, upon which we are dependent
for physical repair and maintenance of the leased lines. We have no or little
43
control over how USA.NET or the Chinese telephone companies conduct their
respective businesses and cannot cause of any of these entities to take steps
necessary to protect our interests, such as creating redundant systems to which
we could turn in the event of an interruption in service. The occurrence of a
natural disaster, power failures, telecommunications failure or other
unanticipated problem that interrupts or otherwise negatively affects the level
of service afforded by either of Sichuan Guo Xun or USA.NET could have a
material adverse effect our business.
SICHUAN GUO XUN'S AND USA.NET'S NETWORKS ARE SUBJECT TO SECURITY RISKS AND
INAPPROPRIATE USE BY INTERNET USERS THAT COULD INTERRUPT OUR SERVICES
The future success of our business will depend on the security of the
networks of third parties over which we have no control. Despite implementation
of security measures, we remain vulnerable to computer viruses, sabotage,
break-ins and similar disruptive problems caused by subscribers or other
Internet users. Any breach of Sichuan Guo Xun's or USA.NET's network security or
other inappropriate use of the network through which we conduct our businesses,
such as the sending of excessive volumes of unsolicited bulk e-mail or "spam,"
could lead to interruptions, delays, or cessation of services to our
subscribers. Sichuan Guo Xun's Internet subscribers and our e-mail and advanced
messaging subscribers, in turn, could terminate their membership or assert
claims against us. Third parties could also potentially jeopardize the security
of confidential information stored in the computer systems of Sichuan Guo Xun or
USA.NET or our subscribers' computer systems by their inappropriate use of the
Internet, which could cause losses to our subscribers or us or deter potential
customers from subscribing to our services. Inappropriate use of the Internet
includes attempting to gain unauthorized access to information or systems,
commonly known as "cracking" or "hacking." Although we intend to continue to
implement security measures with respect to Sichuan Guo Xun, "hackers" have
circumvented measures taken by other ISPs in the past, and these hackers may be
able to circumvent the security measures in the future. To fix problems caused
by computer viruses or other inappropriate uses or security breaches, we may
have to interrupt, delay, or cease service to our subscribers, which could have
a material adverse effect on our business. In addition, we expect that our
subscribers will increasingly use the Internet for commercial transactions in
the future. Any network malfunction or security breach could cause these
transactions to be delayed, not completed at all, or completed with compromised
security. As a result, subscribers or others may assert claims of liability
against us. Further, until more comprehensive security technologies are
developed, the security and privacy concerns of existing and potential
subscribers may inhibit the growth of the Internet and e-mail and advanced
messaging industries in general and our subscriber base and revenue in
particular.
OUR SERVICES AND REPUTATION MAY BE ADVERSELY AFFECTED BY SOFTWARE DEFECTS
Our services depend on complex software developed by third parties,
such as the software developed by USA.NET which drives our Web based e-mail and
advanced messaging products. Software often contains defects, particularly when
44
first introduced or when new versions are released. These defects could cause
service interruptions that damage our reputation, increase our service costs,
cause us to lose revenue, delay market acceptance or divert our development
resources, any of which could materially adversely affect our business,
operating results and financial condition. We may not discover software defects
that affect our services or enhancements until we deploy the software.
FAILURE TO PAY ROYALTIES MAY RESULT IN THE LOSS OF THE AGREEMENT BY WHICH WE
ACQUIRED TORCHMAIL.COM, INC.
We are required to pay ongoing royalties to the seller of
TorchMail.com, Inc. to retain ownership of that corporation and the use of
USA.NET's Web based e-mail and advanced messaging products and services. Any
failure to make such payments, or otherwise meet our obligations to the seller
of TorchMail.com, Inc., could cause us to forfeit that subsidiary, its
subscriber base and the USE.Net e-mail and advance messaging products. We are
required to pay to the seller of TorchMail.com, Inc. royalties based upon the
number of seats (e-mail boxes) we service ranging from between $.01 to $.10 per
seat per month. If we fail to make these payments, or otherwise breach our
agreement with the seller of TorchMail.com, Inc., we will lose our right to
TorchMail.com Inc. and we would lose the entire amount we have invested in this
business through the date of any such forfeiture. The lose of TorchMail.com,
Inc. would have a material adverse affect on our business.
IF WE ARE UNABLE TO RETAIN KEY EXECUTIVES OR HIRE NEW QUALIFIED PERSONNEL, OUR
BUSINESS WILL BE ADVERSELYAFFECTED
Our success greatly depends on our ability to attract and retain key
technical, sales, marketing, information systems, and financial and executive
personnel. We are especially dependent on the continued services of our senior
management team, particularly Brian Ransom, our President, and Owen Li, our
General Manager of Chinese operations. The loss of Mr. Ransom, Mr. Li or other
senior managers could have a materially detrimental effect on us. We have
entered into employment agreements with each of Mr. Ransom and Mr. Li, however,
these agreements are terminable by us and each of these employees. All other
members of our senior management team can terminate their employment at any
time. We do not maintain key person life insurance on any of our personnel. If
we fail to attract, hire or retain the necessary personnel, or if we lose the
services of any member of our senior management team, our business could be
adversely affected.
WE MUST ESTABLISH, MAINTAIN AND STRENGTHEN OUR BRANDS TO REMAIN COMPETITIVE
To be successful, we believe that we must establish and maintain our
brands. We must succeed in our marketing efforts, provide high-quality services
and increase our user base to build our brand awareness. If consumers, Web
portals, businesses or advertisers do not perceive our services to be of high
quality, or if users reject our new services, the value of our brands would be
diluted. If we are unable to establish and maintain our brands, our business,
45
operating results and financial condition would be materially adversely affected
COMPETITION
Both the ISP industry and Web based e-mail/advanced messaging
industries in the geographic areas where we do business are highly competitive.
The ISP industry in China is dominated nationally and in each province
by PRC government owned ISP's. These entities are significantly larger and
possess greater financial and personnel resources than do Sichuan Guo Xun or us.
Furthermore, these ISPs have access to inexpensive telecommunications lines and
can charge significantly lower prices than Sichuan Guo Xun. In order to be
competitive with and overcome the inherent advantages possesses by these
entities, we will have to offer higher quality Internet access services by
decreasing the subscriber to line ratio and providing faster and more reliable
services. In addition, if the PRC relaxes constraints on licensing and other
impediments to entering the provincial ISP market, we can expect many new
entrants into the market, both Western and Asian, most of which will have
substantially greater resources than we have at our disposal. We can offer no
assurance that we will be able to compete successfully against public or private
ISPs now existing or which enter the market in the future.
While we are not aware of any other entities currently offering Web
based e-mail and professional messaging services, we expect that other entities
will enter the market to avail themselves of the enormous potential which exists
in China. Many of the entities which we would expect to enter the market are
substantially larger and have greater financial, technical and personnel
resources than we do. There can be no assurance that we will be able to compete
successfully against any of our competitors in the Web based e-mail and advanced
messaging products industry.
RISKS RELATING TO DOING BUSINESS IN CHINA AND OUR STRATEGIC
RELATIONSHIP WITH SICHUAN GUO XUN
OUR BUSINESS DEPENDS ON CONTINUED GROWTH OF THE INTERNET IN CHINA
Our future success substantially depends on continued growth in the use
of computers, the Internet and Web based e-mail and advanced messaging services
in China. Although we believe that computer and Internet usage and the
popularity of Web based e-mail and advanced messaging services in China will
continue to grow as it has in the past, we cannot be certain that this growth
will continue or that it will continue in its present form. The growth of
computer usage and the Internet in China is constrained by the cost of computers
and other Internet access devices to Chinese people relative to their annual
income and current technology infrastructure and no assurance can be given that
computers or other Internet access devices will be offered at prices within the
budget of the average Chinese consumer or that the technological infrastructure
will be enhanced. If Internet usage declines in China or evolves away from our
46
business, our growth will slow or stop and our financial results will suffer.
RECENTLY ENACTED CHINESE LAWS RELATING TO THE ABILITY OF COMPANIES ENGAGED IN
INTERNET ACTIVITIES IN CHINA TO TRADE PUBLICLY COULD NEGATIVELY IMPACT OUR
BUSINESS
We are in the process of developing a Web site to provide financial
information content and our plan of operation contemplates the possible
development or acquisition of an general services and information Internet
content provider which would serve as a portal to the World Wide Web. New rules
adopted by the PRC which have not yet been formally announced provide that
companies (whether organized in China or overseas) engaged in Internet
activities in China would be required to secure approval from PRC authorities to
list their shares in the overseas markets, including the United States. If we
own all or any portion of such an operation, we may be required to obtain PRC
approval to undertaking an offering of our securities or for seeking a listing
on the NASDAQ Market. We can provide no assurance that we will be successful in
obtaining approval of the PRC to any offering of securities we may wish to
undertake or to the listing of our securities on the NASDAQ Stock Market or
other exchange. If we cannot obtain PRC approval to such stock exchange listing,
we may have to forego opportunities in this potentially lucrative field which
could materially adversely effect our future results of operations.
WE MUST DEVOTE SIGNIFICANT MANAGERIAL, TECHNICAL AND FINANCIAL RESOURCES TO OUR
STRATEGIC RELATIONSHIP WITH SICHUAN GUO XUN AND THIS RELATIONSHIP MAY NOT PROVE
TO BE PROFITABLE
Our relationship with Sichuan Guo Xun exposes us to a number of
significant risks and uncertainties, such as:
o We may fail to generate sufficient revenues from these
operations to offset the expenses and resources we devote to
developing, maintaining and enhancing such services;
o The resources we need to devote to these relationships and our
services may be greater than we anticipate; and
o These relationships may divert our resources and our
management's time and attention from our other services,
including our e-mail/advanced messaging services
These risks and uncertainties could result in material adverse effects upon
our business, operating results and financial condition. Our strategic
relationship with Sichuan Guo Xun requires that we devote significant
managerial, technical and financial resources to this relationship. Our
agreement with Sichuan Guo Xun requires us to support its operations by
contributing hardware and software to our PRC subsidiary, which will require a
substantial capital contribution. We have invested $700,000 in our PRC
subsidiary to purchase additional hardware and other capital equipment used in
the provision of Internet access services and to provide service and support in
order to achieve our expansion and growth objectives and expect to provide
47
substantial additional capital in the future. If we are unable to provide this
additional capital to purchase hardware and software on a timely basis, Sichuan
Guo Xun may terminate our relationship. Please see our discussion in "Business -
ISP Services" for additional information regarding our relationship with Sichuan
Guo Xun.
SICHUAN GUO XUN IS DEPENDENT ON NATIONAL TELECOMMUNICATIONS CARRIERS FOR
CONNECTIONS AND IS SUBJECT TO THEIR LINE CHARGES
Sichuan Guo Xun relies on traditional telecommunications carriers to
transmit its traffic over local and long distance networks, both with respect to
dial-up service for its subscriber base as well as for line charges which
connect it to China's Internet backbone. Specifically, it relies on the PRC
telephone monopolies such as China Telecom and China Unicom. The benefits of
competition and alternative sources of supply are not present in these markets.
These entities can set rates and charges for Sichuan Guo Xun's lines while
competing only against themselves. Although line rates and charges have been
reduced since the break-up of China Telecom into several government owned
telecommunications carriers, there can be no assurance that line rates will
continue to decrease or that rates will not increase in the future. Sichuan Guo
Xun will have to pay the line rates charged by these entities to continue in
business. Although we have been assured that additional lines are available,
these entities may deny or delay the allocation of leased lines to Sichuan Guo
Xun for no reason. Any drastic increase in the rates charged by the
telecommunications monopolies for access lines or any failure to obtain
additional lines will adversely affect our business and potentially slow our
growth. In addition, these networks may experience disruptions and capacity
constraints that are not easily remedied. Sichuan Guo Xun has no means of
replacing these services.
IF SICHUAN GUO XUN DOES NOT SUCCEED IN DEVELOPING SUFFICIENT NETWORK CAPACITY,
IT MAY LOSE CUSTOMERS
The success of Sichuan Guo Xun will depend, in part, on the capacity,
reliability and security of its network. Sichuan Guo Xun's network includes
computers, servers, routers, modems and other related hardware and software.
While Sichuan Guo Xun has not experienced network capacity constraints to date,
such constraints may occur in the future, if Sichuan Guo Xun grows as we
anticipate, in connection with:
o the ability to obtain additional dial-up telephone numbers and
telecommunications lines by which subscribers access Sichuan
Guo Xun; and
o system wide services, such as e-mail and news services, which
can affect all members.
These capacity constraints may result in slowdowns, delays or
inaccessibility when subscribers try to use a particular service. Poor network
performance could cause subscribers to terminate their membership with us. To
reduce the probability of such problems, we will be required to expand and
48
improve Sichuan Guo Xun's network. Such expansion and improvement will be very
costly and time consuming. We have committed to provide $1 million to Sichuan
Guo Xun to expand its network and have provided $700,000 to date. We may not
have sufficient funds or otherwise be able to expand or adapt Sichuan Guo Xun's
network to meet additional demand or changing subscriber requirements on a
timely basis or at a commercially reasonable cost.
INCREASED GOVERNMENT REGULATION MAY INCREASE OUR COST OF DOING BUSINESS OR CAUSE
US TO CHANGE THE WAY WE CONDUCT OUR BUSINESS
Any new legislation or regulation adopted by the PRC regarding the
Internet, or the application or uncertainty relating to the application of
existing laws and regulations to the Internet, could materially adversely affect
our business, operating results and financial condition. Legislation could
impair the growth of the Internet and decrease the acceptance of the Internet as
a communications and commercial medium. This could decrease the demand for our
services, increase our cost of doing business or otherwise have a material
adverse affect on our business, financial condition and operating results.
