**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


WASHINGTON,
      D.C. 20549




**FORM
      10-Q**




**[X]
      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT**


**OF
      1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006**




**[ 
      ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE**


**ACT
      OF 1934**




**FOR
      THE TRANSITION PERIOD FROM __________ TO __________**




*COMMISSION
      FILE NUMBER: 000-24985*









**PACIFICNET
      INC.**


(Exact
      name of registrant in its charter)





**Delaware**
            
            **91-2118007**(State
                or other jurisdiction of
              incorporation
                or organization)
            
            (I.R.S.
                Employer
              Identification
                Number)




23/F,
                TOWER A, TIMECOURT, NO.6 SHUGUANG XILI,CHAOYANG
                DISTRICT, BEIJING, CHINA 100028
            
            n/a(Address
                of principal executive offices)
            
            (Zip
                Code)




Registrant’s
      telephone number, including area code:  0086-10-59225000




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




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
      the
      Exchange Act).




Large
      Accelerated Filer o Accelerated
      Filer o   Non-accelerated filer ý




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




As
      of
      August 10, 2006, there were 11,369,336 shares of the issuer’s common stock, par
      value $0.01 per share, outstanding.




1




**PACIFICNET
      INC.**


**Form 10-Q
      for the Quarterly Period Ended June 30, 2006**




**TABLE
      OF CONTENTS**





**PART I.**
            **FINANCIAL
                INFORMATION**Item
                1.
            Financial
                Statements (Unaudited)
            3Condensed
                Consolidated Balance Sheets
            3Condensed
                Consolidated Income Statements
            4Condensed
                Consolidated Statements of Cash Flows
            6Notes
                to Condensed Consolidated Financial Statements
            7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            19Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            28Item
                4.
            Controls
                and Procedures
            29**PART II.**
            **OTHER
                INFORMATION**Item
                1.
            Legal
                Proceedings
            33Item
                1A.
            Risk
                Factors
            33Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            34Item
                3.
            Defaults
                upon Senior Securities
            34Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            34Item
                5.
            Other
                Information
            34Item
                6.
            Exhibits
            34Signatures
            
            35






2


**PART
      I - FINANCIAL INFORMATION**




**ITEM
      1.** **FINANCIAL
      STATEMENTS**




**PACIFICNET
      INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


(In
      thousands of United States dollars, except par values and share
      numbers)







**June
                30, 2006**
              **(Unaudited)**
            
            **December
                31, 2005**
              **(Audited)****ASSETS***Current
                Assets:*Cash
                and cash equivalents
            
            $
            5,935
            
            $
            9,579Restricted
                cash - pledged bank deposit
            
            
            230
            
            
            1,652Accounts
                receivables
            
            
            16,112
            
            
            5,998Inventories
            
            
            2,368
            
            
            1,836Loan
                receivable from related parties
            
            
            4,753
            
            
            2,520Loan
                receivable from third parties
            
            
            1,010
            
            
            1,572Other
                current assets
            
            
            8,444
            
            
            7,973Total
                Current Assets
            
            
            38,852
            
            
            31,130Property
                and equipment, net
            
            
            8,361
            
            
            4,300Investments
                in affiliated companies and subsidiaries
            
            
            463
            
            
            410Marketable
                equity securities - available for sale
            
            
            539
            
            
            539Goodwill
            
            
            16,688
            
            
            14,227Other
                assets - debt issuance costs (net)
            
            
            957
            
            
            -**TOTAL
                ASSETS**
            
            **$**
            **65,860**
            
            **$**
            **50,606****LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                Liabilities:Bank
                line of Credit
            
            
            889
            
            
            1,060Bank
                loans-current portion
            
            
            401
            
            
            188Capital
                lease obligations - current portion
            
            
            88
            
            
            126Accounts
                payable
            
            
            4,101
            
            
            3,186Accrued
                expenses and other payables
            
            
            2,558
            
            
            4,620Income
                tax payable
            
            
            33
            
            
            296Subscription
                payable
            
            
            390
            
            
            775Loan
                payable to related party
            
            
            570
            
            
            369Total
                Current Liabilities
            
            
            9,030
            
            
            10,620Long-term
                liabilities:Bank
                loans - non current portion
            
            
            1,498
            
            
            6Capital
                lease obligations - non current portion
            
            
            43
            
            
            78Convertible
                DebentureWarrant
                Liability
            
            
            615Compound
                Embedded Derivatives Liability
            
            
            7,177Total
                long-term liabilities
            
            
            9,333
            
            
            84Total
                liabilities
            
            
            18,363
            
            
            10,704Minority
                interest in consolidated subsidiaries
            
            
            11,898
            
            
            8,714Commitments
                and contingenciesStockholders'
                Equity:Preferred
                stock, par value $0.0001, Authorized - 5,000,000 sharesIssued
                and outstanding - none
            
            
            --
            
            
            --Common
                stock, par value $0.0001, Authorized - 125,000,000 shares;
              Issued
                and outstanding:June
                30, 2006 - 13,483,497 shares issued, 11,369,336
                outstandingDecember
                31, 2005 - 12,000,687 issued, 10,831,024 outstanding
            
            
            1
            
            
            1Treasury
                stock, at cost (2006 Q2: 2,114,161 shares, 2005: 1,169,663 shares)
            
            
            (243
            )
            
            (119
            )Additional
                paid-in capital
            
            
            60,678
            
            
            57,690Cumulative
                other comprehensive income (loss)
            
            
            399
            
            
            247Accumulated
                deficit
            
            
            (24,714
            )
            
            (26,587
            )Less
                stock subscription receivable
            
            
            (522
            )
            
            (44
            )Total
                Stockholders' Equity
            
            
            35,599
            
            
            31,188**TOTAL
                LIABILITIES AND STOCKHOLDERS' EQUITY**
            
            **$**
            **65,860**
            
            **$**
            **50,606**




3


**PACIFICNET
      INC. AND SUBSIDIARIES**


**CONSOLIDATED
      INCOME STATEMENTS**


(Unaudited.
      In thousands of United States dollars, except loss per share and share
      amounts)







THREE
                MONTHS ENDED JUNE 30
            
            SIX
                MONTHS ENDED JUNE 302006
            
            2005
              (as
                restated)
            
            2006
            
            2005
              (as
                restated)Revenues
            
            $
            19,330
            
            $
            12,280
            
            $
            34,364
            
            $
            21,492Services
            
            
            7,812
            
            
            6,060
            
            
            16,700
            
            
            9,324Product
                sales
            
            
            11,518
            
            
            6,220
            
            
            17,664
            
            
            12,168Cost
                of revenues
            
            
            (14,407
            )
            
            (9,613
            )
            
            (22,960
            )
            
            (17,127
            )Services
            
            
            (4,027
            )
            
            (3,880
            )
            
            (7,283
            )
            
            (6,201
            )Product
                sales
            
            
            (10,380
            )
            
            (5,733
            )
            
            (15,677
            )
            
            (10,926
            )Gross
                margin
            
            
            4,923
            
            
            2,667
            
            
            11,404
            
            
            4,365Selling,
                general and administrative expenses
            
            
            (3,177
            )
            
            (1,376
            )
            
            (7,500
            )
            
            (2,257
            )Depreciation
                and amortization
            
            
            (161
            )
            
            (99
            )
            
            (219
            )
            
            (142
            )Interest
                expense
            
            
            (214
            )
            
            -
            
            
            (302
            )
            
            -**EARNINGS
                FROM OPERATIONS**
            
            
            1,371
            
            
            1,192
            
            
            3,383
            
            
            1,966Interest
                income
            
            
            49
            
            
            -
            
            
            81
            
            
            -Change
                in fair value of derivatives
            
            
            208
            
            
            
            
            
            208Sundry
                income
            
            
            161
            
            
            313
            
            
            286
            
            
            406**Earnings
                before Income Taxes and Minority Interest**
            
            
            1,789
            
            
            1,505
            
            
            3,958
            
            
            2,372Provision
                for income taxes
            
            
            (85
            )
            
            (37
            )
            
            (200
            )
            
            (64
            )Share
                of earnings of associated companies
            
            
            52
            
            
            12
            
            
            49
            
            
            4Minority
                interests
            
            
            (804
            )
            
            (887
            )
            
            (1,934
            )
            
            (1,304
            )**Net
                Earnings Available to Common Stockholders**
            
            $
            952
            
            $
            593
            
            $
            1,873
            
            $
            1,008**BASIC
                EARNINGS PER SHARE**
            
            $
            0.09
            
            $
            0.06
            
            $
            0.17
            
            $
            0.10**DILUTED
                EARNINGS PER SHARE**
            
            $
            0.08
            
            $
            0.06
            
            $
            0.16
            
            $
            0.10




The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.