Further, the growth and development of the Internet messaging market may prompt
calls for more stringent consumer protection laws that may impose additional
burdens on companies conducting business online. These laws may impose
additional burdens on our business. For example, because we rely on the
collection and use of personal data from our users for targeting advertisements,
any laws or regulations that restrict our ability to collect or use such
information may harm us. Hong Kong has enacted laws or adopted regulations that
prevent Internet companies or Web portals from selling any information collected
from users.
WE MAY BE SUBJECT TO CRIMINAL PENALTIES, INCLUDING REVOCATIONS OF OUR LICENSE TO
DO BUSINESS IN CHINA IF WE ARE SUBJECT TO CLAIMS BASED ON THE NATURE AND CONTENT
OF MATERIALS TRANSMITTED THROUGH OUR FINANCIAL SERVICES WEB SITE AND VIA OUR WEB
BASED E-MAIL AND MESSAGING SERVICES
As a provider of Internet content and Web based e-mail and messaging
services, we may be subject to legal claims involving matters such as a breach
of Chinese national security, defamation, negligence, invasion of privacy,
copyright infringement and other claims based on the nature and content of the
materials transmitted over our financial information Web site and by e-mail. We
intend to exhibit only PRC government sanctioned news and information over our
financial services Web site and to engage appropriate personnel to monitor the
content distributed on such site to ensure compliance with PRC content
requirements. We do not and cannot screen all of the content generated by our
e-mail and messaging service users and we could be exposed to liability with
respect to this content. Online content restrictions in China are extremely
broad and cover many areas, including breaches of national security; disclosure
of State secrets; infringement on State; social or collective interests or the
legal rights and interests of citizens; or illegal or criminal and prohibit the
transmission of indecent or obscene information and content. While we are
unaware of any enforcement of these laws by the PRC in connection with the
content of e-mail and online messages, the PRC government could successfully use
49
these laws to terminate operations of Web based e-mail and messaging providers
licensed to operate in China.
BECAUSE SICHUAN GUO XUN LACKS FULL REDUNDACY OF ITS COMPUTER SYSTEMS, A SYSTEMS
FAILURE COULD PREVENT IT FROM OPERATING ITS BUSINESS
Sichuan Guo Xun relies on the Internet and, accordingly, upon the
continuous reliable and secure operation of its Internet servers, hardware,
software and infrastructure, such as leased lines from telecommunications
service providers operated by the government of China. While Sichuan Guo Xun
does have limited back-up capability, it does not have full redundancy of all of
its computer and telecommunications systems. As a result, failure of key primary
or back-up systems to operate properly could lead to a loss of customers and
damage Sichuan Guo Xun's reputation. We are working to increase the extent of
the redundancy of Sichuan Guo Xun's systems to lessen the effects of any system
failure, but we cannot make any assurance that existing back-up and redundancy
systems or these implemented in the future will be sufficient to avoid the
problems which may result from a failure of existing systems.
REGULATION OF THE INTERNET AND INFORMATION INDUSTRY IN THE PRC MAY ADVERSELY
AFFECT OUR BUSINESS
The PRC has enacted regulations governing the provision of ISP
services, Internet access and the distribution of news and other information.
The Chinese government regulates access to the Internet by imposing strict
licensing requirements and requiring ISPs in China to use the government
operated international inbound and outbound Internet backbones (the telephone
lines which connect China's domestic internet network with the international
internet network). Sichuan Guo Xun has been issued all licenses required to
offer Internet access services in the Province of Sichuan. There can be no
assurance that Sichuan Guo Xun's will retain its license.
We have begun the process of developing a financial information Web
site and in the future, we hope to develop a Web portal which will provide news
and other information to users. The Propaganda Department of the Communist Party
has been given the responsibility to censor news published in China to ensure,
supervise and control political correctness. The Ministry of Information
Industry has published implementing regulations that subject online information
providers to potential liability for content included on their portals and the
actions of subscribers and others using their systems, including liability for
violation of Chinese laws prohibiting the distribution of content deemed to be
socially destabilizing. Because many Chinese laws, regulations and legal
requirements with regard to the Internet are relatively new and untested, their
interpretation and enforcement of what is deemed to be socially destabilizing by
Chinese authorities may involve significant uncertainty. In addition, the
Chinese legal system is a civil law system in which decided legal cases have
little precedential value. As a result, in many cases it is difficult to
determine the type of content that may result in liability. We cannot predict
the effect of further developments in the Chinese legal system, particularly
with regard to the Internet, including the promulgation of new laws, changes to
existing laws or the interpretation or enforcement thereof, or the preemption of
50
local regulations by national laws. Periodically, the Ministry of Public
Security has stopped the distribution of information over the Internet which it
believes to be socially destabilizing. The Ministry of Public Security has the
authority to cause any local ISP to block any Web site maintained outside of
China at its sole discretion. Web sites that are blocked in China include many
major NEWS-RELATED WEB SITES SUCH AS WWW.CNN.COM, WWW.LATIMES.COM,
WWW.NYTIMES.COM AND WWW.APPLEDAILY.COM.HK. These laws will affect the Chinese
language Web portal which we propose to develop in the future.
The Chinese government has also expressed its intention to closely
control possible new areas of business presented by the Internet, such as
Internet telephony. We cannot provide assurance that we will be able to obtain
any necessary license required in the future or that future changes in Chinese
government policies affecting the provision of ISP services, information
services, including the provision of online services, will not impose additional
regulatory requirements on us or our strategic partner, intensify competition in
the Chinese information industry or otherwise have a material adverse effect on
our business, financial condition and results of operations.
THERE ARE ECONOMIC RISKS ASSOCIATED WITH DOING BUSINESS IN CHINA
The PRC economy has experienced significant growth in the past decade,
but such growth has been uneven across geographic and economic sectors and has
recently been slowing. There can be no assurance that such growth will not
continue to decrease or that any slow down will not have a negative effect on
our business. The PRC economy is also experiencing deflation which may continue
in the future. The current economic situation may adversely affect our
profitability over time as expenditures for advertisements may decrease due to
the results of slowing domestic demand and deflation. On October 7, 1998, the
Guangdong International Trust and Investment Corporation, an investment holding
company of Guangzhou Province, was declared insolvent and shut down by the PRC
government. Subsequently many other similarly situated PRC provincial investment
holding companies have defaulted on their loans and experienced financial
difficulties. As a result, our clients and suppliers may have limited access to
credit that may adversely affect our business. In addition, the international
financial markets in which the securities of the PRC government, agencies and
private entities are traded also have experienced significant price fluctuations
upon speculation that the PRC government may devalue the Renminbi which could
increase our costs relative to our PRC revenues.
RESTRICTIONS ON CURRENCY EXCHANGE MAY LIMIT OUR ABILITY TO UTILIZE OUR REVENUES
EFFECTIVELY
We expect to derive a significant portion of revenues in the form of
Renminbi. Although Chinese governmental policies were introduced in 1996 to
allow greater convertibility of the Renminbi, significant restrictions still
51
remain. We can provide no assurance that the Chinese regulatory authorities will
not impose greater restrictions on the convertibility of the Renminbi. Any
future restrictions on currency exchanges may limit our ability to utilize
revenue generated in Renminbi to fund our business activities outside the PRC.
A CHANGE IN CURRENCY EXCHANGE RATES COULD INCREASE OUR COSTS RELATIVE TO OUR
REVENUES
We expect to generate a portion of our revenues and to incur expenses
and liabilities in Chinese Renminbi and U.S. dollars. As a result, we are
subject to the effects of exchange rate fluctuations with respect to any of
these currencies. We have not entered into agreements or purchase instruments to
hedge our exchange rate risks although we may do so in the future.
THE UNCERTAINTY OF THE ENFORCEABILITY OF OUR CONTRACTUAL RIGHTS MAY HAVE A
SERIOUS ADVERSE IMPACT ON OUR BUSINESS
The legal system in China is still at a developmental stage. There are
uncertainties in terms of the predictability and transparency of its laws and
regulations. The judicial system is relatively young. As a result, our
contractual rights in China are subject to these uncertainties. We may have
serious disruptions and suffer significant losses in terms of business
opportunities and operations if our contractual rights cannot be fully enforced.
RISKS RELATING TO OUR STOCK
POSSIBLE DELISTING OF OUR STOCK FROM TRADING ON THE ELECTRONIC BULLETIN BOARD
Our common stock is listed on the electronic bulletin board of the
over-the-counter market. In early 1999, NASDAQ adopted regulations that would
prohibit securities that are not registered under the Securities Exchange Act of
1934 from trading on any market or electronic exchange, including the electronic
bulletin board. Any securities not so registered by the date specified by NASDAQ
would be "delisted," that is dropped from the electronic bulletin board from
trading. Under these new rules, our class of common stock must be registered
under the Securities Exchange Act of 1934 by January 19, 2000. This Form 10-SB
is intended to register our class of common stock under the Securities Exchange
Act of 1934. However, by law, registration statements such as this Form 10-SB do
not become effective until 60 days after filing with the Securities and Exchange
Commission. A date 60 days from the filing of this Form 10-SB would extend
beyond the January 19, 2000 deadline. If the Securities and Exchange Commission
does not declare this Form 10-SB effective prior to the delisting date, our
common stock will be delisted from trading on the electronic bulletin board and
holders of our common stock would have no means of liquidating their shares.
Once delisted, we cannot predict when, if ever, our class of common stock would
be re-listed for trading on the electronic bulletin board or any other market or
52
exchange as the approval to re-list the common stock is subject to review by the
NASD.
BECAUSE OUR COMMON STOCK PRICE IS BELOW $5.00, WE ARE SUBJECT TO ADDITIONAL
RULES AND REGULATIONS.
The SEC has adopted regulations which generally define a "penny stock"
to be any equity security that has a market price (as defined) of less than
$5.00 per share, subject to certain exceptions. Our common stock presently is a
"penny stock". Because our stock is a "penny stock", it is subject to rules that
impose additional sales practice requirements on broker/dealers who sell our
securities to persons other than established customers and accredited investors.
There can be no assurance that the common stock will trade for $5.00 or more per
share, or if so, when.
Although we desire to list the common stock on the Nasdaq SmallCap
Market and intend to apply for a listing on the SmallCap market at such time as
we meet the listing criteria, there can be no assurance that we will ever
qualify.
In order to qualify for initial listing on the Nasdaq SmallCap Market a
company must, among other things, have:
>> at least $4,000,000 in net tangible assets;
>> a $5,000,000 "public float;" and
>> a minimum bid price for its securities of $4.00 per share.
>> maintain $2,000,000 in net tangible assets, and
>> a $1,000,000 market value of the public float.
In addition, continued inclusion requires two market makers and a minimum bid of
$1.00 per share. Failure to meet these maintenance criteria may result in the
discontinuance of Nasdaq SmallCap Market listing.
Absent Nasdaq SmallCap Market or other Nasdaq or stock exchange
listing, trading, if any, in common stock will, as it presently is, continue in
53
the "Electronic Bulletin Board" administered by the National Association of
Securities Dealers, Inc. As a result, you may find it difficult to dispose of or
to obtain accurate quotations as to the market value of the common stock.
OUR STOCK PRICE IS HIGHLY VOLATILE
In the past, our common stock has traded at volatile prices. We believe
that the market prices will continue to be subject to significant fluctuations
due to various factors and events that may or may not be related to our
performance. The stock market has from time to time experienced significant
price and volume fluctuations, which have particularly affected the market
prices of the stocks of Internet-sector companies and companies operating in
China which may be unrelated to the operating performance of such companies.
Furthermore, our operating results and prospects from time to time may be below
the expectations of public market analysts and investors.
FACTORS OUTSIDE OF OUR CONTROL MAY AFFECT OUR OPERATING RESULTS AND CAUSE OUR
QUARTERLY RESULTS TO FLUCTUATE
Our financial results may fluctuate significantly because of several
factors, many of which are beyond our control. These factors include:
o our failure to keep pace with changing technology;
o costs associated with gaining and retaining members and
capital expenditures for upgrading our systems and
infrastructure;
o timing and market acceptance of new and upgraded Internet
service introductions, technologies and services by us and our
competitors;
o loss of subscribers, seasonal fluctuations in demand for our
services; o downward pressure on prices due to increased
competition;
o changes in our operating expenses, including
telecommunications costs; and
o the effect of potential acquisitions. Fluctuations caused by
these and other factors could cause our business to suffer.
WE HAVE NO INTENTION OF PAYING DIVIDENDS
We have never paid any cash dividends on our common stock. We currently
intend to retain all future earnings, if any, for use in our business and do not
expect to pay any dividends in the foreseeable future.
54
THE FUTURE SALE OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD CAUSE OUR STOCK
PRICE TO FALL
The market price of our common stock could fall if our stockholders
sell substantial amounts of common stock, including shares issued upon the
exercise of outstanding options, in the public market following this offering.
Such sales might also make it more difficult for us to sell equity securities in
the future at a time and price that we deem appropriate. Please refer to our
discussion in "Shares Eligible for Future Sale."
CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Form 8-K may include "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act. We
intend the forward-looking statements to be covered by the safe harbor
provisions for forward-looking statements in these sections. All statements
regarding our expected financial position and operating results, our business
strategy, our financing plans and the outcome of any contingencies are
forward-looking statements. These statements can sometimes be identified by our
use of forward-looking words such as "may," "believe," "plan," "will,"
"anticipate," "estimate," "expect," "intend" and other phrases of similar
meaning. Known and unknown risks, uncertainties and other factors could cause
the actual results to differ materially from those contemplated by the
statements. The forward-looking information is based on various factors and was
derived using numerous assumptions. Although we believe that our expectations
that are expressed in these forward-looking statements are reasonable, we cannot
promise that our expectations will turn out to be correct. Our actual results
could be materially different from our expectations, including the following:
o the Internet and Web based e-mail may not grow as quickly as
anticipated in China;
o we may lose subscribers or fail to grow our subscriber base;
o the service providers with which we do business may fail to
provide adequate services or develop and provide us with
competitive products;
o we may not successfully integrate operations, personnel or
assets obtained through acquisitions;
o we may fail to compete with existing and new competitors;
o we may not be able to sustain growth;
o we may not adequately respond to technological developments
impacting the Internet;
o we may fail to identify and correct a significant Year 2000
compliance problem and experience a major system failure;
55
o we may not be able to find needed financing; and
o internal laws and regulations governing our operations in
China may change in a way which materially and negatively
effects our business.
This list is intended to identify some of the principal factors that could
cause actual results to differ materially from those described in the
forward-looking statements included elsewhere in this report. These factors are
not intended to represent a complete list of all risks and uncertainties
inherent in our business, and should be read in conjunction with the more
detailed cautionary statements included in this prospectus under the caption
"Risk Factors."
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
Form 8-K. The following discussion contains forward-looking statements. Our
actual results may differ significantly from those projected in the
forward-looking statements. Factors that might cause future results to differ
materially from those projected in the forward-looking statements include, but
are not limited to, those discussed in "Risk Factors" and elsewhere in this
document.
OVERVIEW
CathayOnline, Inc. was incorporated in September, 1995 and in December
1998, the management of the Company changed with the objective of analyzing and
implementing a strategy with respect to the long term opportunities in the
Internet within the People's Republic of China and other Chinese speaking
markets including the Internet Service Providing market and collateral operating
and Web based services such as Web based e-mail, advanced messaging services,
integration of Internet services with other forms and means of communication.
Additionally the Company was exploring opportunities in online lottery kiosks.
From January 1999 through June 1999, our operating activities consisted
primarily of identifying opportunities, negotiating Letters of Understanding
with several of those opportunities, planning and development of the operations,
implementing the corporate structure, recruiting personnel, raising capital and
purchasing operating assets. During the period from June through October, we
finalized a number of agreements including: the acquisition of TorchMail.com; a
first to market reseller Agreement with USA.NET, under which TorchMail.com, a
wholly owned subsidiary, obtained the right to market a Chinese language version
of USA.NET's Web based email and advanced messaging services to the Chinese
speaking markets; the establishment of a wholly-owned subsidiary, Sichuan
CathayOnline Technologies Co. Ltd., which, through a joint project with Sichuan
Guo Xun Xin Xi Chan Ye You Xian Gong Si operates a government licensed Internet
Service Provider in the Sichuan province in China; the establishment of a
56
co-branded Website with register.com under which TorchMail.com will sell primary
level domains, and; the indirect acquisition of interests in ten lottery kiosks
in Guangzhou, China (which have been sold prior to the date hereof). To date, we
having invested over $700,000 in our PRC subsidiary, Sichuan CatahyOnline
Technologies, to provide technological and personnel support, allowing Sichuan
Guo Xun to expand its operations to accommodate up to 25,000 subscribers.
Presently, we generate no significant income and have incurred net
losses since inception. Our prospects must be considered in light of the
significant risks, costs and difficulties often encountered by enterprises in
their early stages of development, in particular companies in the Internet
sector and, more specifically, targeting and operating in the Greater China and
Asian markets.
Our capital and operating expenses will increase significantly in the
near future as the result of commitments and hiring requirements to meet
marketing objectives. With these requirements in mind, we are seeking to raise
up to $10 million to fund our anticipated expenses. There is no guarantee that
we will be able to raise the funds and there are no guarantees that we will not
require to raise further capital for operations and expansion in the near
future.
We expect to expand our employee base, from the existing 45 employees,
by an additional 30 over the next 6 months, including sales, marketing,
operational , technical and customer support resources. In particular, we intend
to expand our sales force to market the services provided by the ISP and the
marketing of the Web based e-mail and advanced messaging services under the name
TorchMail. The primary target of the ISP is medium to large sized corporations
and government institutions in the Sichuan province desiring to establish or
expand their online presence, providing training, service, technical support and
Web site development to our clientele.
We intend to further develop existing strategic partnerships and
identify new opportunities to expand our distribution channels of the Chinese
language Web based e-mail and advanced messaging services to the Chinese
speaking markets, in particular partnerships with ISP's, portals, Web hosting
companies and government institutions in the People's Republic of China, Hong
Kong, Taiwan, Malaysia, Singapore and Indonesia.
Currently, we make our principal offices in New York and have marketing
offices or representation in Chengdu, Guangzhou and Beijing, China and
Vancouver, Canada.
Additionally, we have entered into a letter of intent with CleanWay
Corp. in which, if made into a final agreement, would permit TorchMail to offer
live stock quotes, create its own financial Website on which viewers could
57
obtain live stock quotes and have the first right of refusal to provide Web
based email to any other sites or companies using the live quotes as provided by
StockSecrets. Though we are continuing the discussions with CleanWay as to the
nature of a definitive agreement, in addition to discussing the technical
aspects of implementing the service, no definitive agreement has been signed and
there can be no assurance that we will be able to offer these services.
On July 2 ,1999, we acquired 100% TorchMail.com, Inc. for an initial
payment of 2,500,000 shares of our common stock plus ten thousand dollars for
legal expenses. Further payments possibly may have to be made for the
acquisition of TorchMail upon the resale of 360,000 Seats (mailboxes created
within a Customer Account of use of Services by a User) we will issue an
additional 2,500,000 shares, upon the resale of 500,000 Seats the Company will
issue 1,250,000 shares and upon the resale of 750,000 Seats the Company will
issue 1,250,000 shares. We are confident that we will generate sufficient
revenues from our Web based e-mail and advanced messaging operations to support
all future payments required to be made under various agreements we have entered
relating to these operations.
SICHUAN ISP PROJECT:
On August 10, 1999, we organized, in accordance with the laws of the
PRC, a wholly-owned subsidiary, Sichuan CathayOnline Technologies Co. Ltd.
("Sichuan CathayOnline"), which operates in the City of Chengdu. On September 9,
1999, Sichuan CathayOnline entered into a management and consultancy service
agreement (the "Agreement") with Sichuan Guo Xun Xin Xi Chan Ye You Xian Gong Si
("Sichuan Guo Xun"), an ISP in Sichuan Province licensed by the Sichuan
Administrative Bureau for Posts and Telecommunications for an initial term from
September 8, 1999 to March 23, 2003. Pursuant to the Agreement, Sichuan
CathayOnline and Guo Xun will work jointly in providing Internet services and
Sichuan CathayOnline is entitled to 90% of the profit generated from such
services.
TORCHMAIL.COM, INC.
CathayOnline, through its wholly owned subsidiary TorchMail.com, Inc.
and its partnership with USA.NET, has budgeted to sell in excess of 360,000 Web
based professional advanced messaging services Seats to the Chinese speaking
markets through November 30, 2000. During the ramp-up period of reaching the
target, the costs payable to USA.NET drop significantly to TorchMail,
substantially increasing the profit margin to our operations. We intend to seek
out and train strategically located sales teams to promote the product and
services to the Chinese speaking markets in the People's Republic of China, Hong
Kong, Taiwan, Singapore, Indonesia, Malaysia and the Philippines.
With the rapidly evolving nature of the technology industry, potential
58
for political uncertainty and our limited operating history, we believe that any
period to period comparisons of our revenues and operating results are not
meaningful and should not be relied upon as an indication of future performance.
As of December 1, 1999 the Company had 45 employees, in comparison with no full
time employees at December 31, 1998. CathayOnline does not believe that its
historical growth rates for revenues, expenses, capital investments or personnel
are indicative of future results.
RESULTS OF OPERATIONS
During the period from September 20, 1995 to January 6, 1998, we did
not engage in any operations and were considered dormant. On January 6, 1998, we
obtained a Certificate of renewal from the State of Nevada. As of June 30, 1999
the Company was in the development stage and has only recently commenced planned
principal operations.
Since inception, we have incurred significant losses and, as of June
30, 1999, had an accumulated deficit of approximately $325,000. It is our
intention to invest heavily to expand network infrastructure and expand sales
and marketing. We expect to incur substantial operating losses in the
foreseeable future.
INCOME TAXES
No provision for federal and state incomes taxes has been recorded as
we have incurred net operating losses from inception through June 30, 1999. As
of June 30, 1999, we had approximately $300,000 of federal and state net
operation loss carryforwards available to offset future taxable income which
expire in varying amounts beginning in 2010. Under the Tax Reform Act of 1986,
the amounts of and benefits from net operating loss carryforwards may be
impaired or limited in certain circumstances. Because there is significant doubt
as to whether we will realize any benefit from this deferred tax asset, we have
established a full valuation allowance as of June 30, 1999.
INFLATION AND REGULATION
Our operations have not been, and in the near term are not expected to
be, materially affected by inflation or changing prices. We will encounter
competition from a variety of firms selling Internet services in its market
area. Many of these firms have long-standing customer relationships and are
well-staffed and well financed. The Company believes that competition in the
Internet industry is based on competitive pricing, although the ability,
reputation and support of a marketing network is also significant. The Company
59
does not believe that any recently enacted or presently pending proposed
legislation will have a material adverse effect on its results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Management's Discussion and Analysis and other parts of this
registration statement contain information based on management's beliefs and
forward-looking statements that involve a number of risks, uncertainties, and
assumptions. There can be no assurance that actual results will not differ
materially from the forward-looking statements as a result of various factors,
including but not limited to the following:
The markets for many of our product offerings are characterized by
rapidly changing technology, evolving industry standards, and frequent new
product introductions. Our operating results will depend to a significant extent
on our ability to design, develop, or otherwise obtain and introduce new
products, services, systems, and solutions and to reduce the costs of these
offerings. The success of these and other new offerings is dependent on many
factors, including proper identification of customer needs, cost, timely
completion and introduction, differentiation from offerings of our competitors,
and market acceptance. The ability to successfully introduce new products and
services could have an impact on future results of operations.
FLUCTUATIONS IN QUARTERLY RESULTS
We have incurred operating losses since inception, and cannot be
certain that we will achieve profitability on a quarterly or annual basis in the
future. We believe that future operating results will be subject to quarterly
fluctuations due to a variety of factors, including, but not limited to:
o Continued growth of the Internet in China;
o Continued growth of the Internet and e-mail usage in Asia;
o Our ability to attract and retain customers and maintain
customer satisfaction;
o Technical difficulties or system outages;
o Government regulation surrounding the Internet;
o Fulfilling contractual obligations under the agreement with
USA.NET;
60
o Pricing policies of competitors;
o Ability to attract and retain qualified personnel with Chinese
language and Internet industry expertise, in particular
technical, sales and marketing personnel;
o The amount and timing of operating costs and capital
expenditures relating to expansion of our business and
infrastructure;
o The ability to upgrade, develop and maintain our systems and
infrastructure; and
o Failure to increase sales.
In addition to the factors set forth above, the Company's operating
results will be impacted by the extent to which the Company incurs non-cash
charges associated with stock-based arrangements with the employees and
non-employees.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have funded our operations from the net proceeds
from the sale of common stock. In 1999, CASH PROVIDED BY FINANCING ACTIVITIES
WAS APPROXIMATELY $1,922,850 million.
We have no debt.
Our current cash balances will not be sufficient to meet our working
capital and capital expenditure requirements for the next 12 months. It is
anticipated that with the further expansion of the operations we will incur
negative cash flows, therefore requiring us to seek additional financings to
support the growth in operations, both on a short term and long term basis. We
expect to acquire or invest in businesses, products, services and technologies
that complement or augment its service offerings and customer base. We currently
are engaged in discussions with a number of companies regarding strategic
acquisitions or investments. Although these discussions are ongoing, no
definitive agreements have been signed and there can be no assurance that any of
these discussions will result in actual acquisitions. It is anticipated that
some of the acquisitions will be paid for by issuing additional common stock and
this could dilute our shareholders. In addition, there may be the requirement to
amortize significant amounts of goodwill and other intangible assets in
connection with future acquisitions, which would materially increase the
61
Company's operating expenses. In addition, we may seek to raise funds by
offering debt or equity to the public. There is no guarantee that we will be
able to raise the funds. Thereafter, we may need to raise additional funds in
order to meet funding requirements of a more rapid expansion plan, potential
acquisitions, development of new or enhanced products or services, in response
to competitive pressures or to acquire technologies or complimentary products or
businesses.
If we cannot obtain outside financing, we will consider scaling back
our expansion plans for TorchMail and Sichuan Guo Xun's operations, and
re-evaluate certain potential acquisitions and, instead, rely upon internally
generated cash flow. Resources that would have been allocated to a more
aggressive expansion plan would then be diverted towards a broad based
advertising campaign to build upon the subscriber bases permitting an internally
financed growth.