4
 **PACIFICNET
        INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY**







**PREFERRED
                STOCK**
            
            **COMMON
                STOCK**
            
            **ADDITIONAL
                PAID-IN CAPITAL**
            
            **STOCK
                SUBSCRIPTION**
              **RECEIVABLE**
            
            **CUMULATIVE
                OTHER COMPREHENSIVE INCOME**
            
            **ACCUMUL**
              **ATED**
              **DEFICIT**
            
            **TREASURY
                STOCK**
            
            **TOTAL
                STOCKHOLDERS' EQUITY****BALANCE
                AT DECEMBER 31, 2005**
              **(10,831,024
                SHARES)**
            
            
            **--**
            
            **$**
            **1**
            
            **$**
            **57,690**
            
            **$**
            **(44**
            **)**
            **$**
            **247**
            
            
            **($26,587**
            **)**
            
            **($119**
            **)**
            **$**
            **31,188**Net
                earnings
            
            
            --
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,873
            
            
            
            
            
            1,873Exercise
                of stock options for cash and receivable (269,000 shares)
            
            
            --
            
            
            
            
            
            564
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            564Issuance
                of common stock for acquisition of subsidiaries(293,512
                shares)
            
            
            --
            
            
            
            
            
            2,275
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,275PIPE
                related expenses
            
            
            --Repurchase
                of common shares(less
                24,200 shares)
            
            
            --
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (124
            )
            
            (124
            )Cumulative
                foreign exchange gain/(loss)
            
            
            --
            
            
            
            
            
            
            
            
            
            
            
            152
            
            
            
            
            
            
            
            
            152Stock-based
                compensation
            
            
            
            
            
            
            
            
            120
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            120Issuance
                of warrants for fees of issuing convertible debt (16,000
                warrants)
            
            
            
            
            
            
            
            
            29
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            29Less
                stock subscription receivable
            
            
            --
            
            
            
            
            
            
            
            
            (478
            )
            
            
            
            
            
            
            
            
            
            
            (478
            )**BALANCE
                AT JUNE 30, 2006**
              **(11,369,336
                SHARES)**
            
            
            **--**
            
            **$**
            **1**
            
            **$**
            **60,678**
            
            **$**
            **(522**
            **)**
            **$**
            **399**
            
            **$**
            **(24,714**
            **)**
            **$**
            **(243**
            **)**
            **$**
            **35,599**







The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.




5
 **PACIFICNET
        INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(Unaudited.
      In thousands of United States dollars, except earnings per share and share
      amounts)




SIX
                MONTHS ENDED JUNE 30**2006**
            
            **2005****Cash
                Flows from operating activities**Net
                earnings
            
            $
            1,873
            
            $
            1,008*Adjustment
                to reconcile net earnings to net cash used in operating
                activities:*Equity
                loss of associated company
            
            
            (49
            )
            
            (4
            )Provision
                for income taxes
            
            
            33
            
            
            64Provision
                for allowance for doubtful accounts
            
            
            28
            
            
            -Minority
                Interest
            
            
            1,934
            
            
            1304Depreciation
                and amortization
            
            
            768
            
            
            141Stock-based
                compensation
            
            
            120
            
            
            *-*Change
                in fair value of derivatives
            
            
            (208
            )
            
            -*Changes
                in current assets and liabilities net of effects from purchase of
                subsidiaries:*Accounts
                receivable and other current assets**
            
            
            (10,370
            )
            
            (2,027
            )Inventories
            
            
            (415
            )
            
            (891
            )Accounts
                payable and other accrued expenses
            
            
            (1,745
            )
            
            295***Net
                cash used in operating activities***
            
            
            **(8,031**
            **)**
            
            **(110**
            **)****Cash
                flows from investing activities**Decrease
                in restricted cash
            
            
            1,422
            
            
            2,796Increase
                in purchase of marketable securities
            
            
            -
            
            
            (421
            )Acquisition
                of property and equipment
            
            
            (3,124
            )
            
            (1,341
            )Acquisition
                of subsidiaries and affiliated companies
            
            
            (836
            )
            
            (1,183
            )Loans
                receivable from third parties
            
            
            562
            
            
            (2,081
            )Loans
                receivable from related party
            
            
            (2,233
            )
            
            (1,157
            )***Net
                cash used in investing activities***
            
            
            **(4,209**
            **)**
            
            **(3,387**
            **)****CASH
                FLOWS FROM FINANCING ACTIVITIES:**Increase
                in loan payable to related party
            
            
            201
            
            
            390Advances
                (repayments) under bank line of credit
            
            
            (171
            )
            
            142Advances
                under bank loan
            
            
            623
            
            
            727Increase
                (repayments) of amount borrowed under capital lease obligations
            
            
            (73
            )
            
            62Repurchase
                of treasury shares
            
            
            (124
            )
            
            -Proceeds
                from exercise of stock options and warrants
            
            
            86
            
            
            981Proceeds
                from issuance of convertible debenture
            
            
            8,000
            
            
            -***Net
                cash provided by financing activities***
            
            
            **8,542**
            
            
            **2,302****Effect
                of exchange rate change on cash and cash
                equivalents**
            
            
            **54**
            
            
            **-****NET
                DECREASE IN CASH AND CASH EQUIVALENTS**
            
            
            **(3,644**
            **)**
            
            **(1,195**
            **)****CASH
                AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD**
            
            
            **9,579**
            
            
            **6,764****CASH
                AND CASH EQUIVALENTS, END OF THE PERIOD**
            
            **$**
            **5,935**
            
            **$**
            **5,569****CASH
                PAID FOR:**Interest
            
            $
            292
            
            $
            127Income
                taxes
            
            $
            463
            
            $
            34**NON-CASH
                INVESTING AND FINANCING ACTIVITIES:**Issuance
                of option shares through increase in subscription
                receivable
            
            
            522
            
            
            -Investments
                in subsidiaries acquired through the issuance of common stock
            
            
            2,275
            
            $
            1,977




The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.




6


**PACIFICNET
      INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Amounts
      expressed in United States dollars unless otherwise stated)







**1.
      BASIS OF PRESENTATION**




***Description
      of Operations*** -
      PacificNet Inc. (referred to herein as "PacificNet" or the "Company"), through
      our subsidiaries, provides outsourcing services, value-added telecom services
      (VAS), communication products distribution services and the design and
      distribution of entertainment kiosks and gaming machines. Our business process
      outsourcing (BPO) services include call centers, providing customer relationship
      management (CRM), mail order direct marketing and telemarketing services, and
      our information technology outsourcing (ITO) includes software programming
      and
      development. We are value-added resellers and providers of telecom VAS, which
      is
      comprised of interactive voice response (IVR) systems, call center management
      systems, and voice over Internet protocol (VOIP), as well as mobile phone VAS,
      such as short messaging services (SMS) and multimedia messaging services (MMS).
      The Company's operations are primarily targeted in the mainland China, Hong
      Kong
      and Macau Special Administrative Region markets.




***Condensed
      Consolidated Financial Statements*** - The
      condensed consolidated financial statements have been prepared in accordance
      with U.S. generally accepted accounting principles (“GAAP”) for interim
      financial reporting consistent in all material respects with those applied
      in
      the Company’s Annual Report on Form 10-KSB for the year ended December 31,
      2005, but do not include all disclosures required by GAAP. You should read
      these
      interim condensed consolidated financial statements in conjunction with the
      audited financial statements, including the notes thereto, and the other
      information set forth in the Company’s Annual Report on Form 10-KSB for the year
      ended December 31, 2005. The condensed unaudited consolidated financial
      statements include the accounts of Pacificnet Inc. and its subsidiaries and
      variable interest entities (“VIEs”) for which the Company is the primary
      beneficiary. All significant intercompany balances and transactions have been
      eliminated in consolidation. In the opinion of management, all material
      adjustments considered necessary for a fair presentation of the Company’s
      interim results have been reflected. PacificNet’s 2005 Annual Report on Form
      10-KSB includes certain definitions and a summary of significant accounting
      policies and should be read in conjunction with this report. The results for
      interim periods are not necessarily indicative of annual results.




***Use
      of Estimates*** - The
      preparation of the consolidated financial statements in conformity with GAAP
      requires 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 reported amounts of
      revenues and expenses during the reporting period. Actual results could differ
      from those estimates, and such differences may be material to the financial
      statements. Certain prior year amounts have been reclassified to conform to
      the
      current year presentation.







**2.
      RECENT ACCOUNTING PRONOUNCEMENTS**




In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards (“SFAS”) 123-R, *Share-Based
      Payment* (“SFAS
      123(R)”). SFAS 123(R) replaces SFAS 123, *Accounting
      for Stock-Based Compensation* ,
      and
      supersedes APB Opinion 25, *Accounting
      for Stock Issued to Employees* .
      SFAS
      123(R) requires, among other things, that all share-based payments to employees,
      including grants of stock options, be measured based on their grant-date fair
      value and recognized as expense. Effective January 1, 2006, PacificNet adopted
      the fair value recognition provisions of SFAS 123(R) using the modified
      prospective application method. Under this transition method, compensation
      expense recognized for the quarter June 30, 2006, includes the applicable
      amounts of: (a) compensation expense of all stock-based payments granted prior
      to, but not yet vested as of January 1, 2006 (based on the grant-date fair
      value
      estimated in accordance with the original provisions of SFAS 123 and previously
      presented in pro forma footnote disclosures), and (b) compensation expense
      for
      all stock-based payments granted subsequent to January 1, 2006 (based on the
      grant-date fair value estimated in accordance with the new provisions of SFAS
      123(R)). Results for periods prior to January 1, 2006, have not been restated.
      See Note 7.




7


In
      February 2006, the FASB issued SFAS No. 155, *Accounting
      for Certain Hybrid Financial Instruments—an amendment of FASB Statements
      No. 133 and 140* (“SFAS 155”). This statement amends *SFAS
      No. 133,*  *Accounting
      for Derivative Instruments and Hedging Activities* (“SFAS 133”), and SFAS No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities* and
      resolves issues addressed in SFAS 133 Implementation Issue No. D1,
“Application of Statement 133 to Beneficial Interest in Securitized
      Financial Assets.” This Statement: (a) permits fair value re-measurement
      for any hybrid financial instrument that contains an embedded derivative that
      otherwise would require bifurcation; (b) clarifies which interest-only
      strips and principal-only strips are not subject to the requirements of
      SFAS 133; (c) establishes a requirement to evaluate beneficial
      interests in securitized financial assets to identify interests that are
      freestanding derivatives or that are hybrid financial instruments that contain
      an embedded derivative requiring bifurcation; (d) clarifies that
      concentrations of credit risk in the form of subordination are not embedded
      derivatives; and, (e) eliminates restrictions on a qualifying
      special-purpose entity’s ability to hold passive derivative financial
      instruments that pertain to beneficial interests that are or contain a
      derivative financial instrument. The standard also requires presentation within
      the financial statements that identifies those hybrid financial instruments
      for
      which the fair value election has been applied and information on the income
      statement impact of the changes in fair value of those instruments. The Company
      is required to apply SFAS 155 to all financial instruments acquired, issued
      or subject to a re-measurement event beginning January 1, 2007, although
      early adoption is permitted as of the beginning of an entity’s fiscal year. The
      Company is evaluating the provisions of SFAS 155. The effects of adopting
      of SFAS 155 on the Company’s financial statements are not known at this
      time.




In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an
      Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the
      accounting for uncertainty in tax positions. This Interpretation requires that
      the Company recognize in its financial statements the impact of a tax position
      if that position is more likely than not of being sustained on audit, based
      on
      the technical merits of the position. The provisions of FIN 48 are effective
      for
      the Company on January 1, 2007, with the cumulative effect of the change in
      accounting principle, if any, recorded as an adjustment to opening retained
      earnings. The Company is currently evaluating the impact of adopting FIN 48
      on
      its consolidated financial position, cash flows and results of operations.




Other
      recent accounting pronouncements issued by the FASB (including its Emerging
      Issues Task Force (“EITF”)), the American Institute of Certified Public
      Accountants (“AICPA”), and the SEC did not or are not believed by management to
      have a material impact on the Company's present or future financial
      statements.







**3.
      EARNINGS PER SHARE**




Basic
      and
      diluted earnings per share (EPS) amounts in the financial statements are
      computed in accordance with SFAS No. 128, "Earnings Per Share." Basic EPS is
      based on the weighted average number of common shares outstanding. Diluted
      EPS
      is based on the weighted average number of common shares outstanding plus
      dilutive common stock equivalents. Basic EPS is computed by dividing net
      earnings available to common stockholders (numerator) by the weighted average
      number of common shares outstanding (denominator) during the period. Diluted
      EPS
      is calculated by dividing net earnings by the weighted average number of common
      shares outstanding and other dilutive securities. Dilutive EPS for second
      quarter of 2006 exclude the potential dilutive effect of 766,000 warrants and
      800,000 convertible debentures because their impact would be anti-dilutive
      based
      on current market prices. All per share and per share information are adjusted
      retroactively to reflect stock splits and changes in par value.




The
      reconciliation of the numerators and denominators of the basic and diluted
      EPS
      calculations was as follows:





Three
                Months Ended June 30
            
            Six
                Months Ended June 302006
            
            2005
            
            2006
            
            2005(IN
                THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND PER
                SHARE
                AMOUNTS)
            
            (IN
                THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND PER
                SHARE
                AMOUNTS)Numerator:
                earnings
            
            $
            952
            
            $
            593
            
            $
            1,873
            
            $
            1,008Denominator:Weighted-average
                shares used to compute basic EPS
            
            
            11,022,984
            
            
            9,887,274
            
            
            10,939,834
            
            
            9,840,681Dilutive
                potential from assumed exercise of stock options and
                warrants
            
            
            856,713
            
            
            731,501
            
            
            962,185
            
            
            718,383Weighted-average
                shares used to compute diluted EPS
            
            
            11,879,697
            
            
            10,618,775
            
            
            11,902,019
            
            
            10,559,064Basic
                earnings per common share:
            
            $
            0.09
            
            $
            0.06
            
            $
            0.17
            
            $
            0.10Diluted
                earnings per common share:
            
            $
            0.08
            
            $
            0.06
            
            $
            0.16
            
            $
            0.10




8


**4.
      GOODWILL AND PURCHASED INTANGIBLE ASSETS**




The
      changes in the carrying amount of goodwill for the following reporting periods
      are summarized below:





(US$000s)
            
            Group
                1.
              Outsourcing
              Services
            
            Group
                2.
              Value-Added
              Services
            
            Group
                3.
              Distribution
                of
              Communications
            
            TotalBalance
                as of December 31, 2005
            
            $
            3,543
            
            $
            9,584
            
            $
            1,100
            
            $
            14,227Goodwill
                acquired during the first quarter
            
            
            --
            
            
            461
            
            
            --
            
            
            461Impairment
                losses
            
            
            --
            
            
            --
            
            
            --
            
            
            --Goodwill
                written off related to sale of business unit
            
            
            --
            
            
            --
            
            
            --
            
            
            --Balance
                as of March 31, 2006
            
            $
            3,543
            
            $
            10,045
            
            $
            1,100
            
            $
            14,688Goodwill
                acquired during the second quarter
            
            
            --
            
            
            1,571
            
            
            429
            
            
            2,000Impairment
                losses
            
            
            --
            
            
            --
            
            
            --
            
            
            --Goodwill
                written off related to sale of business unit
            
            
            --
            
            
            --
            
            
            --
            
            
            --Balance
                as of June 30, 2006
            
            $
            3,543
            
            $
            11,616
            
            $
            1,529
            
            $
            16,688






**5** **.
      STOCKHOLDERS' EQUITY**




a)
      COMMON
      STOCK




For
      the
      quarter ended June 30, 2006, the Company had the following equity transactions:
      (i) 245,000 shares of common stock were issued as a result of the exercise
      of
      stock options with cash consideration of $521,700 in the aggregate; (ii) 234,725
      shares of common stock were released from escrow (PACT treasury shares) for
      acquisition of iMobile and GZ3G valued at $1,877,800.







b)
      STOCK
      OPTION PLAN - See Note 7 for further details.




The
      status of the Stock Option Plan as of June 30, 2006, is as follows:





OPTIONS
            
            WEIGHTED
              AVERAGE
              EXERCISE
                PRICEOUTSTANDING,
                DECEMBER 31, 2005
            
            
            1,384,100
            
            $
            3.99Granted
            
            
            -
            
            
            -Cancelled
            
            
            -
            
            
            -Exercised
            
            
            (24,000
            )
            $
            1.75OUTSTANDING,
                MARCH 31, 2006
            
            
            1,360,100
            
            $
            4.17Granted
            
            
            -
            
            
            -Cancelled
            
            
            (680,000
            )
            $
            6.57Exercised
            
            
            (245,000
            )
            $
            2.13OUTSTANDING,
                JUNE 30, 2006
            
            
            435,100
            
            $
            2.00




On
      May
      28, the board of director and management approved and authorized the
      cancellation of 680,000 stock options that were previously granted during fiscal
      year 2005, that were unvested and unexercised. The option cancellation was
      authorized by the board and the management in order to reduce stock compensation
      expense due to the implementation of FASB 123R.