Net of depreciation, our investment in property and equipment was
nominal up to October 31, 1999. Installation of infrastructure equipment in
Chengdu, purchases of furniture and equipment for new employees, and leasehold
improvements related to office expansions accounted for this increase. It is
expected that our investments in property and equipment will continue to grow as
the Company seeks to increase capacity and services.
SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN SHAREHOLDERS.
The following table sets forth information as of March 30, 2000, regarding the
beneficial ownership of Common Stock of (1) each person or group known by us to
beneficially own 5% or more of the outstanding shares of Common Stock, (2) each
director and officer and (3) all executive officers and directors as a group.
Unless otherwise noted, the persons named below have sole voting and investment
power with respect to the shares shown as beneficially owned by them.
Amount of
Name of Beneficial Percent of Outstanding
Beneficial Owner (1) Ownership Shares of Class Owned (2)
- ------------------ --------- -------------------------
Brian W. Ransom (3) 18,025,000 44.06%
Owen Li (4) 1,952,184 6.60%
Peter Lau (5) 1,759,000 6.43%
Yuning Wang (6) 1,805,006 5.57%
Ken Levy 7,000 *
All officers and directors
AS A GROUP (3 PERSONS) 23,548,190 (7) 42.50%
- ------------------------------------
62
* Less than 1% of the outstanding shares.
1. The address for each of the officers and directors of the Company is c/o our
corporate headquarters in New York.
2. The percentage of shares owned of the outstanding class gives effect to the
issuance of shares of common stock to such person upon the exercise the warrants
held by that person and exercisable within 60 days of the date hereof.
3. Includes 15,050,000 shares issuable upon the exercise of common stock
purchase warrants granted to Mr. Ransom, 50,000 of which were granted to Mr.
Ransom on April 29, 1999 in connection with an investment of $25,000 in units of
which these warrants were a part, and 15,000,0000 warrants issued on October 26,
1999 as partial compensation for the services he will render as our President.
The 50,000 warrants are exercisable for a period of 2 years after issuance at a
price of $.60, if exercised during the first year after issuance, and $.70 per
share, if exercised during the second year after issuance. The 15,000,000
warrants are exercisable for a period of 3 years commencing on the date of grant
at an exercise price of $.33 per share. Ten million of these warrants are held
by a corporation all of the shares of which will be held in a trust of which Mr.
Ransom is the sole beneficiary. The shares of common stock underlying the
15,000,000 warrants are subject to registration under the Securities Act of
1933.
4. Table includes 1,500,000 shares issuable upon the exercise of common stock
purchase warrants granted to Mr. Li on October 26, 1999. The warrants are
exercisable for a period of 3 years commencing on the date of grant at an
exercise price of $.33 per share. The shares of common stock underlying these
warrants are subject to registration under the Securities Act of 1933.
5. Table includes 1,500,000 shares issuable upon the exercise of common stock
purchase warrants granted to Mr. Lau on October 26, 1999. The warrants are
exercisable for a period of 3 years commencing on the date of grant at an
exercise price of $.33 per share. The shares of common stock underlying these
warrants are subject to registration under the Securities Act of 1933.
6. Table includes 1,500,000 shares issuable upon the exercise of common stock
purchase warrants granted to Mr. Wang on October 26, 1999. The warrants are
exercisable for a period of 3 years commencing on the date of grant at an
exercise price of $.33 per share. The shares of common stock underlying these
warrants are subject to registration under the Securities Act of 1933.
7. Figure includes only the first three individuals named in the table and
assumes exercise of all convertible securities held by these individuals.
63
DIRECTORS AND EXECUTIVE OFFICERS, PROMOTORS AND CONTROL PERSONS.
The following table lists, as of March 31, 2000, our directors,
executive officers and key employees, as well as promoters and control persons
of our company:
NAME AGE TITLE
- ---- --- -----
Brian W. Ransom 38 President and a Director
Owen Li 36 Director and Managing Director-Sichuan
CathayOnline Technologies Co. Ltd. (HK)
Peter Lau 46 Chief Financial Officer and Secretary
Ken Levy 54 Director
All directors hold office until the next annual meeting of stockholders
and until their successors have been elected and qualified. The Board of
Directors elects the officers annually.
Brian W. Ransom has served as our President and a Director since
December 1998. From 1991 until he joined us, Mr. Ransom acted as an independent
consultant to and negotiator for North American and European companies. He
consulted on matters relating to corporate structuring, corporate finance,
foreign exchange and interest rate risk control management and negotiation of
strategic relationships between corporations and corporations and governments.
Mr. Ransom has been responsible for the management of a US$1.5 billion loan
portfolio and the management of a currency-trading portfolio. He has held
positions on the boards of two Canadian mutual fund companies, an international
fiduciary, as well as the boards of software and manufacturing firms
Mr. Owen Li has been one of our Directors and has served as the
Managing Director of Sichuan CathayOnline Technologies Co., Ltd., our
wholly-owned Chinese subsidiary that interfaces with Sichuan Guo, since June
1999. In his ca pacity as Managing Director of the Sichuan CathayOnline, Mr. Li
specializes in technology planning and business development in computers and
telecommunications. Prior to joining us, from September 1997 through May 1999,
Mr. Li served as the Manager of ChengduNet, an ISP located in Chengdu, Sichuan
Province, which no longer exists. From July 1991 through September 1997, he was
employed by the Workers' Compensation Board of the Province of British Columbia,
Canada, as a Data Base Administrator. Mr. Li brings to us 12 years of technical
experience in computer communications, including 7 years of management
experience in the telecommunications industry, as well as extensive experience
as a system administrator and technical architect. Mr. Li has consulted for the
University of British Columbia, BC research, the Worker's Compensation Board,
and ProNet. Mr. Li was awarded a bachelors degree in computer science from
Sichuan University in 1985 and a masters degree in computer science from the
University of British Columbia, Canada, in 1991.
64
Peter Lau has been our Chief Financial Officer since joining us in
October 1999. Mr. Lau was elected as a Director and appointed as Secretary on
December 15, 1999. Mr. Lau has more than twenty years professional experience in
corporate finance, accounting and marketing. Prior to becoming associated with
us, since 1996, he served as the Managing Director of Corporate Finance, Manager
of Special Projects, and Managing Director of United States operations for
American Frontier Financial, Inc., a United States registered securities
brokerage firm, and Heng Fung Capital, Inc. and Heng Fung Equities, Inc., Hong
Kong merchant banking companies with offices in Hong Kong and the United States.
While with the Heng Fung group, Mr. Lau established a U.S. merchant banking and
investment banking operation on Wall Street. From 1994 through 1996, Mr. Lau
served as the Managing Director of Corporate Finance for Ridgewood Capital LLC.,
where he provided corporate financial and advisory services, negotiated and
arranged equity and debt financing, and developed new business. Mr. Lau also is
a director of Advanced Environmental Technology Inc. Mr. Lau is a certified
public accountant by training and has been employed by Deloitte & Touche as an
accountant and a senior management consultant. Mr. Lau was awarded a bachelor's
degree in accounting from University of Hartford in 1976 and a masters degree in
accounting from University of Hartford in 1978.
Ken Levy was appointed as a member of our Board of Directors on
February 22, 2000. In January 2000, Mr. Levy joined United Network Marketing
Systems, a technology incubator located in New York, as that company's
President, where is responsible for identifying investment and acquisition
opportunities and negotiating agreements and developing the company's
acquisitions and investments. From March 1997 through December 1999, Mr. Levy
served as the Managing Director of Janssen Meyers Associates LP, an investment
banking firm located in New York. From 1994 through March 1997, he was the
President of Marshall Alexander & Marshall, an investment banking firm located
in New York. Mr. Levy was awarded a bachelor of arts degree in chemistry from
Hofstra University in 1968.
AGREEMENTS WITH MANAGEMENT
On October 30, 1999, we entered into an employment agreement with Brian
Ransom to serve as our President and Chief Executive Officer. This agreement
provides that Mr. Ransom will serve as President for a period of 2 years. We
will pay Mr. Ransom annual compensation of $60,000 for his services; a monthly
bonus based upon the number of Web based professional messaging e-mail accounts
we establish during the term of his employment, as described below; and a cash
bonus to be determined by the Board of Directors upon the conclusion of each
year of the term of his agreement with us. Mr. Ransom's bonus upon the resale by
us of Web based professional messaging e-mail accounts we establish during the
term of his employment shall be calculated as follows:
o 35,000 seats and up to the resale of 99,999 seats, we will pay
a bonus equal to $.01 per seat per month;
o 100,000 seats and up to the resale of 199,999 seats, we will
pay a bonus equal to $.03 per seat per month;
65
o 200,000 seats and up to the resale of 299,999 seats, we will
pay a bonus equal to $.05 per seat per month;
o 300,000 seats and up to the resale of 399,999 seats, we will
pay a bonus equal to $.07 per seat per month; and
o 400,000 seats and above, we will pay a bonus equal to $.10 per
seat per month.
We have agreed (and any other entity which may acquire TorchMail.com, Inc.
in the future must agree) to pay the foregoing bonus for so long as TorchMail
shall derive revenues from its Web based professional messaging e-mail accounts.
In addition, we have issued to Mr. Ransom warrants to purchase up to 15
million shares or our common stock. The warrant is exercisable for a period of 3
years at an exercise price of $.33 per share. Either we or Mr. Ransom may
terminate his employment agreement with or without cause on 60 day's written
notice.
On June 29, 1999, we entered into a Management Agreement with Owen Li,
one of our Directors and the President of Sichuan CathayOnline Technologies Co.,
Ltd. to serve as the General Manager of that entity for a period of 3 years. Mr.
Li is responsible for all aspects of our operations in the Province of Sichuan.
Mr. Li will receive an aggregate of $10,000 per month payable as follows: (i)
Sichuan CathayOnline Technologies Co., Ltd. will pay to Mr. Li $6,500 per month,
in cash, (ii) we have issued 120,000 shares upon the execution of the agreement;
and (iii) we will issue to Mr. Li in each month during the term of the agreement
a number of shares of our common stock as shall be equal to $3,500 divided by
the average bid price per share of common stock for the last five trading days
of each month and deduct a 10% discount from such price. In addition, we have
agreed to issue into a trust for Mr. Li's benefit, the following shares, an
indeterminate portion of which he has agreed to transfer to employees of Sichuan
CathayOnline Technologies Co., Ltd., as incentives for their performance:
o we must issue to Mr. Li an indeterminate number of shares to
which he became entitled upon the execution of the agreement
which shall be calculated by dividing $60,000 by the lesser of
$.50 or the average closing bid price per share of our common
stock over the 3 day period prior to the execution of our
agreement with Mr. Li;
o we have issued 27,278 shares of common stock;
o at such time as Mr. Li has registered 7,500 subscribers to
Sichuan Guo Xun, we have agreed to issue a number of shares of
our common stock as shall be calculated by dividing $75,000 by
the lesser of $.50 or the average closing bid price per share
of our common stock over the 3 day period prior to the
execution of our agreement with Mr. Li; and
o at such time as Mr. Li has registered 16,000 subscribers to
66
Sichuan Guo Xun, we have agreed to issue a number of shares of
our common stock as shall be calculated by dividing $90,000 by
the lesser of $.50 or the average closing bid price per share
of our common stock over the 3 day period prior to the
execution of our agreement with Mr. Li.
In addition, we have issued to Mr. Li warrants to purchase up to 1.5
million shares or our common stock. The warrant is exercisable for a period of 3
years at an exercise price of $.25 per share. Mr. Li has agreed that, unless he
first receives our written permission, he will not engage in any activities that
compete with our business within any geographic area where Sichuan CathayOnline
Technologies Co., Ltd. is licensed to do business in the telecommunications
field in the PRC. Each party is entitled to terminate the agreement on 5 day's
notice, in our case, if Mr. Li fails top perform his obligations under the
agreement and in Mr. Li's case, if we have not funded Sichuan CathayOnline
Technologies Co., Ltd. with $1 million within 6 months of June 29, 1999.
On October 1, 1999, we entered into a Consulting Agreement with Peter
Lau, our Chief Financial Officer to serve in such capacity for a period of one
year. We will pay Mr. Lau a consulting fee of $48,000 per year and to issue to
Mr. Lau 3,000 shares of our common stock in each month during the term of the
agreement. In addition, we have agreed to pay Mr. Lau (i) a fee equal to 3% of
the gross proceeds which we may derive from any financing or loan obtained
through Mr. Lau; (ii) a fee, in cash or stock as we and Mr. Lau may agree, equal
to 5% of the gross value of any merger acquisition or disposition to a part
introduced to us by him; (iii) an additional undetermined fee for serving on the
Board of Directors; and (iv) a to be determined bonus. In addition, we have
issued to Mr. Lau warrants to purchase up to 1.5 million shares or our common
stock. The warrant is exercisable for a period of 3 years at an exercise price
of $.25 per share.
EXECUTIVE COMPENSATION.
The following table sets forth the information regarding compensation paid (on
an annualized basis) for the Named Executive Officers for the periods indicated.
SUMMARY COMPENSATION TABLE
- --------------------------------------------------------------------------------
Restricted
NAME AND PRINCIPAL POSITION YEAR SALARY STOCK AWARDS
- --------------------------- ---- ------ ------------
Brian Ransom, President 1999 $25,000 $37,500 (1)
- ------------------------------------------------------------------------------
None of our other executive officers received compensation in excess of $100,000
for the fiscal year ended June 30, 1999.
1. Includes 150,000 shares of common stock issued to Mr. Ransom in consideration
of services rendered. We valued these shares at $.25 each for an aggregate value
of $37,500.