9


c)
      WA RRANTS




At
      June
      30, 2006, the Company had outstanding and exercisable warrants to purchase
      an
      aggregate of 1,007,138 shares of common stock. The weighted average remaining
      life is 3.88 years and the weighted average price per share is $10.61 per share
      as follows:




Shares
                of common stock
            
            EXERCISE
                PRICE
              PER
                SHARE
            EXPIRATION
                DATE OF
              WARRANTS123,456
            
            $7.15
            January
                15, 2009117,682
            
            $3.89
            November
                15, 2009350,000
            
            $12.21
            December
                9, 2009400,000
            
            $12.20
            March
                13, 201116,000
            
            $12.20
            March
                13, 20111,007,138




On
      March
      13 of 2006, we issued 400,000 warrants to several institutional investors in
      connection with a private placement of $8 million in convertible debentures.
      On
      the same day we issued 16,000 warrants to our placement agent for the
      transaction. See Note 7 for further details.






d)
      TREASURY STOCK




The
      following is a summary of the movement of the Company's shares held as treasury
      stock for the quarterly ended June 30 of 2006:





**Number
                of**
              **shares**
            
            **Remarks**Balance,
                December 31, 2005:
            
            
            1,169,663Plus:
                options exercised and issued during Q1
            
            
            24,000Share
                consideration for acquisition of ChinaGoHi issued during Q1 under
                Sale and
                Purchase Agreement
            
            
            137,500Less:
                Shares issued to Shanghai Classic
            
            
            (24,200
            )Plus:
                Repurchase of shares from Shanghai Classic
            
            
            24,200Holdback
                shares as contingent consideration
              due
                to performance targets not yet met
            
            
            1,017,723
            
            
            Including
                687,500 shares relating to ChinaGoHi; 138,348 shares to Guangzhou
                Wanrong;
                191,875 shares to iMobileBalance,
                March 31, 2006
            
            
            2,348,886Less:  
                Shares issued to iMobile
            
            
            (38,375
            )Shares
                issued to Guangzhou 3G
            
            
            (196,350
            )Balance,
                June 30, 2006
            
            
            **2,114,161**Shares
                outstanding at June 30, 2006
            
            
            11,369,336Shares
                issued at June 30, 2006
            
            
            13,483,497




On
      March
      13, 2006, we repurchased 24,200 restricted shares of our common stock from
      Yueshen, a subsidiary of Shanghai Classic for a repurchase price of RMB1,000,000
      (approximately USD$124,223 using exchange rate of 1USD= 8.05 RMB). The
      repurchase of the shares was proposed by Yueshen and was unanimously agreed
      by
      the both parties.




10


**6.
      STOCK-BASED COMPENSATION**




Prior
      to
      January 1, 2006, PacificNet accounted for awards granted under stock-based
      compensation plans following the recognition and measurement principles of
      APB
      25, *Accounting
      for Stock Issued to Employees* ,
      and
      related interpretations. Accordingly, compensation expense was recognized for
      awards granted at an exercise price less than fair market value of the
      underlying common stock on the date of grant. Effective January 1, 2006,
      PacificNet adopted the fair value recognition provisions of SFAS 123(R). See
      Note 2 for a
      description of the Company’s adoption of SFAS 123R. The fair value of stock
      options is determined using the Black-Scholes option pricing model, which is
      consistent with the valuation techniques previously utilized for options in
      footnote disclosures required under SFAS 123, as amended by FASB Statement
      No. 148, “Accounting for Stock-Based Compensation - Transition and
      Disclosure.” The determination of the fair value of stock-based compensation
      awards on the date of grant using an option-pricing model is affected by the
      Company’s stock price as well as assumptions regarding a number of complex and
      subjective variables, including the expected volatility of the Company’s stock
      price over the term of the awards, actual and projected employee stock option
      exercise behaviors, risk-free interest rate and expected dividends. The
      amount of stock-based compensation expense recognized during the three months
      ended June 30, 2006 was $58,334.




During
      the quarter ended June 30, 2006, the Company did not grant any new stock
      options, 245,000 options were exercised, and 680,000 options were cancelled.
      See
      note 5 b) for the status of the Company’s stock option plan.




Additional
      information on options outstanding as of June 30, 2006 is as
      follows:





WEIGHTED
              AVERAGE
              EXERCISE
              PRICE
            OPTIONS
            AVERAGE
              REMAINING
              CONTRACTUAL
              LIFEOptions
                outstanding
            $2.00
            435,100
            1.08
                yearsOptions
                exercisable
            $2.00
            435,100
            1.08
                years






**7.
      CONVERTIBLE DEBENTURES**




On
      March
      13, 2006, we completed a private placement in which we sold $8,000,000 in
      convertible debentures and issued warrants to purchase up to an aggregate of
      400,000 shares of common stock. The debentures are convertible at any time
      into
      shares of our common stock at an initial fixed conversion price of $10.00 per
      share, subject to adjustments for certain dilutive events. The debentures are
      due March 13, 2009. The warrants are exercisable for a period of five years
      at
      an exercise price of $12.20 per share. At the closing of the private placement,
      we prepaid the first year's interest on debentures equal to 5% of the aggregate
      principal amount of debentures. We will pay interest in cash or shares, provided
      that certain conditions are met, at the rate of 6% for the second year the
      debentures are outstanding and then 7% for the third. Beginning January 1,
      2007,
      we are obligated to redeem up to $320,000 every month, plus accrued, but unpaid
      interest, liquidated damages and penalties. We also have the option to prepay
      the debentures at any time, provided that certain conditions have been met,
      after the 12 month anniversary of the effective date of the registration
      statement that has been filed with the Securities and Exchange Commission with
      respect to the common stock issuable upon conversion of the debentures, some
      or
      all of the outstanding debentures for cash in an amount equal to 120% of the
      principal amount outstanding, plus accrued, but unpaid interest, liquidated
      damages and penalties outstanding. At any time after the six month anniversary
      of the effective date of the registration statement, we may force the holders
      to
      convert up to 50% of the then outstanding principal amount of the debentures,
      subject to certain trading conditions being met. If any event of default occurs
      under the debentures or other related documents, the holders may elect to
      accelerate the payment of the outstanding principal amount of the
      debenture, plus accrued, but unpaid interest, liquidated damages and penalties,
      which shall become immediately due and payable.




C.E.
      Unterberg, Towbin L.L.C. acted as placement agent and received a negotiated
      cash
      fee in the amount of $449,500 and a warrant to purchase up to 16,000 shares
      at
      an exercise price of $12.20 per share, which expire five years from the date
      of
      issuance. The fair value of these warrants totaled $28,952 and such amount
      was
      charged to other assets, net, and will be amortized over the life of the
      debentures, and credited to additional paid-in capital during the six months
      ended June 30, 2006. Maxim Group also acted as Placement Agent and received
      a
      cash fee in the amount of $50,000.




In
      connection with the issuance of the debentures, the Company incurred $1,043,000
      of issuance costs, which primarily consisted of investment banker fees, legal
      and other professional fees. These costs are being amortized and are recorded
      as
      additional expense through three years, the scheduled date on which holders
      have
      the option to require the Company to repurchase the debentures. Amortization
      expense related to the issuance costs during the three months ended June 30,
      2006 was $86,000. At June 30, 2006, net debt issuance costs associated with
      the
      debentures was $957,000 and is recorded in other assets, net.




11


The
      gross
      proceeds of $8,000,000 are recorded as a liability net of a debt discount of
      $8,000,000 consisting of an allocation of the fair values attributed to the
      Investors’ warrants and to the embedded conversion feature in accordance with
      EITF issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to
      and Potentially Settled in a Company’s Own Stock.” The debt discount consisted
      of a $693,278 value related to the Investors’ warrants and a value attributed to
      the compound embedded derivatives liability, including embedded options and
      registration rights.




In
      accordance with recent FASB guidance, due to certain factors, including a
      liquidated damages provision in the registration rights agreement and an
      indeterminate amount of shares to be issued upon conversion of the debentures,
      the Company values and accounts for the embedded conversion feature related
      to
      the Debentures, the Investors’ warrants, and the registration rights as
      derivative liabilities. Accordingly, these derivative liabilities are measured
      at fair value with changes in fair value reported in earnings as long as they
      remain classified as liabilities. The Company reassesses the classification
      at
      each balance sheet date. If the classification required under EITF No. 00-19
      changes as a result of events during the period, the contract should be
      reclassified as of the date of the event that caused the
      reclassification.




An
      aggregate gain of $207,679 representing the change in fair value of these
      derivative liabilities was recognized during the six months ended June 30,
      2006.







**8.
      SEGMENT INFORMATION**




The
      Company determines and classified its operating segments in accordance with
      SFAS
      No. 131 “DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
      INFORMATION.”  The
      Company identifies and classifies its operating segments based on reporting
      entities that exhibit similar long-term financial performance based on the
      nature of the products and services with similar economic characteristics such
      as margins, business practices and target market. The operating segments are
      classified into four major segments which are summarized as
      follows:




(1)
      Outsourcing Services - involves human voice services such as Business Process
      Outsourcing, CRM, call center, IT Outsourcing and software development services.
      These types of services are conducted through our subsidiaries EPRO,
      Smartime/Soluteck and PacificNet Solution Ltd.




(2)
      Value-Added Telecom Services (VAS) - primarily involves machine voice services
      such as Interactive Voice Response, SMS and related VAS, which are conducted
      through our subsidiaries such as ChinaGoHi (Lion Zone, aka ChinaGoHi), Linkhead,
      Clickcom and Guangzhou 3G.




(3)
      Communication Products Distribution Services Group - primarily involves voice
      products distribution such as distribution of mobile phones and related software
      and accessories, calling cards and other communication products, as well as
      gaming machines and entertainment kiosks, which are conducted through our
      subsidiaries iMobile, Shanghai Classic, PacificNet Communications Limited,
      Take1
      and PacificNet Games Limited.




(4)
      Other
      Business -other administrative, financial and investment services and non-core
      businesses such as PacificNet Power Limited (PacPower), Pacific Financial
      Services Limited, etc.




The
      Company's reportable segments are operating units, which represent the
      operations of the Company's significant business operations. Summarized
      financial information concerning the Company's reportable segments is shown
      in
      the following table. The "Other" column includes the Company's other
      insignificant services and corporate related items, and, as it relates to
      segment earnings (loss), income and expense not allocated to reportable
      segments.





For
                the three months ended June 30, 2006
            Group
                1.
              Outsourcing
              Business
              ($)
            Group
                2.
              VAS
                Business
              
              ($)
            Group
                3.
              Communications
              Distribution
              Business
                ($)
            Group
                4.
              Other
                Business
              
              ($)
            Total
              
              
              ($)Revenues
            3,552,000
            5,517,000
            8,914,000
            1,347,000
            19,330,000(%
                of Total Revenues)
            18%
            29%
            46%
            7%
            100%Earnings
                / (Loss) from Operations
            283,000
            1,130,000
            208,000
            -250,000
            1,371,000(%
                of Total Earnings)
            21%
            82%
            15%
            -18%
            100%Total
                Assets
              (%
                of Total Assets)
            8,503,000
              13%
            20,382,000
              31%
            12,626,000
              19%
            24,349,000
              37%
            65,860,000
              100%Goodwill
            3,543,000
            11,616,000
            1,529,000
            -
            16,688,000Geographic
                Area
            HK,
                PRC
            PRC
            HK,
                PRC
            HK,PRC,USA




12





For
                the three months ended June 30, 2005
            Group
                1.
              Outsourcing
              Business
              ($)
            Group
                2.
              VAS
                Business
              
              ($)
            Group
                3.
              Communications
              Distribution
              Business
                ($)
            Group
                4.
              Other
                Business
              
              ($)
            Total
              
              ($)Revenues
            3,403,000
            4,744,000
            4,055,000
            78,000
            12,280,000(%
                of Total Revenues)
            28%
            39%
            33%
            1%
            100%Earnings
                / (Loss) from Operations
            305,000
            1,086,000
            118,000
            -317,000
            1,192,000(%
                of Total Earnings)
            26%
            91%
            10%
            -27%
            100%Total
                Assets
              (%
                of Total Assets)
            5,468,000
              13%
            11,261,000
              27%
            13,661,000
              32%
            12,030,000
              28%
            42,420,000
              100%Goodwill
            3,543,000
            8,005,000
            1,100,000
            -
            12,648,000Geographic
                Area
            HK,
                PRC
            PRC
            HK,
                PRC
            HK,PRC,USA







For
                the six months ended June 30, 2006
            Group
                1.
              Outsourcing
              Business
              ($)
            Group
                2.
              VAS
                Business
              
              ($)
            Group
                3.
              Communications
              Distribution
              Business
                ($)
            Group
                4.
              Other
                Business
              
              ($)
            Total
              
              
              ($)Revenues
            6,579,000
            12,557,000
            11,851,000
            3,377,000
            34,364,000(%
                of Total Revenues)
            19%
            37%
            34%
            10%
            100%Earnings
                / (Loss) fromOperations
            403,000
            2,844,000
            265,000
            -129,000
            3,383,000(%
                of Total Earnings)
            12%
            84%
            8%
            -4%
            100%Total
                Assets
            8,503,000
            20,382,000
            12,626,000
            24,349,000
            65,860,000(%
                of Total Assets)
            13%
            31%
            19%
            37%
            100%Goodwill
            3,543,000
            11,616,000
            1,529,000
            -
            16,688,000Geographic
                Area
            HK,
                PRC
            PRC
            HK,
                PRC
            HK,PRC,USA







For
                the six months ended June 30, 2005
            Group
                1.
              Outsourcing
              Business
              ($)
            Group
                2.
              VAS
                Business
              
              ($)
            Group
                3.
              Communications
              Distribution
              Business
                ($)
            Group
                4.
              Other
                Business
              
              ($)
            Total
              
              ($)Revenues
            6,492,000
            6,154,000
            8,731,000
            115,000
            21,492,000(%
                of Total Revenues)
            30%
            29%
            41%
            1%
            100%Earnings
                / (Loss) fromOperations
            649,000
            1,589,000
            236,000
            -508,000
            1,966,000(%
                of Total Earnings)
            33%
            81%
            12%
            -26%
            100%Total
                Assets
            5,468,000
            11,261,000
            13,661,000
            12,030,000
            42,420,000(%
                of Total Assets)
            13%
            27%
            32%
            28%
            100%Goodwill
            3,543,000
            8,005,000
            1,100,000
            -
            12,648,000Geographic
                Area
            HK,
                PRC
            PRC
            HK,
                PRC
            HK,PRC,USA







13




Product
      and service revenues classified by major geographic areas are as follows (in
      US$):





For
                the three months ended June 30, 2006
            Hong
                Kong
            PRC
            United
                States
            TotalProduct
                revenues
            8,546,000
            2,972,000
            -
            11,518,000Service
                revenues
            3,504,000
            4,308,000
            -
            7,812,000






For
                the three months ended June 30, 2005
            Hong
                Kong
            PRC
            United
                States
            TotalProduct
                revenues
            4,085,000
            2,135,000
            -
            6,220,000Service
                revenues
            2,452,000
            3,608,000
            -
            6,060,000






For
                the six months ended June 30, 2006
            Hong
                Kong
            PRC
            United
                States
            TotalProduct
                revenues
            12,094,000
            5,570,000
            -
            17,664,000Service
                revenues
            6,535,000
            10,165,000
            -
            16,700,000






For
                the six months ended June 30, 2005
            Hong
                Kong
            PRC
            United
                States
            TotalProduct
                revenues
            8,761,000
            3,407,000
            -
            12,168,000Service
                revenues
            4,686,000
            4,638,000
            -
            9,324,000






**9** **.
      RELATED PARTY TRANSACTIONS**




*LOAN
      DUE TO AND FROM RELATED PARTIES*




As
      of
      June 30, 2006, there was a total loan receivable of approximately $4,753,000
      due
      from related parties while the loan due to related party was
      $570,000.




As
      of
      June 30, 2006, the related party loan receivables included $1,026,000 due from
      Take 1, an affiliated company that is 20% owned by PacificNet, and $3,727,000
      due from shareholders and directors of certain of the Company’s subsidiaries.
      The loans receivable from shareholders and directors of these subsidiaries
      is
      comprised of $1,249,000 due from a shareholder of Yueshen, $192,000 due from
      a
      director of Soluteck, $265,000 due from a director of Clickcom, and $2,021,000
      due from a company owned by a shareholder of Lion zone (ChinaGoHi). The terms
      of
      these related parties loan receivables and payables are summarized
      below:




*LOAN
      TO TAKE 1**(Cheer Era)*




Take
      1 is
      an affiliated company and is 20% owned by PacificNet as of June 30, 2006. A
      convertible loan of $1,026,000 is outstanding from Take 1 as of June 30, 2006.
      Conversion terms of the convertible loan provide PacificNet an option at any
      time during the Term to convert in part or in whole of the then outstanding
      loan
      principle up to $1,794,000 (or HKD$800,000) into shares of Take 1 to reach
      51%
      ownership of Take 1. The loan was extended as a working capital loan to finance
      the expansion of Take 1's business in Europe and North America.




14


*LOAN
      TO**YUESHEN'S
      SHAREHOLDER*




As
      of
      June 30, 2006, there was a $1,249,000 loan receivable due from the shareholder
      of Yueshen, a subsidiary of the Company. The purpose of the loan was to repay
      the working capital loan owed by the predecessor of Yueshen prior to
      PacificNet's acquisition, and to finance Yueshen shareholder's other projects.
      This loan is collateralized with 106,240 PacificNet shares owned by the
      shareholder of Yueshen.




*LOAN
      TO SOLUTEK'S DIRECTOR*




As
      of
      June 30, 2006, there was a loan outstanding of $192,000 receivable from a
      director of Soluteck, payable in three equal installments of $72,314 each,
      which
      includes principal plus interest, due on December 14 for three consecutive
      years
      ending 2007. The interest rate for the loan is 8% per annum plus 5% penalty
      interest in case it has not been timely paid. The loan is collateralized with
      100,000 PacificNet's shares owned by the borrowing director and Ms Iris Lo,
      and
      the remaining assets of Smartime Holding Ltd.