67
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
On January 19, 2000, the Company borrowed an aggregate of $795,000 from
Lothian Bancorp Ltd., a company owned entirely by the sister-in-law of the
Company's President, Brian Ransom. The loan is evidenced by a promissory note
dated the date of the loan and bears interest at the rate of 9% per annum. The
Company will repay $500,000 of this loan from the proceeds of the Initial
Closing of this Offering and will repay the balance of the loan upon the final
closing of the Offering, if the maximum offering is achieved, or, if the maximum
offering is not achieved, then within twelve months of the Final Closing. The
Company has agreed to repay the balance of the loan within twelve months from
the date of the promissory note.
DESCRIPTION OF SECURITIES.
GENERAL
Our authorized capital consists of 50,000,000 shares of common stock,
par value $.001 per share. At March 31, 2000 there were outstanding 25,858,913
shares of common stock. In February 1999, our Board of Directors and
shareholders approved an amendment to our Articles of Incorporation which
authorized 30,000,0000 shares of par value $.001 blank check preferred stock. We
have not amended our Articles of Incorporation to authorize the issuance of
these shares but expect to do so in the near future. Set forth below is a
summary description of certain provisions relating to our capital stock
contained in our Articles of Incorporation and By-Laws and under the Foreign and
Domestic Corporation Laws of the State of Nevada. The summary is qualified in
its entirety by reference to our Articles of Incorporation and By-Laws and the
Nevada corporation laws.
We are contemplating affecting a reverse split of the outstanding
shares of our common stock but will make such determination based upon market
and other conditions during the second quarter of 2000.
BLANK CHECK PREFERRED STOCK
The amendment to our Articles of Certificate of Incorporation
authorizes our Board of Directors to issue, without any action on the part of
our shareholders, an aggregate of 30,000,000 shares of "blank check" preferred
stock. The Board shall have authority to divide the blank check preferred stock
into one or more series and has broad authority to fix and determine the
relative rights and preferences, including the voting rights of the shares of
each series. The blank check preferred stock could be used as a method of
discouraging, delaying, or preventing a change in control of the Company or be
used to resist takeover offers opposed by management. Under certain
circumstances, the Board could create impediments to or frustrate persons
seeking to effect a takeover or otherwise gain control of the Company by causing
shares of blank check referred stock with voting or conversion rights to be
68
issued to a holder or holders who might side with the Board in opposing a
takeover bid that the Board determines not to be in our best interest. In
addition, our ability to issue such shares of blank check preferred stock with
voting or conversion rights could dilute the stock ownership of such person or
entity. No shares of blank check preferred stock are currently issued and
outstanding and we have no plans to issue any shares of blank check preferred
stock.
COMMON STOCK
We are authorized to issue 50,000,000 shares of common stock. Each
outstanding share of common stock has one vote on all matters requiring a vote
of the stockholders. There is no right to cumulative voting; thus, the holders
of fifty percent or more of the shares outstanding can, if they choose to do so,
elect all of the directors. In the event of a voluntary or involuntary
liquidation, all stockholders are entitled to a prorata distribution after
payment of liabilities and after provision has been made for each class of
stock, if any, having preference over the common stock. The holders of the
common stock have no preemptive rights with respect to our offerings of shares
of our common stock. Holders of common stock are entitled to dividends if, as
and when declared by the Board out of the funds legally available therefor. It
is our present intention to retain earnings, if any, for use in our business.
Dividends are, therefore, unlikely in the foreseeable future.
WARRANTS
Employee and Consultants Warrants: During October 1999, we issued to
our employees and consultants (or their designees) in consideration for services
rendered warrants to purchase up to 21,700,000 shares of our common stock. The
warrants are exercisable for a period of 3 years commencing on October 26, 1999
at an exercise price of $.33 per share. The shares of common stock issuable upon
exercise of these warrants are subject to registration as described below. These
warrants provide for cashless exercise by the holders. These warrants are not
redeemable. As of the date hereof, none of these warrants have been exercised.
Investor Warrants: During April and June 1999, we issued an aggregate
of 2,990,000 common stock purchase warrants to eight investors, including 50,000
warrants to our President. These warrants are exercisable for a period of 2
years from the date of issuance at an exercise price of $.60, if exercised
during the first year after issuance, and $.70 if exercised in the second year
after issuance. Theses warrants are not redeemable. As of the date hereof,
200,000 warrants have been exercised.
Regulation S Warrants: During the first quarter of 2000 we sold and
issued 6,892,857 redeemable Common Stock purchase warrants to purchase a like
number of shares of Common Stock. Each such warrant entitles the holder to
purchase one share of Common Stock, subject to adjustment in the event of any
stock dividend, stock split, subdivision or combination, or any reclassification
of the outstanding shares of Common Stock at any time after issuance until the
expiration of these warrants, a date two years after the date upon which the
69
underlying shares of Common Stock are registered for resale under the Securities
Act of 1933, at a price of $.847 per share. We may redeem these warrants at a
price of US$.10 per warrant commencing one year after the effective date of the
registration statement under the Securities Act of 1933 covering the underlying
Common Stock provided that (i) a registration statement covering the underlying
common stock is then effective and (ii) the average closing bid price per share
of Common Stock for the thirty (30) day period ending five (5) days prior to the
date of the redemption notice of the Warrants is at least $1.05 per share.
REGISTRATION RIGHTS
We have granted registration rights covering the 21,700,000 shares of
common stock issuable to our employees and consultants upon the exercise of
warrants issued to them as consideration for services rendered to us during the
last year. These persons shall have the right to include all of the shares
issuable upon exercise of these warrants in any registration statement we may
file under the Securities Act of 1933 (with certain exceptions). The holders of
the shares of common stock issuable upon exercise of the warrants have agreed to
reduce the number of shares which may be registered if their shares are to be
included in a registration statement which also includes securities being
offered by us if the underwriter of such offering determines the total number of
shares or securities being registered must be reduced because of prevailing
market factor. Further, the holders of the shares issuable upon exercise of the
warrants have agreed to resell the shares in three equal tranches. These
shareholders may sell: (i) up to one third of their shares commencing 6 months
after the effective date of the registration statement by which the shares are
registered; (ii) up to an additional one third of their shares 12 months after
the effective date of the re registration statement by which the shares are
registered; and (iii) up to an additional one third of their shares 18 months
after the effective date of the re registration statement by which the shares
are registered.
We also have granted registration rights to the holders of 6,892,857
shares of Common Stock and 6,892,857 shares of common stock underlying
redeemable common stock purchase warrants sold pursuant to Regulation S. We have
agreed that, if at any time during the one-year period commencing on April 3,
2000, we propose to file, on our behalf and/or on behalf of any of our
securities holders, a registration statement relating to its capital stock under
the Securities Act of 1933 other than in connection with a dividend
reinvestment, employee stock purchase, option or similar plan in connection with
a merger, consolidation or reorganization, we shall give written notice to all
holders of these warrants at least twenty (20) days before the filing with the
SEC of such registration statement. Such notice shall offer to include in such
filing that number of the shares of common stock as the holders may request
pursuant to written notice to us within ten (10) days after the date of mailing
of such offer. We shall thereupon include in such filing that number of shares
of common stock and shares of common stock underlying the warrant so requested
by the holders of these securities and, subject to our limited right to withdraw
such filing, shall use our best efforts to effect registration of all of such
shares of Common Stock Under the Securities Act Of 1933. We have agreed to use
our best efforts to keep such registration statement continuously effective
under the Securities Act of 1933 until the date which is two years after the
date that such registration statement is declared effective by the SEC or such
70
earlier date when all securities covered by such registration statement have
been sold or may be sold without volume restrictions pursuant to Rule 144(k)
promulgated under the Securities Act of 1933. In addition, we have agreed that
at any time commencing October 1, 2000, holders of at least fifty one percent of
the outstanding shares of common stock and shares of common stock underlying the
above-described warrants, may notify us of their desire to sell these
securities. Upon receipt of such notice, we shall promptly thereafter notify all
other holders of these securities that did not sign such notice, in writing,
that a registration is to be effected, and prepare and file, within sixty (60)
days of the receipt of the demand registration notice, with the SEC a
registration statement on the appropriate form and use our best efforts to cause
such registration statement to become effective in order that participating
holders of the securities may sell them.
STOCK SPLITS
On January 5, 1998, we affected a 1-for-44 split of our outstanding
shares of common stock. On August 27, 1998, we affected a 1-for-2.273 split of
our outstanding shares of common stock. All stock information included in this
registration statement reflects these stock splits.
SHARES ELIGIBLE FOR FUTURE SALE
As of the date of this Form 8-K, we have a total of 25,858,913 shares
of common stock outstanding. Of these outstanding shares, 11,287,700 shares are
freely tradable, without restriction by or further registration under the
Securities Act of 1933 by persons other than our "affiliates," as defined in
Rule 144 under the Securities Act.
All the other outstanding shares of common stock (6,046,071 shares) are
"restricted securities" for purposes of the Securities Act and may not be sold
unless they are registered under the Securities Act or unless an exemption from
registration, such as that provided by Rule 144, is available.
We can make no prediction as to the effect, if any, that market sales
of shares of Common Stock or the availability of shares for sale will have on
the market price prevailing from time to time. Nevertheless, sales of
significant numbers of shares of Common Stock in the public market could
adversely affect the market price of the Common Stock and could impair our
future ability to raise capital through an offering of its equity securities.
TRANSFER AGENT
The Transfer Agent for the common stock is Signature Stock Transfer
Inc. located at Office in the Park, 14675 Midway Road, Suite 221, Dallas, Texas
75244.
71
MARKET PRICE AND DIVIDENDS ON REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET PRICE
On March 30, 2000, the closing bid price pr share of our common stock
was $1.312.
The following table sets forth the quarterly high and low closing bid
and closing ask prices (in U.S. dollars) for our common stock for the period
August 26, 1998 through the first three quarters of 1999:
Closing Bid
--------- High Low --------
1998
August 26 thru September 30 UNPRICED
October 1 thru December 31 $1.50 $.01
1999
January 4 thru March 31 $1.25 $.50
April 1 thru June 30 $1.25 $.31
July 1 thru September 30 $ .99 $.50
October 1 thru December 31
2000
January 3 thru March 30 $2.00 $1.25
Source: National Quotation Bureau, LLC
The foregoing data represents prices between dealers and does not
include retail mark-ups, mark-downs or commissions, nor does such data represent
actual transactions or adjustments for stock-splits or dividends.
DIVIDENDS
To date, we have not declared or paid dividends on our common stock. We
presently plan to retain earnings, if any, for use in our business.
TRADING MARKET
Our common stock trades on the NASD Electronic Bulletin Board under the
symbol "CAOL".
72
PRINCIPAL MARKET-MAKERS
On March 30, 2000, there were 17 active market makers of our common
stock. The principal market makers of our common stock. The principal market
makers during the first quarter of 2000 have been Knight Securities, Inc., Wm.
V. Frankel & Co., Incorporated, Herzog Heine Geduld, Inc., Sharpe Capital, Inc.
Fleet Trading/ A division of Fleet Securities, M.H. Meyerson & Co., Inc.,
Sherwood Securities Corp., and Hill Thompson Magid & Co., Inc.
NUMBER OF SHAREHOLDERS OF RECORD
At March 30, 2000, there were approximately 361 shareholders of record
of our common stock.
LEGAL PROCEEDINGS.
We are not presently party to any material legal proceeding nor are we
aware of any material pending or potential legal proceeding, which might be
instituted against us.
INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Our Articles of Incorporation provide that none of our directors or
officers shall be personally liable to the corporation or any stockholder for
damages for breach of fiduciary duty as a director or officer or for any act or
omission on their part, except that liability shall not be eliminated for acts
or omissions which involve intentional misconduct, fraud or a knowing violation
of the law or the payment of dividends in violation of Nevada's corporate laws.
Additionally, our By-Laws provide for the indemnification of any of our
directors, officers and employees by reason of their serving in such capacity
against reasonable expenses, including attorneys' fees, actually and reasonably
incurred by them in connection with the defense of any action, suit or
proceeding or any appeal therein which they, or any of them, are made parties or
a party, except if such person is adjudged to have been liable for negligence or
misconduct in the performance of such person's duties. Our Board of Directors
shall fix the amount of the indemnity payable by us. Such indemnification is not
deemed to be exclusive of any other rights to which those indemnified may be
entitled, under any by-law, agreement, vote of stockholders or otherwise. The
foregoing provisions of our Articles of Incorporation may reduce the likelihood
of derivative litigation against our directors and officers for breach of their
fiduciary duties, even though such action, if successful, might otherwise
benefit us and our stockholders.
73
PART F/S
The financial statements of the Company and supplementary data are
included beginning immediately following the signature page to this report. The
Following is a list of the financial statements and financial statement
schedules included.
1. FINANCIAL STATEMENTS PAGE
CATHAYONLINE, INC.
Independent Auditor's Report...............................................F - 1
Balance Sheets
December 31, 1999 (Unaudited) and
June 30, 1999 and 1998...................................................F - 2
Statements of Operations for the
Six Months Ended December 31, 1999 (Unaudited) and the
Years Ended June 30, 1999 and 1998......................................F - 4
Statement of Stockholders' Equity for the
Six Months Ended December 31, 1999 (Unaudited) and the
Years Ended June 30, 1999 and 1998......................................F - 5
Statements of Cash Flows for the
Six Months Ended December 31, 1999 (Unaudited) and the
Years Ended June 30, 1999 and 1998......................................F - 6
Notes to Financial Statements..............................................F - 8
LAZZARA FINANCIAL ASSET RECOVERY, INC.