*L**OAN
      TO DIRECTOR OF CLICKCOM*




As
      of
      June 30, 2006, there was a loan of $265,000 receivable from the shareholders
      of
      Clickcom VIE. The loan was advanced by the Company to Clickcom VIE which in
      turn
      was loaned to the shareholders of Clickcom VIE to finance the development of
      new
      projects. Pursuant to the loan agreement signed between the Company and Clickcom
      VIE, this loan has a two year term and is due on August 30, 2007. The loan
      bears
      interest at a rate of 2% per annum and is personally and jointly guaranteed
      by
      all three of the shareholders of Clickcom VIE. As additional collateral,
      Clickcom VIE has pledged up to 130,000 PacificNet's shares and all remaining
      assets and equity ownership of Clickcom BVI.




*LOAN
      TO A COMPANY OWNED BY A SHAREHOLDER OF LION ZONE
      (CHINAGOHI)*




As
      of
      June 30, 2006, a loan of $2,021,000 was receivable from a company owned by
      a
      shareholder of Lion Zone (ChinaGoHi). The loan is collateralized with this
      company’s real estate.




*L**OAN
      PAYABLE TO RELATED PARTY*




As
      of
      June 30, 2006, a loan of $570,000 was payable to a shareholder of EPRO. The
      loan
      was advanced to Epro for working capital purposes. The loan is due on August
      4,
      2010. Interest being charged per annum is at Hong Kong Prime lending rate,
      which
      was approximately 6.5% per annum in 2005 and 8% in 2006..






**10.
      COMMITMENTS AND CONTINGENCIES**




*Operating
      leases* .
      The
      Company leases warehouse and office space under operating leases with fixed
      monthly rentals. None of the leases included contingent rentals. Lease expense
      charged to operations for 2006 Q2 amounted to $598,000 (2005 Q2: $191,000).
      Future minimum lease payments under non-cancelable operating leases are $819,000
      for July 2006 through June 2007 and $986,000 for July 2007 through June
      2012.




*Restricted
      Cash* - The
      Company has a $230,000 pledged bank deposit for Epro which represents overdraft
      protections with certain financial institutions.




*Bank
      Line Of Credit* :
      As of
      June 30, 2006, Epro has an overdraft banking facility with certain major
      financial institutions in the aggregate amount of $889,000, which is secured
      by
      a pledge of its fixed deposits of $230,000, pursuant to the following terms:
      interest will be charged at the Hong Kong Prime Rate per annum and payable
      at
      the end of each calendar month or the date of settlement, whichever is
      earlier.




*Minimum
      Stated Capital Requirements* .
      Guangzhou Dianxun Co, Limited (DE) ("Dianxun"), a subsidiary of the Group,
      is
      carrying on business as a telecommunication value added service provider in
      the
      People's Republic of China ("PRC"). Initially, Dianxun obtained a certificate
      (the "Certificate") from PRC authorities to transact business in accordance
      with
      PRC Telecommunication Rules which require that all telecommunication value
      added
      service providers n conduct business if the Certificate is granted, and if
      the
      Company maintains a minimum capital requirement of at least
      RMB10,000,000.




In
      order
      to satisfy the capital requirement of RMB 10,000,000, the shareholders of
      Dianxun contributed relevant assets equivalent to RMB9,000,000 on behalf of
      Dianxun and such assets were verified by an independent professional accountant.
      Subsequently, such assets were returned back to the shareholders. In the opinion
      of management, even though the capital requirement is not currently fulfilled,
      Dianxun can continue to carry on business. No provision for any loss arising
      from the consequential actions that may be taken by the authority in the PRC
      and
      any potential penalties or claims for the Company not maintaining the minimum
      stated capital requirements of the PRC have been made in these financial
      statements.




15


Dianxun's
      contribution to consolidated revenues and net earnings for 2006 was
      approximately 0.42% and 1.14% respectively. Pursuant to a request by the PRC
      authorities, PacificNet agreed to loan Clickcom the remaining balance of the
      registration capital to provide the stated capital in accordance with PRC
      laws.




*Bank
      Loans.* Bank
      loans represent the following at June 30, 2006:




Secured
                [1]
            $1,088,000Unsecured
            $811,000Less:
                current portion
            $401,000Non
                current portion
            $1,498,000




Bank
      Loans are generated by two of the Company's subsidiaries. One of the
      subsidiaries is Pacificnet Epro Holdings Limited, a company incorporated in
      the
      Hong Kong Special Administrative Region of the PRC, primarily engaged in the
      business of providing call center and customer relationship management (CRM)
      services as well as other business outsourcing services.




[1]
      The
      loans were secured by the following: joint and several personal guarantees
      executed by certain directors of the subsidiary of the Company; corporate
      guarantee executed by a subsidiary of the Company; second legal charge over
      a
      property owned by a subsidiary of the Company; and pledged bank deposits of
      $230,000 of a subsidiary of the Company.




(Aggregate
      future maturities of borrowing for the next five years are as follows: 2006:
      $354,000, 2007: $277,000 and 2008: $231,000)




The
      remaining bank loans of $1,038,000 are generated by PacificNet Inc. relating
      to
      a fixed asset bought during the first quarter with total cost of $1,648,000.
      The
      repayment of the bank loan was $44,000. (Aggregate future maturities of
      borrowing for the following period are as follows: Less than 1 year: $47,000,
      1-5 year: $217,000 and after 5 years: $774,000)






CAPITAL
      LEASE OBLIGATIONS. The Company leases various equipments under capital leases
      expiring in various years through 2008. Aggregate minimum future lease payments
      under capital leases for each of the next five years are as
      follows:




(2006:
      $88,000; 2007: $41,000; and 2008: $2,000)







**11** **.
      OTHER CURRENT ASSETS**




Other
      current assets consist of the following at June 30, 2006 (in
      thousands):





June
                30, 2006
              $
                (in thousands)Deposit
            
            
            $1,216Prepayment
            
            
            $1,027Other
                receivables
            
            
            $5,539Prepaid
                Expense
            
            
            $618Tax
                Receivable
            
            
            $44Total
            
            
            $8,444






**12.
      INVENTORY**




Inventories
      of approximately $2.4 million consist primarily of finished goods and represent
      telecommunication products such as mobile phone, rechargeable phone cards,
      smart
      chip, and interactive voice response cards and are accounted for using the
      first-in, first out (FIFO) method. Most inventories are held by the Company’s
      Linkhead subsidiary.




16


**13.
      SUBSCRIPTION RECEIVABLE**




Subscription
      receivable of approximately $522,000 represents funds receivable from the
      exercise of options.







**14.
      INCOME TAXES**




The
      Company is registered in the Delaware and has operations in primarily three
      tax
      jurisdictions - the PRC, Hong Kong and the United States. For operations in
      the
      United States of America, Hong Kong and Taiwan, the Company has incurred net
      accumulated operating losses for income tax purposes. The Company believes
      that
      it is more likely than not that these net accumulated operating losses will
      not
      be utilized in the future. Therefore, the Company has provided full valuation
      allowance for the deferred tax assets arising from the losses at these locations
      as of June 30, 2006. Accordingly, the Company has no net deferred tax assets
      as
      of June 30, 2006.




The
      components of income before income taxes are as follows:




United
      States of America




The
      components of earnings before income taxes separating U.S. and non U.S.
      operations are as follows:




As
      of
      June 30, 2006, the Company’s subsidiary in the United States of America had net
      operating loss carryforwards available to offset future taxable income. Federal
      net operating losses can generally be carried forward 20 years. The Tax Reform
      Act of 1986 limits the use of net operating loss and tax credit carryforwards
      in
      certain situations when changes occur in the stock ownership of a company.
      In
      the event the Company has a change in ownership, utilization of carryforwards
      could be restricted. The deferred tax assets for the United States subsidiary
      at
      June 30, 2006 consists mainly of net operating loss carryforwards and were
      fully
      reserved as the management believes it is more likely than not that these assets
      will not be realized in the future.




Hong
      Kong




As
      of
      June 30, 2006, the Company’s Hong Kong subsidiary had net operating loss
      carryforwards which can be carried forward indefinitely to offset future taxable
      income. The deferred tax assets for the Hong Kong subsidiary at June 30, 2006
      consists mainly of net operating loss carryforwards and were fully reserved
      as
      the management believes it is more likely than not that these assets will not
      be
      realized in the future.




China




Pursuant
      to the PRC Income Tax Laws, the Company’s subsidiaries and VIEs are generally
      subject to Enterprise Income Taxes (“EIT”) at a statutory rate of 33%, which
      comprises 30% national income tax and 3% local income tax. Some of these
      subsidiaries and VIEs are qualified new technology enterprises and under PRC
      Income Tax Laws, they are subject to preferential tax rates.




Composition
      of income tax expenses for China operation




The
      following table sets forth current and deferred portion of income tax expenses
      of the Company’s China subsidiaries and VIEs, which were included in the
      consolidated statements for the periods presented:




Deferred
      Tax Assets


Net
                  Operating Loss Carry forwards
              
              $
              86,000Total
                  deferred tax assets
              
              
              86,000Less:
                  Valuation Allowance
              
              
              (86,000
              )Deferred
                  Tax Assets
              
              $
              -


Income
      tax payable was approximately $33,000 at June 30, 2006, a decrease from $296,000
      at December 31, 2005. The decrease was primarily attributed to the settling
      of a
      tax liability by Lion Zone (ChinaGoHi).




17


**15.
      SUBSEQUENT EVENTS**




**Stock
      Option Exercise**




On
      July
      1, 2006, PacificNet issued 100,000 shares of common stock as a result of stock
      option exercise in accordance to PacificNet’s stock option plan.





**Business
      Acquisitions**




**Able
      Entertainment Technology Ltd by PacificNet Games Limited**




On
      August
      3, 2006, PacificNet’s wholly owned subsidiary PacificNet Games Limited
      (“PacGames”, Chinese Company Name [__________ ] )
      completed the acquisition of 100% of Able Entertainment Technology Ltd., a
      leading gaming technology provider based in the Macau Special Administrative
      Region of China, by exchanging 65% of the share ownership of PacificNet Games
      Limited and the issuance of 200,000 restricted shares of PacificNet Inc. 
Upon completion of this transaction, PacificNet Inc. owns 35% of PacificNet
      Games Limited (Chinese Company Name [__________] ).
      Under
      the purchase agreement, Able Entertainment Technology Ltd has committed to
      generate an annual profit of USD$1,600,000 and will provide for an adjustment
      to
      the purchase price if the PacGames does not achieve an annual net profit of
      USD$1,600,000 during the first 12-month period and USD$3,000,000 during the
      second 12-month period.




The
      consideration was paid as follows:




The
      purchase consideration for the entire Issued Shares of 100,000 shares
      (representing 100%) of the equity interest of Able Entertainment Technology
      Ltd.
      is 650 shares (representing 65%) of the ownership interest in PacificNet Games
      Limited, a Special Purpose Vehicle (SPV) company registered in the BVI, plus
      200,000 restricted PACT shares.  Able Entertainment Technology Ltd. has
      represented it expects to generate USD$1,600,000, and will provide for an
      adjustment to the purchase price if the Company does not achieve an annual
      net
      profit of USD$1,600,000 during the first 12-month period and USD$3,000,000
      during the second 12-month period. The purchase consideration is payable 100%
      in
      restricted shares of PACT, equivalent to 200,000 restricted PACT
      shares.





**Allink
      Hong Kong Limited**




On
      August
      11, 2006, PacificNet’s wholly owned subsidiary PacificNet Communications Limited
      (“PacCom”) completed the acquisition of 80% of Allink Hong Kong Limited (Allink,
      Chinese name “[__________] ”),
      a
      leading provider of security and surveillance technology and services based
      in
      the Hong Kong Special Administrative Region of China, through the issuance
      of
      200,000 restricted shares of PacificNet Inc.  Upon completion of this
      transaction, PacificNet Inc. owns 80% of Allink. Under the purchase agreement,
      Allink has committed to generate an annual profit of HKD$3,000,000 (approx
      USD$385,000) and will provide for an adjustment to the purchase price if the
      Allink does not achieve an annual net profit of HKD$3,000,000.  Allink
      operates one of the leading CCTV communication and security surveillance
      technology and services provider utilizing extra low voltage technology for
      property management companies in Hong Kong and Macau, China.




The
      consideration was paid as follows:




(1)
            The
                purchase consideration for 80% of the equity interest of the Company
                is
                payable entirely (100%) in restricted shares of PACT, equivalent
                to
                200,000 restricted PACT shares.




(2)
            The
                purchase price is payable upon achievement of certain quarterly earn-out
                targets based on net profits.




In
      July
      2006, PacificNet opened an office in Macau in order to serve the growing needs
      of many large clients in the gaming, entertainment, hotel, casino and real
      estate development industries in the region.  PacificNet’s new Macau office
      is 1400 sq. ft. and is located at Av. Do Dr. R. Rodrigues No. 600E, Edif, First
      International Commercial Centre, P906, Macau Special Administrative Region,
      China.  In addition, PacificNet opened a second office in Zhuhai, a city in
      the PRC adjacent to Macau, as an R&D center and a back office support center
      to provide product design, development, manufacturing, and customer and
      technical support services for the growing Macau market.




In
        July
        2006, PacificNet was selected by NASDAQ to become a member of the newly
        established NASDAQ Global Market. PacificNet's trading symbol will be
        NasdaqGM:PACT. The NASDAQ Global Market consists of over 1,450 companies
        that
        have applied for listing, having met and continued to meet stringent financial
        and liquidity requirements and agreed to meet specific corporate governance
        standards. Formerly called The NASDAQ National Market, this market was renamed
        in 2006 to reflect the global leadership and international reach of this
        market
        and the companies whose securities are listed here. For more information
        on the
        requirements to be included on The NASDAQ Global Market, please see Listing
        Standards & Fees at http://www.nasdaq.com/about/nasdaq_listing_req_fees.pdf .




18


**ITEM
      2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**




THE
      FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE INFORMATION
      CONTAINED IN THE FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO
      APPEARING ELSEWHERE HEREIN AND IN CONJUNCTION WITH THE MANAGEMENT'S DISCUSSION
      AND ANALYSIS SET FORTH IN THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE
      YEAR ENDED DECEMBER 31, 2005.







**PRELIMINARY
      NOTE REGARDING FORWARD-LOOKING STATEMENTS**




The
      statements contained in this Form 10-Q that are not purely historical are
      forward-looking statements within the meaning of Section 27A of the Securities
      Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
      1934,
      as amended. These include statements about the Company's expectations, beliefs,
      intentions or strategies for the future, which are indicated by words or phrases
      such as "anticipate," "expect," "intend," "plan," "will," "the Company
      believes," "management believes" and similar words or phrases. The
      forward-looking statements are based on the Company's current expectations
      and
      are subject to certain risks, uncertainties and assumptions, including those
      set
      forth in the discussion under "Description of Business," including the "Risk
      Factors" described in that section, and "Management's Discussion and Analysis
      or
      Plan of Operation." The Company's actual results could differ materially from
      results anticipated in these forward-looking statements. All forward-looking
      statements included in this document are based on information available to
      the
      Company on the date hereof, and the Company assumes no obligation to update
      any
      such forward-looking statements.







**FACTORS
      THAT COULD AFFECT FUTURE RESULTS**




Factors
      that might cause actual results, performance or achievements to differ
      materially from those projected or implied in such forward-looking statements
      include, among other things:




l
            the
                impact of competitive products;


l
            changes
                in laws and regulations;


l
            adequacy
                and availability of insurance
                coverage;


l
            limitations
                on future financing;


l
            increases
                in the cost of borrowings and unavailability of debt or equity
                capital;


l
            the
                inability of the Company to gain and/or hold market
                share;


l
            exposure
                to and expense of resolving and defending liability claims and other
                litigation;


l
            consumer
                acceptance of the Company's
                products;


l
            managing
                and maintaining growth;


l
            customer
                demands;


l
            market
                and industry conditions,


l
            the
                success of product development and new product introductions into
                the
                marketplace;


l
            the
                departure of key members of management,
                and


l
            the
                effect of the United States War on Terrorism, as well as other risks
                and
                uncertainties that are described from time to time in the Company's
                filings with the Securities and Exchange
                Commission.




Regarding
      one of our subsidiaries, for example, Epro is engaged in the business of
      providing outsourced call center services with over 15 years of field experience
      in Hong Kong and China. The factors that could affect current and future results
      are as follows:




l
            insufficient
                sales forces for business development & account
                servicing;


l
            lack
                of PRC management team in
                operation;


l
            less
                familiarity on partners' product
                knowledge;


l
            deployment
                costs of a new HR application and the costs to upgrade the call center
                computer system;


l
            increasing
                operations costs (cost of salaries, rent, interest rates & inflation)
                under rising economy in Hong Kong;


l
            insufficient
                brand awareness initiatives in the
                market;


l
            salary
                increases due to an active labor market in Hong Kong and GuangZhou;
                and


l
            increasing
                competition of call center solutions in the Hong Kong and PRC
                markets.






**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**




Our
      discussion and analysis or plan of operations is based upon our consolidated
      financial statements, which have been prepared in accordance with accounting
      principles generally accepted in the United States. The preparation of these
      financial statements requires us to make estimates and judgments that affect
      the
      reported amounts of assets, liabilities, revenues and expenses, and related
      disclosure of contingent assets and liabilities.