Independent Auditor's Report..............................................F - 17
Balance Sheet
December 31, 1999.......................................................F - 18
Statement of Operations for the
Year Ended December 31, 1999...........................................F - 19
Statement of Stockholders' Equity for the
Year Ended December 31, 1999...........................................F - 20
Statement of Cash Flows for the
Year Ended December 31, 1999...........................................F - 21
Notes to Financial Statements.............................................F - 22
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules required by Regulation S-X
are included herein.
All schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
3. UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
Overview..................................................................F - 24
Unaudited Pro Forma Condensed Balance Sheets
December 31, 1999.......................................................F - 25
Unaudited Pro Form Condensed Statements of Operations for the
year Ended December 31, 1999...........................................F - 26
Notes to Unaudited Pro Forma Condensed Combined Financial Statements......F - 27
74
PART III
ITEM 1. INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
3.1 Articles of Incorporation of CathayOnline Inc.
3.2 By-Laws of CathayOnline Inc.
3.3 Certificate of Incorporation of CathayOnline (BVI) Ltd.
3.4 Memorandum and Articles of Association of CathayOnline (BVI) Ltd.
3.5 Certificate of Incorporation of CathayOnline Technologies (Hong Kong)
Limited
3.6 Memorandum and Articles of Association of CathayOnline Technologies
(Hong Kong) Limited
3.7 Certificate of Incorporation of Sichuan CathayOnline Technologies Co.,
Ltd.
3.8 Articles of Association of Sichuan CathayOnline Technologies Co., Ltd.
3.9 Certificate of Incorporation of TorchMail.com, Inc.
3.10 Memorandum and Articles of Association of TorchMail.com, Inc.
4.1 Specimen Form of Common Stock Certificate
4.2 Form of Warrant issued to Employees and Consultants
4.3 Form of Warrant issued in April 1999 Offering
4.4 Form of Warrant issued in June 1999 Offering
4.5 Form of Warrant Issued in Regulation S Offering
75
10 Material Contracts
10.1 Exclusive Management, Operating and Consultancy Service Agreement with
Sichuan Guo Xun Xin Xi Chan Ye You Xian Gong Si
10.2 Agreement to Acquire TorchMail.com Inc.
10.3 Reseller Agreement between TorchMail.com Inc. and USA.NET Inc. THIS
AGREEMENT HAS BEEN SUBMITTED TO THE SECURITIES AND EXCHANGE COMMISSION
UNDER SEPARATE COVER WITH A REQUEST THAT THE EXHIBIT BE GRANTED
CONFIDENTIAL TREATMENT.
10.4 Agreement with Moorgate Management Inc for the Sale of Kiosks
10.5 Letter of Intent with Clean Way Corp.
10.6 Employment Agreement between CathayOnline Inc. and Brian Ransom
10.7 Management Agreement with Owen Li
10.8 Consulting Agreement with Peter Lau
10.9 Public Relations Agreement with Talk Stock with Me Inc.
10.10 Share Purchase Agreement Relating to the Purchase of CMD Capital
Limited
10.11 Agreement with register.com
10.12 Lease Agreement with Sichuan Dongfu Group Company
10.13 Sublease for Office at 570 Lexington Avenue, New York, New York
10.14. Lease Agreement with Beijing Tongkai Development Co., Ltd. for Office
Space in Beijing, China
10.15 Lease Agreement with Harwood Corporation for Space at 543 Granville
Street, Vancouver, British Columbia, Canada
23.1 Consent of Robison, Hill & Co.
76
23.2 Consent of Barry L. Friedman, P.C.
23.3 Consent of Beijing Sage Law Firm
27.1 Financial Statement Schedule
99.1 Opinion of Beijing Sage Law Firm as to Legality of Operations of
Sichuan CathayOnline Technologies Co. Ltd.
77
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Current Report on Form 8-K be signed on its
behalf by the undersigned thereunto duly authorized.
CATHAYONLINE INC.
DATE: APRIL 3, 2000 BY: /S/ BRIAN RANSOM
-------------- -----------------
78
INDEPENDENT AUDITOR'S REPORT
CATHAYONLINE, INC.
(Formerly Kyocera Management, Ltd.)
(A Development Stage Company)
We have audited the accompanying balance sheets of CathayOnline, Inc.
(formerly Kyocera Management, Ltd.) (a development stage company) as of June 30,
1999 and 1998, and the related statements of operations, stockholders' equity,
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of CathayOnline, Inc.
(formerly Kyocera Management, Ltd.) (a development stage company) as of June 30,
1999 and 1998, and the results of its operations and its cash flows for the
years then ended, in conformity with generally accepted accounting principles.
Respectfully submitted
/S/ ROBISON, HILL & CO.
Certified Public Accountants
Salt Lake City, Utah
October 7, 1999
F - 1
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
(Unaudited)
December 31, June 30,
-----------------------
1999 1999 1998
--------- --------- ---------
Current Assets:
Cash & Cash Equivalents ............. $ 126,025 $ 164,982 $ --
Restricted Cash ..................... 6,920 6,920 --
Accounts Receivable ................. 2,500 -- --
Prepaid Expenses .................... 56,166 -- --
--------- --------- ---------
Total Current Assets ............. 191,611 171,902 --
Fixed Assets:
Equipment ........................... 288,267 3,680 --
Furniture & Fixtures ................ 13,291 -- --
Leasehold Improvements .............. 237,079 -- --
--------- --------- ---------
538,637 3,680 --
Less Accumulated Depreciation ....... (27,201) (64) --
--------- --------- ---------
Total Fixed Assets ............... 511,436 3,616 --
Other Assets:
Intangibles, Net .................... 9,750 -- --
Deposits ............................ 171 -- --
Investment in Subsidiaries .......... -- 204,546 --
--------- --------- ---------
Total Other Assets ............... 9,921 204,546 --
--------- --------- ---------
Total Assets: ......................... $ 712,968 $ 380,064 $ --
========= ========= =========
F - 2
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
(CONTINUED)
(Unaudited)
December 31, June 30,
----------------------
1999 1999 1998
--------- --------- ---------
Current Liabilities:
Accounts Payable & Accrued Expenses . $ 85,197 $ 79,726 $ --
Short-term Notes Payable ............ 453,187 -- --
--------- --------- ---------
Total Liabilities ................ 538,384 79,726 --
Stockholders' Equity:
Common Stock, Par value $.001
Authorized 50,000,000 shares,
Issued 17,492,771 shares at
December 31, 1999,
11,752,700 at June 30, 1999
and 2,639,868 at June 30, 1998 .... 17,493 11,753 2,640
Paid-In Capital ..................... 1,966,329 1,043,373 860
Stock Subscribed Receivable ......... (468,750) (429,250) --
Deficit Accumulated During the
Development Stage ................. (1,340,488) (325,538) (3,500)
--------- --------- ---------
Total Stockholders' Equity ....... 174,584 300,338 --
--------- --------- ---------
Total Liabilities and
Stockholders' Equity ........... $ 712,968 $ 380,064 $ --
========= ========= =========
The accompanying notes are an integral part of these financial statements.
F - 3
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
Cumulative
(Unaudited) since
For the Six inception
Months Ended For the year ended of
December 31, June 30, development
-------------------------
1999 1999 1998 stage
----------- ----------- ----------- -----------
Revenues: .................... $ 9,952 $ -- $ -- $ 9,952
Cost of Revenues ............. -- -- -- --
----------- ----------- ----------- -----------
Gross Margin ................. 9,952 -- -- 9,952
Expenses:
General & Administrative ..... 1,019,976 321,647 2,353 1,345,123
----------- ----------- ----------- -----------
Net Loss from Operations ..... (1,010,024) (321,647) (2,353) (1,335,171)
Other Income (Expense)
Interest, Net ................ (4,926) (391) -- (5,317)
----------- ----------- ----------- -----------
Net Loss ................ $(1,014,950) $ (322,038) $ (2,353) $(1,340,488)
----------- ----------- ----------- -----------
Basic & Diluted loss per share $ (0.06) $ (0.06) $ --
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F - 4
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF STOCKHOLDERS' EQUITY
Deficit
Accumulated
Stock During
Common Stock Paid-In Subscribed Development
Shares Par Value Capital Receivable Stage
----------- ----------- ----------- ----------- -----------
Balance at July 1, 1997 .......... 1,099,956 $ 1,100 $ 2,100 $ -- $ (1,147)
January 5, 1998 Issuance of Stock
for services and payment of
accounts payable ............... 1,539,912 1,540 (1,240) -- --
Net Loss ......................... -- -- -- -- (2,353)
----------- ----------- ----------- ----------- -----------
Balance at June 30, 1998
As originally reported ......... 2,639,868 2,640 860 -- (3,500)
Cancellation of Officer Shares ... (1,539,912) (1,540) 1,540 -- --
Retroactive adjustment for 2.273
to 1 stock split August 27, 1998 1,400,244 1,400 (1,400) -- --
----------- ----------- ----------- ----------- -----------
Restated balance June 30, 1998 ... 2,500,200 2,500 1,000 -- (3,500)
December 29, 1998 Issuance of
Stock for cash ................ 5,785,000 5,785 52,065 -- --
Capital Contributed by shareholder -- -- 2,526 -- --
March 9, 1999 Issuance of Stock
for payment of
accounts payable .............. 202,500 203 (203) -- --
April 2, 1999 Issuance of Stock
for payment of
accounts payable .............. 475,000 475 118,275 -- --
April 29, 1999 Issuance of Stock
for cash ...................... 700,000 700 349,300 -- --
June 24, 1999 Issuance of Stock
for cash ...................... 2,090,000 2,090 520,410 (429,250) --
Net Loss ......................... -- -- -- -- (322,038)
----------- ----------- ----------- ----------- -----------
Balance at June 30, 1999 ......... 11,752,700 $ 11,753 $ 1,043,373 $ (429,250) $ (325,538)
=========== =========== =========== =========== ===========
Issuance of stock (Unaudited) .... 5,740,071 5,740 922,956 (39,500) --
Net Loss (Unaudited) ............. -- -- -- -- (1,014,950)
----------- ----------- ----------- ----------- -----------
Balance at December 31, 1999
(Unaudited) ...................... 17,492,771 $ 17,493 $ 1,966,329 $ (468,750) $(1,340,488)
=========== =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F - 5
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
Cumulative
(Unaudited) Since
For the Six Inception
Months Ended For the years ended of
December 31, June 30, Development
-------------------------
1999 1999 1998 Stage
----------- ----------- ----------- -----------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net Loss .................................. $(1,014,950) $ (322,038) $ (2,353) $(1,340,488)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization .......... 27,387 64 2,053 30,651
Issuance of common stock for expenses .. -- 140,350 300 140,650
Change in operating assets and liabilities:
Restricted cash ........................ -- (6,920) -- (6,920)
Accounts Receivable .................... (2,500) -- -- (2,500)
Prepaid Expenses ....................... (56,166) -- -- (56,166)
Deposits ............................... (171) -- -- (171)
Accounts Payable & Accrued Expenses .... 8,658 79,726 -- 88,384
----------- ----------- ----------- -----------
Net Cash Used in operating activities ... (1,037,742) (108,818) -- (1,146,560)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of fixed assets ............... (369,911) (3,680) -- (373,591)
Purchase of intangible assets .......... (10,000) -- -- (10,000)
Investment in subsidiaries ............. -- (204,546) -- (204,546)
----------- ----------- ----------- -----------
Net cash used in investing activities ..... (379,911) (208,226) -- (588,137)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from issuance of common stock .... 928,696 479,500 -- 1,408,196
Proceeds from short-term notes ............ 450,000 -- -- 450,000
Capital contributed by shareholder ........ -- 2,526 -- 2,526
----------- ----------- ----------- -----------
Net Cash Provided by Financing
Activities ................................ 1,378,696 482,026 -- 1,860,722
----------- ----------- ----------- -----------
F - 6
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
(CONTINUED)
Cumulative
(Unaudited) Since
For the Six Inception
Months Ended For the years ended of
December 31, June 30, Development
-------------------------
1999 1999 1998 Stage
----------- ----------- ----------- -----------
Net (Decrease) Increase in
Cash and Cash Equivalents ............... $ (38,957) $ 164,982 $ -- $ 126,025
Cash and Cash Equivalents
at Beginning of Period .................. 164,982 -- -- --
----------- ----------- ----------- -----------
Cash and Cash Equivalents
at End of Period ........................ $ 126,025 $ 164,982 $ -- $ 126,025
=========== =========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
Cash paid during the year for:
Interest ................................ $ 2,429 $ -- $ -- $ 2,429
Income taxes ............................ $ -- $ -- $ -- $ --
SUPPLEMENTAL DISCLOSURE OF
NON-CASH INVESTING AND
FINANCING ACTIVITIES: None
The accompanying notes are an integral part of these financial statements.
F - 7
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of accounting policies for CathayOnline, Inc. (formerly
Kyocera Management, Ltd.) is presented to assist in understanding the Company's
financial statements. The accounting policies conform to generally accepted
accounting principles and have been consistently applied in the preparation of
the financial statements.
The unaudited financial statements as of December 31, 1999 and for the
six months then ended reflect, in the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to fairly state the
financial position and results of operations for the six months. Operating
results for interim periods are not necessarily indicative of the results which
can be expected for full years.
ORGANIZATION AND BASIS OF PRESENTATION
The Company was incorporated under the laws of the State of Nevada on
September 20, 1995 using the name of Kyocera Management, Ltd. The name was
changed to CathayOnline, Inc. on April 14, 1999. The Company ceased all
operating activities during the period from September 20, 1995 to January 6,1998
and was considered dormant. On January 6, 1998, the Company obtained a
Certificate of renewal from the State of Nevada. The Company as of June 30, 1999
is in the development stage, and has only recently commenced planned principal
operations.
PRINCIPLES OF CONSOLIDATION
The unaudited consolidated financial statements for December 31, 1999
and the six months then ended include the accounts of Cathayonline, Inc. and its
wholly-owned subsidiaries, CathayOnline Technologies (Hong Kong) Ltd., a British
Virgin Islands corporations, TorchMail.com Inc., a Turks & Caicos, BWI
corporation, and Sichuan CathayOnline Technologies Co. Ltd., a Chengdu (PRC)
corporation. All significant inter-company accounts and transactions have been
eliminated.
NATURE OF BUSINESS
ON THE 30TH of June the Company announced its exclusive partnership
with Sichuan Guo Xun Xin ChanYe You Xian Gong Si, a licensed Internet Service
Provider employing 28 industry professionals, through its wholly owned
subsidiary Sichuan CathayOnline Information Technologies Co. Ltd., of Chengdu,
China.
F - 8
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
NATURE OF BUSINESS (CONTINUED)
Subsequent to June 30, 1999 CathayOnline, through a right to first
market partnership with USA.net, launched its English version of TorchMail.com,
a web based email and advanced messaging service for the Chinese speaking
markets, through its newly acquired wholly owned subsidiary, Torchmail.com, Inc.
These markets include but are not limited to Peoples Republic of China, Hong
Kong, Taiwan, Singapore, and Malaysia.
Furthermore, the Company through its wholly owned subsidiary
CathayOnline Technologies (Hong Kong) Ltd., through a partnership with Wan Rong
Services Co. Ltd., became the operator of 10 online lottery kiosks in Guangzhou,
China.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents to the extent the funds are not being held for investment
purposes.
PERVASIVENESS OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles required management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
TRANSLATION OF FOREIGN CURRENCY
The Companies functional currencies include U.S. Dollars, Canadian
Dollars and Chinese Renminbi. All balance sheet accounts of foreign operations
are translated into U.S. dollars at the year-end rate of exchange and statement
of operations items are translated at the weighted average exchange rates for
the year. The resulting translation adjustments are made directly to a separate
component of the stockholders' equity. Certain foreign activities are considered
to be an extension
F - 9
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
TRANSLATION OF FOREIGN CURRENCY (CONTINUED)
of the U.S. operations, and the gain or loss resulting from remeasuring these
transactions into U.S. dollars is included in income. Gains or losses from other
foreign currency transactions, such as those resulting from the settlement of
foreign receivables or payables, are included in the Statements of Operations.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided for
in amounts sufficient to relate the cost of depreciable assets to operations
over their estimated service lives, principally on a straight-line basis from 3
to 5 years.
Upon sale or other disposition of property and equipment, the cost and
related accumulated depreciation or amortization are removed from the accounts
and any gain or loss is included in the determination of income or loss.
Expenditures for maintenance and repairs are charged to expense as
incurred. Major overhauls and betterments are capitalized and depreciated over
their useful lives.
Intangible assets are amortized over useful life of 5 to 10 years.
The Company has adopted the Financial Accounting Standards Board SFAS
No., 121, "Accounting for the Impairment of Long-lived Assets." SFAS No. 121
addresses the accounting for (i) impairment of long-lived assets, certain
identified intangibles and goodwill related to assets to be held and used, and
(ii) long-live lived assets and certain identifiable intangibles to be disposed
of. SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles be held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. If the sum of the expected future cash flows from the
used of the asset and its eventual disposition (undiscounted and without
interest charges) is less than the carrying amount of the asset, an impairment
loss is recognized.
F - 10
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
RECLASSIFICATIONS
Certain reclassifications have been made in the 1998 financial
statements to conform with the 1999 presentation.
LOSS PER SHARE
The reconciliations of the numerators and denominators of the basic
loss per share computations are as follows:
Per-Share
INCOME SHARES AMOUNT
------ ------ ------
(Numerator) (Denominator)
FOR THE SIX MONTHS ENDED DECEMBER 31, 1999 (UNAUDITED)
Basic Loss per Share
Loss to common shareholders ........... $(1,014,950) 15,949,718 $ (0.06)
=========== =========== ===========
FOR THE YEAR ENDED JUNE 30, 1999
Basic Loss per Share
Loss to common shareholders ........... $ (322,038) 5,748,248 $ (0.06)
=========== =========== ===========
FOR THE YEAR ENDED JUNE 30, 1998
Basic Loss per Share
Loss to common shareholders ............ $ (2,353) 2,500,200 $ --
=========== =========== ===========
The effect of outstanding common stock equivalents including 24,490,000
and 2,990,000 as of December 31, 1999 and June 30, 1999, respectively, would be
anti-dilutive and are thus not considered.
F - 11
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 2 - INCOME TAXES
As of June 30, 1999, the Company had a net operating loss carryforward
for income tax reporting purposes of approximately $300,000 that may be offset
against future taxable income through 2014. Current tax laws limit the amount of
loss available to be offset against future taxable income when a substantial
change in ownership occurs. Therefore, the amount available to offset future
taxable income may be limited. Accordingly, the potential tax benefits of the
loss carryforwards are offset by a valuation allowance of the same amount.
NOTE 3 - DEVELOPMENT STAGE COMPANY
The Company has not begun principal operations and as is common with a
development stage company, the Company has had recurring losses during its
development stage.
NOTE 4 - COMMITMENTS
As of June 30, 1999 all activities of the Company have been conducted
by corporate officers from their business offices. Currently, there are no
outstanding debts owed by the company for the use of these facilities and there
are no commitments for future use of the facilities.
NOTE 5 - COMMON STOCK TRANSACTIONS
The Company was initially incorporated to allow for the issuance of up
to 25,000 shares of no par value common stock. On January 5, 1998, the Company
approved the amendment of it's Articles of Incorporation to allow for the
issuance of up to 50,000,000 shares of $0.001 par value common stock. The
Amended Articles of Incorporation were filed with the State of Nevada on April
20, 1998. All amounts presented in the accompanying financial statements reflect
the effect of this change in the par value of the Company's stock as of the
first day of the first period presented.
On January 5, 1998, the Company's Board of Directors approved a 44 for
1 forward stock split on its issued and outstanding common stock. All issued and
outstanding share and per share amounts in the accompanying financial statements
reflect the effect of this stock split as of the first day of the first period
presented.
F - 12
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 5 - COMMON STOCK TRANSACTIONS (CONTINUED)
At inception, the Company issued approximately 9,999 shares of common
stock (439,956 post split shares) to its officers and directors for services
performed and payments made on the Company's behalf during its formation. This
transaction was valued at approximately $0.02 per share or an aggregate
approximate $200.
During 1996, to provide initial working capital, the Company completed
a private placement sale of an aggregate of approximately 15,000 shares of
common stock (660,000 post split shares) at approximately $0.20 per share. These
sales generated approximately $3,000 in proceeds to the Company which were
primarily used to pay organizational expenses.
On January 5, 1998, prior to the stock split, the Company issued
approximately 34,998 shares of common stock (1,539,912 post split shares) to
officers and directors of the Company for management services rendered to the
Company. This transaction was valued at approximately $300, which approximated
the fair value of the services rendered to the Company. On August 26, 1998 the
Officers surrendered these shares to the Company for cancellation.
On August 27, 1998 the Board of Directors authorized 2.273 to 1forward
stock split on its issued and outstanding common stock. All references in the
accompanying financial statements to the number of common shares and per-share
amounts for 1998 and 1997 have been restated to reflect the stock split.
On December 29, 1998 the Company issued 5,785,000 shares pursuant to
Rule 504 of Regulation D promulgated by the United States Securities and
Exchange Commission. 3,625,000 shares were issued for cash at $0.01 per share
and 2,160,000 shares were issued for cash.
On March 9, 1999 the Company completed a private placement sale of an
aggregate of 202,500 common shares being issued for payments made on the
Company's behalf.
On April 2, 1999 the Company completed a private placement sale of an
aggregate of 475,000 shares of common stock for payments made on the Company's
behalf.
On April 29, 1999 the Company issued 700,000 shares pursuant to
Regulation S promulgated by the United States Securities and Exchange
Commission. The shares were issued for cash at $0.50 per share.
F - 13
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 5 - COMMON STOCK TRANSACTIONS (CONTINUED)
On June 24, 1999 the Company issued 2,090,000 shares pursuant to
Regulation S promulgated by the United States Securities and Exchange
Commission. The shares were issued for cash and at $0.25 per share.
NOTE 6 - PREFERRED STOCK
The Board of Directors of the Company has the authority to determine by
resolution the number of preferred shares to be issued by series, the rate and
terms for payment of cumulative or non-cumulative dividends, the conversion
features of the preferred stock, the redemption rights and prices, if any, the
terms of the sinking fund, if any, to be provided for the shares, the voting
powers of preferred shareholders and any other special rights, qualifications,
limitations, or restrictions. As of December 31, 1999, no preferred stock had
been issued.
NOTE 7 - STOCK OPTIONS AND WARRANTS
Employee and Consultants Warrants: During October 1999, the Company
issued to employees and consultants (or their designees) in consideration for
services rendered warrants to purchase up to 21,700,000 shares of our common
stock. The warrants are exercisable for a period of 3 years commencing on
October 26, 1999 at an exercise price of $.33 per share. The shares of common
stock issuable upon exercise of these warrants are subject to registration as
described below. These warrants provide for cashless exercise by the holders.
These warrants are not redeemable. As of the date hereof, none of these warrants
have been exercised.
Investor Warrants: During April and June 1999, the Company issued an
aggregate of 2,990,000 common stock purchase warrants to eight investors,
including 50,000 warrants to our President. These warrants are exercisable for a
period of 2 years from the date of issuance at an exercise price of $.60, if
exercised during the first year after issuance, and $.70 if exercised in the
second year after issuance. Theses warrants are not redeemable. As of the date
hereof, 200,000 warrants have been exercised.
Regulation S Warrants: During the first quarter of 2000 the Company
sold and issued 6,892,857 redeemable Common Stock purchase warrants to purchase
a like number of shares of Common Stock. Each such warrant entitles the holder
to purchase one share of Common Stock, subject to adjustment in the event of any
stock dividend, stock split, subdivision or combination,
F - 14
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 7 - STOCK OPTIONS AND WARRANTS (CONTINUED)
or any reclassification of the outstanding shares of Common Stock at any time
after issuance until the expiration of these warrants, a date two years after
the date upon which the underlying shares of Common Stock are registered for
resale under the Securities Act of 1933, at a price of $.847 per share. We may
redeem these warrants at a price of US$.10 per warrant commencing one year after
the effective date of the registration statement under the Securities Act of
1933 covering the underlying Common Stock provided that (i) a registration
statement covering the underlying common stock is then effective and (ii) the
average closing bid price per share of Common Stock for the thirty (30) day
period ending five (5) days prior to the date of the redemption notice of the
Warrants is at least $1.05 per share.
All options and warrants have been granted at exercise prices greater
than the market value on the date of granting. All options vest 100% at date of
grant.
1999 1998
----------- -----------
Options outstanding, beginning of year -- --
Granted 2,990,000 --
Expired -- --
Exercised -- --
----------- -----------
Options and warrants outstanding, end of year 2,990,000 --
=========== ===========
Price for options and warrants outstanding,
end of year $0.35 - .070 $ --
Options and warrants granted subsequent to year end --
Option and warrant price range granted subsequent
to year end $0.33 - .847
NOTE 8 - SUBSEQUENT EVENTS
On July 2, 1999 the Company completed an Acquisition (the
"Acquisition") in which it acquired 100% of the issued and outstanding capital
stock of TorchMail.com Inc., a Turks & Caicos, BWI corporation in exchange for
2,500,000 shares of the Company's $.001 par value common stock, comprising
approximately 15% of the Company's issued and outstanding common stock after
giving
F - 15
CATHAYONLINE, INC.
(FORMERLY KYOCERA MANAGEMENT, LTD.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
(REFERENCES TO DECEMBER 31, 1999 ARE UNAUDITED)
(CONTINUED)
NOTE 8 - SUBSEQUENT EVENTS (CONTINUED)
effect to the Acquisition, and $10,000. Further, upon the resale of 360,000
Seats (defined as a mailbox created within a Customer Account for use of the
Services by a User) the Company will issue an additional 2,500,000 shares, upon
the resale of 500,000 Seats the Company will issue 1,250,000 shares and upon the
resale of 750,000 Seats the Company will issue 1,250,000 shares. The transaction
has been accounted for as a purchase. Assets and liabilities are reflected at
their fair market value.
In July through September, the Company acquired the operations of 10
online lottery kiosks through its wholly owned subsidiary CathayOnline
Technologies (Hong Kong) Ltd., with its joint venture partner Wan Rong Services
Co. Ltd., for $100,000. The kiosks sell online lottery tickets for government
sanctioned sports and charitable lotteries to the general public in Guangzhou,
China.
ON THE 10TH of August 1999 the Company's wholly owned subsidiary's
joint venture partner, Guo Xun Xin Xi Chan Ye You Xian Gong Si received a
license from the Republic of China to operate an "electronic information
processing; development, manufacture and sales of telecommunication and computer
networking products; computer networking dial-up services; information systems
infrastructure construction and the related services" business for a period of 4
years. The Company has committed to invest $1,000,000 in this venture. As of
October 1999 the Company has invested approximately $700,000.
During the first quarter of 2000 the Company sold and issued 6,892,857
redeemable Common Stock purchase warrants to purchase a like number of shares of
Common Stock. Each such warrant entitles the holder to purchase one share of
Common Stock, subject to adjustment in the event of any stock dividend, stock
split, subdivision or combination, or any reclassification of the outstanding
shares of Common Stock at any time after issuance until the expiration of these
warrants, a date two years after the date upon which the underlying shares of
Common Stock are registered for resale under the Securities Act of 1933, at a
price of $.847 per share. We may redeem these warrants at a price of US$.10 per
warrant commencing one year after the effective date of the registration
statement under the Securities Act of 1933 covering the underlying Common Stock
provided that (i) a registration statement covering the underlying common stock
is then effective and (ii) the average closing bid price per share of Common
Stock for the thirty (30) day period ending five (5) days prior to the date of
the redemption notice of the Warrants is at least $1.05 per share.
F - 16
BARRY L. FRIEDMAN, P.C.
CERTIFIED PUBLIC 4CCAUNTANT
1582 TULITA DRIVE OFFICE (702) 361-4414
LAS VEGAS, NEVADA 89123 FAX NO. (702) 896-0218
INDEPENDENT AUDITORS' REPORT
Board Of Directors January 17, 2000
Lazzara Financial Asset Recovery, Inc.
Las Vegas, Nevada
I have audited the Balance Sheet of Lazzara Financial Asset Recovery,
Inc., (A Development Stage Company), as of December 31, 1999, and the related
Statements of Operations, Stockholders' Equity and Cash Flows for the period
November 22, 1999, (inception) to December 31, 1999. These financial statements
are the responsibility of the Company's management. My responsibility is to
express an opinion on these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing
standards. Those standards require that I plan and perform the audit to obtain
reasonable assurance about whether the financial statements arc free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Lazzara Financial
Asset Recovery, Inc., (A Development Stage Company), at December 31, 1999, and
the results of its operations and cash flows for the period November 22,1999,
(inception) to December 31, 1999, in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note #3 to the
financial statements, the Company has no established source of revenut This
raises substantial doubt about its ability to continue as a going concern.
Management's plan in regard to these matters are also described in Note #3. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/S/ Barry L. Friedman
Certified Public Accountant
F - 17
LAZZARA FINANCIAL ASSET RECOVERY, INC.
(A DEVELOPMENT STAGE COMPANY)
DECEMBER31, 1999
BALANCE SHEET
-------------
ASSETS
------
CURRENT ASSETS $ --
-------------
TOTAL CURRENT ASSETS $ --
-------------
OTHER ASSETS $ --
-------------
TOTAL OTHER ASSETS $ --
-------------
TOTAL ASSETS $ --
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
OFFICERS ADVANCES (NOTE #6) $ 305
-------------
TOTAL CURRENT LIABILITIES $ 305
-------------
STOCKHOLDERS' EQUITY
Preferred Stock, $001 par value,
Authorized 5,000,000 shares
Issued and outstanding at
December 31, 1999- None $ --
Common stock, $.001 par value,
authorized 20,000,000 shares;
issued and outstanding at
december 31, 1999-5,000,000 shares $ 5,000
Additionai paid-in capital $ --
Deficit accumulated during
development stage $ (5,305)
-------------
TOTAL STOCKHOLDER'S EQUITY $ (305)
-------------
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $ --
=============
The accompanying notes are an integral part of these financial statements
F - 18
LAZZARA FINANCIAL ASSET RECOVERY, INC.
(A Development Stage Company)
November 22, 1999,(Inception) to December 31, 1999
STATEMENT OF OPERAT1ONS
-----------------------
INCOME
Revenue $ --
-------------
EXPENSE
Services $ 5,000
General and
Administrative 305
-------------
TOTAL EXPENSES $ 5,305
-------------
NET LOSS $ (5,305)
=============
Net loss
Per Share $ (.0011)
=============
Weighted average
number of common
shares outstanding 5,000,000
=============
The accompanying notes are an integral part of these financial statements
F - 19
LAZZARA FINANCIAL ASSET RECOVERY, INC.
(A Development Stage Company)
STATEMENT OF STOCKHOLDERS' EQUITY
---------------------------------
Deficit
accumulated
Additional during
common stock paid-in development
Shares Amount Capital stage
----------- ----------- ----------- -----------
November 22, 1999
issued for services 5,000,000 $ 5,000 $ -- $ --
Net loss, November
22, 1999 (inception)
To December 3l, 1999 (5,305)
----------- ----------- ----------- -----------
Balance,
December 31, 1999 5,000,000 $ 5,000 $ -- $ (5,305)
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements
F - 20
LAZZARA FINANCIAL ASSET RECOVERY, INC.
(A Development Stage Company)
NOvember 22, 1999,(Inception) to December 31, 1999
STATEMENT OF CASH FLOWS
-----------------------
Cash Flows From
Operating Activities
Net loss $ (5,305)
Issue common stock for services 5,000
Changes in assets and
Liabilities
Officers Advances 305
-----------
Cash flows from
Operating activities $ --
Cash flows from
Investing activities --
Cash flows from
Financing activities --
-----------
Net increase in cash $ --
Cash,
beginning of period --
-----------
Cash,
end of period $ --
===========
The accompanying notes are an integral part of these financial statements
F - 21
LAZZARA FINANAAL ASSET RECOVERY, INC.
(A Development Stage Company)
NOTES TO F1NANCIAL STATEMENTS
-----------------------------
December 31, 1999
NOTE 1- HISTORY AND ORGANIZATION OF THE COMPANY
The company was organized November 22, 1999, under the laws of the
State of Nevada, as Lazzara Financial Asset Recovery, Inc. The Company currently
has no operations and, in accordance with SFAS #7, is considered a development
stage company
On November 22, 1999, the Company issued 5,000,000 shares of its $.001
par value common stock for services of $5,000.
NOTE 2- ACCOUNTING POLICIES AND PROCEDURES
Accounting policies and procedures have not been determined except as
follows:
1. The Company uses the accrual method of accounting.
2. Earnings per share is computed using the weighted average
number of common shares outstanding.
3. The Company has not yet adopted any policy regarding payment
of dividends. No dividends have been paid since inception.
4. In April 1998, the American Institute of Certified Public
Accountant's issued Statement of Position 98-5 ("SOP 98-511),
Reporting on the Costs of Start-Up Activities" which provides
guidance on the financial reporting of start-up costs and
organization costs. It requires costs of start-up activities
and organization costs to be expensed as incurred. SOP 98-5 is
effective for fiscal years beginning after December 31, 1998,
with initial adoption reported as the cumulative effect of a
change in accounting principle. With the adoption of SOP 98-5,
there has been little or no effect on the company's financial
statements.
NOTE 3- GOING CONCERN
The company's financial statements are prepared using the generally
accepted accounting principles applicable to a going concern, which contemplates
the realization of assets and liquidation of liabilities in the normal course of
business, however, the Company has no current source of revenue. Without
realization of additional capital, it would be unlikely for the Company to
continue as a going concern. It is management's plan seek additional capital
through a merger with an existing operating company.
F - 22
LAZZARA FINANCIAL ASSET RECOVERY, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1999
NOTE 4- WARRANTS AND OPTIONS
There are no warrants or options outstanding to issue any additional
shares of common or preferred stock of the company.
NOTE 5- RELATED PARTY TRANSACTION
The Company neither owns or leases any real or personal property.
Office services are provided without charge by a director. Such costs are
immaterial to the financial statements and, accordingly, have not been reflected
therein. The officers and directors of the Company are involved in other
business activities and may, in the future, become involved in other business
opportunities. If a specific business opportunity becomes available, such
persons may face a conflict in selecting between the Company and their other
business interests, the company has not formulated a policy for the resolution
of such conflicts.
NOTE 6- OFFICERS ADVANCES
While the Company is seeking additional capital through a merger with
an existing operating company, an officer of the Company has advanced funds on
behalf of the company to pay for any costs incurred by it. These funds are
interest free.
F - 23
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
On January 18, 2000 Cathayonline, Inc. ("Cathayonline") and Lazzara
Financial Asset Recovery Inc. ("Lazzara") executed the Merger Agreement that
provides for the reverse merger of Lazzara with and into Cathayonline. See "The
Merger." The following unaudited pro forma condensed combined financial
statements are based on the December 31, 1999 historical consolidated financial
statements of Cathayonline and Lazzara contained elsewhere herein, giving effect
to the transaction under the purchase method of accounting, with Lazzara treated
as the acquiring entity for financial reporting purposes. The unaudited pro
forma condensed combined balance sheet presenting the financial position of the
Surviving Corporation assumes the purchase occurred as of December 31, 1999. The
unaudited pro forma condensed combined statement of operations presents the
results of operations of the Surviving Corporation, assuming the merger was
completed on January 1, 1999.
The unaudited pro forma condensed combined financial statements have
been prepared by management of Cathayonline and Lazzara based on the financial
statements included elsewhere herein. The pro forma adjustments include certain
assumptions and preliminary estimates as discussed in the accompanying notes and
are subject to change. These pro forma statements may not be indicative of the
results that actually would have occurred if the combination had been in effect
on the dates indicated or which may be obtained in the future. These pro forma
financial statements should be read in conjunction with the accompanying notes
and the historical financial information of both Cathayonline and Lazzara
(including the notes thereto) included in this Form 8-K Current Report. See
"FINANCIAL STATEMENTS."
F - 24
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
DECEMBER 31, 1999
Lazzara
Financial
Asset Pro Forma
Cathayonline Recovery Pro Forma Combined
Inc. Inc. Adjustments Balance
----------- ----------- ----------- -----------
ASSETS
Current Assets ................................ $ 191,611 $ -- $ -- $ 191,611
Fixed Assets (net) ............................ 511,436 -- -- 511,436
Intangible and Other Assets ................... 9,921 -- -- 9,921
----------- ----------- ----------- -----------
Total Assets ............................. $ 712,968 $ -- $ -- $ 712,968
=========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Accounts Payable & Accrued Expenses ........... $ 85,197 $ -- $ -- $ 85,197
Short-term Notes Payable ...................... 453,187 305 -- 453,492
----------- ----------- ----------- -----------
Total Liabilities ......................... 538,384 305 -- 538,689
----------- ----------- ----------- -----------
Stockholders' Equity:
Common Stock ................................ 17,493 5,000 (4,975) A 17,518
Additional Paid in Capital .................. 1,966,329 -- (330) 1,965,999
Stock Subscribed Receivable ................. (468,750) -- -- (468,750)
Deficit Accumulated During the
Development Stage ........................ (1,340,488) (5,305) 5,305 (1,340,488)
----------- ----------- ----------- -----------
Total Stockholders' Equity (Deficit) ..... 174,584 (305) -- 174,279
----------- ----------- ----------- -----------
Total Liabilities and Stockholders' Equity $ 712,968 $ -- $ -- $ 712,968
=========== =========== =========== ===========
See accompanying notes to unaudited pro forma condensed combined financial
statements.
F - 25
UNAUDITED PRO FORMA STATEMENTS OF OPERATIONS
FOR THE TEN MONTHS ENDED DECEMBER 31, 1999
Lazzara
Financial
Asset Pro Forma
Cathayonline Recovery Pro Forma Combined
Inc. Inc. Adjustments Balance
------------ ------------ ------------ ------------
Revenues: ......................... $ 9,952 $ -- $ -- $ 9,952
Expenses:
General & Administrative ....... 1,341,623 5,305 -- 1,346,928
Other Expense - Interest, Net .. 5,317 -- -- 5,317
------------ ------------ ------------ ------------
Net Loss .......................... $ 1,336,988 $ 5,305 $ -- $ 1,342,293
============ ============ ============ ============
Loss per share .................... $ (0.08) $ (0.21) $ (0.08)
Weighted average shares outstanding 17,492,771 25,000 17,517,771
See accompanying notes to unaudited pro forma condensed combined financial
statements.
F - 26
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(1) GENERAL
In the reverse, Lazzara will be merged with and into Cathayonline, with the
shares of outstanding Lazzara Common Stock converted into an aggregate of
approximately 25,000 shares of Cathayonline Common Stock outstanding subsequent
to the Merger, subject to certain adjustments. As part of the merger, the name
of Lazzara will be changed to Cathayonline Inc.
(2) FISCAL YEAR ENDS
The unaudited pro forma condensed combined statements of operations for
the year ended December 31, 1999, include Cathayonline's and Lazzara's
operations on a common fiscal year. The financial statements of Cathayonline
have been conformed to the calendar year ended December 31, 1999 by including
the operating results of Cathayonline for the period January 1, 1999 to June 30,
1999 and combining such results with the six months ended December 31, 1999.
(3) PRO FORMA ADJUSTMENTS
The adjustments to the accompanying unaudited pro forma condensed
combined balance sheet as of December 31, 1999, are described below:
(A) Record merger by converting Lazzara Common stock to newly issued
shares of Cathayonline Common Stock, par value $0.001 per share.
The adjustments to the accompanying unaudited pro forma condensed
combined statements of operations are described below:
There are no anticipated adjustments to the statements of operations as
a result of the merger.
F - 27