19


On
      an
      on-going basis, we evaluate our estimates, including those related to accounts
      receivable reserves, provisions for impairment losses of affiliated companies
      and other intangible assets, income taxes and contingencies. We base our
      estimates on historical experience and on various other assumptions that are
      believed to be reasonable under the circumstances, the results of which form
      the
      basis for making judgments about the carrying values of assets and liabilities
      that are not readily apparent from other sources. Actual results may differ
      from
      these estimates under different assumptions or conditions.




Management
      believes the following critical accounting policies reflect our more significant
      estimates and assumptions used in the preparation of our consolidated financial
      statements:






*Allowance
      For Doubtful Accounts*




We
      evaluate the collectibility of our trade receivables based on a combination
      of
      factors. We regularly analyze our significant customer accounts, and, when
      we
      become aware of a specific customer's inability to meet its financial
      obligations to us, such as in the case of bankruptcy filings or deterioration
      in
      the customer's operating results or financial position, we record a specific
      reserve for bad debt to reduce the related receivable to the amount we
      reasonably believe is collectible. We also record reserves for bad debt for
      all
      other customers based on a variety of factors including the length of time
      the
      receivables are past due, the financial health of the customer, macroeconomic
      considerations and historical experience. If circumstances related to specific
      customers change, our estimates of the recoverability of receivables could
      be
      further adjusted. In the event that our trade receivables become uncollectible,
      we would be forced to record additional adjustments to receivables to reflect
      the amounts at net realizable value. The accounting effect of this entry would
      be a charge to earnings, thereby reducing our net earnings. Although we consider
      the likelihood of this occurrence to be remote based on past history and the
      current status of our accounts, there is a possibility of this occurrence.






*Income
      Taxes*




We
      record
      a valuation allowance to reduce our deferred tax assets to the amount that
      is
      more likely than not to be realized. We have considered future market growth,
      forecasted earnings, future taxable income, and the mix of earnings in the
      jurisdictions in which we operate and prudent and feasible tax planning
      strategies in determining the need for a valuation allowance. We currently
      have
      recorded a full valuation allowance against net deferred tax assets as we
      currently believe it is more likely than not that the deferred tax assets will
      not be realized. In the event we determine that we would not be able to realize
      all or part of our net deferred tax assets in the future, an adjustment to
      the
      deferred tax assets would be charged to earnings in the period such
      determination is made. Likewise, if we later determine that it is more likely
      than not that the net deferred tax assets would be realized, the previously
      provided valuation allowance would be reversed.







*Contingencies*




We
      may be
      subject to certain asserted and unasserted claims encountered in the normal
      course of business. It is our belief that the resolution of these matters will
      not have a material adverse effect on our financial position or results of
      operations, however, we cannot provide assurance that damages that result in
      a
      material adverse effect on our financial position or results of operations
      will
      not be imposed in these matters. We account for contingent liabilities when
      it
      is probable that future expenditures will be made and such expenditures can
      be
      reasonably estimated.







*Valuation
      Of Long-Lived Assets Including Goodwill And Purchased Intangible Assets*




We
      review
      property, plant and equipment, goodwill and purchased intangible assets for
      impairment whenever events or changes in circumstances indicate the carrying
      value of an asset may not be recoverable. Our asset impairment review assesses
      the fair value of the assets based on the future cash flows the assets are
      expected to generate. An impairment loss is recognized when estimated
      undiscounted future cash flows expected to result from the use of the asset
      plus
      net proceeds expected from disposition of the asset (if any) are less than
      the
      carrying value of the asset. This approach uses our estimates of future market
      growth, forecasted revenue and costs, expected periods the assets will be
      utilized and appropriate discount rates. Such evaluations of impairment of
      long-lived assets including goodwill arising on a business combination and
      purchased intangible assets are an integral part of, but not limited to, our
      strategic reviews of our business and operations performed in conjunction with
      restructuring actions. When an impairment is identified, the carrying amount
      of
      the asset is reduced to its estimated fair value. Deterioration of our business
      in a geographic region or within a business segment in the future could also
      lead to impairment adjustments as such issues are identified. The accounting
      effect of an impairment loss would be a charge to earnings, thereby reducing
      our
      net earnings.





20


*Convertible
      Debt*




In
      accordance with recent FASB accounting guidance, due to certain factors,
      including a liquidated damages provision in the registration rights agreement
      and an indeterminate amount of shares to be issued upon conversion of the
      debentures, the Company values and accounts for the embedded conversion feature
      related to the Debentures, the Investors’ warrants, and the registration rights
      as derivative liabilities. Accordingly, these derivative liabilities are
      measured at fair value with changes in fair value reported in earnings as long
      as they remain classified as liabilities. The Company reassesses the
      classification at each balance sheet date. If the classification required under
      EITF No. 00-19 changes as a result of events during the period, the contract
      should be reclassified as of the date of the event that caused the
      reclassification.




The
      fair
      value of these derivative instruments, as determined by applying the
      Black-Scholes valuation model, is adjusted quarterly. The Black-Scholes
      valuation model requires the input of highly subjective assumptions, including
      the expected stock price volatility. Additionally, although t he
      Black-Scholes model meets the requirements of SFAS 133, the fair values
      generated by the model may not be indicative of the actual fair values as our derivative
      instruments have characteristics significantly different from traded options.
      Accordingly, the results obtained could be significantly different if other
      assumptions were used. The effect of this entry would be a charge to net
      earnings, thereby either increasing or reducing our net earnings based upon
      the
      assumptions used and the results obtained,








**NATURE
      OF THE OPERATIONS OF THE COMPANY**





**NATURE
      OF BUSINESS.**





We
      were
      incorporated in the state of Delaware in 1987. Our business consists of three
      groups, all of which operate within the outsourcing and telecommunications
      industries in Asia, primarily greater China, which includes the People's
      Republic of China (PRC), or mainland China, Hong Kong Special Administrative
      Region (HKSAR), Macau Special Administrative Region, and Taiwan. Through our
      subsidiaries we provide outsourcing services, value-added telecom services
      (VAS), and communication products distribution services. Our business process
      outsourcing (BPO) services include call centers providing customer relationship
      management (CRM) and telemarketing services, and our information technology
      outsourcing (ITO) includes software programming and development. We are
      value-added resellers and providers of telecom VAS, which comprises interactive
      voice response (IVR) systems, call center management systems, and VOIP, as
      well
      as mobile phone VAS, such as short messaging services (SMS) and multimedia
      messaging services (MMS). In 2004, we commenced our communication products
      distribution service, through wholesale and, to a lesser extent, retail sale
      and
      distribution of mobile phones, software and hardware, mobile accessories, and
      calling cards in Hong Kong and China. Recently, we have also invested in a
      company that designs, manufactures, and distributes multimedia interactive
      self-service kiosks and gaming machines for the casino and slot machine
      operators in Macau Special Administrative Region of China. We intend to continue
      to grow our business by acquiring and managing growing technology and network
      communications businesses with established products and customers in Asia.





Our
      business process outsourcing services generate revenue from call center
      services, call center management software sales, and training and consulting.
      We
      invoice our call center clients monthly at per seat monthly rates, a base price
      plus commission per call, or a per hour charge rate, depending on the client's
      preference. Our call center software clients pay per license, for which there
      is
      usually a one-time charge on sale of the software and annual maintenance fees
      for service. We charge per project for our consulting and training services
      and
      for our telecom VAS, which are invoiced throughout the project. Our telecom
      VAS
      often includes a post-sale service contract for systems integration and
      consulting services for which we bill separately. Our communication products
      such as calling cards, kiosks and cell phones are sold
      cash-on-delivery.





Our
      clients include the leading telecom operators, banks, insurance, travel,
      marketing, and service companies, as well as telecom consumers, in Greater
      China. Clients include China Telecom, China Netcom, China Mobile, China Unicom,
      PCCW, Hutchison Telecom, CSL, SmarTone, Sunday, Swire Travel, Coca-Cola, SONY,
      Samsung, Motorola, Nokia, TNT Express, Huawei, TCL, Dun & Bradstreet,
      American Express, Bank of China, DBS, Hong Kong Government, and Hongkong Post.
      PacificNet employs over 2,300 staff in our various subsidiaries in China with
      offices in Hong Kong, Beijing, Shanghai, Shenzhen, and Guangzhou.





21


PacificNet's
      operations include the following four groups:




(1)
      Outsourcing Services: including Business Process Outsourcing (BPO), call center,
      IT Outsourcing (ITO) and software development services.


(2)
      Value-Added Telecom Services (VAS): including Content Providing (CP),
      Interactive Voice Response (IVR), Platform Providing (PP) and Service Providing
      (SP).


(3)
      Communication Products Distribution: including mobile communication products
      and
      accessories, calling cards, GSM/ CDMA/ XiaoLingTong products, multimedia
      self-service kiosks and gaming machines.


(4)
      Other
      Business: including internal administrative matters, other related corporate
      items, and other business such as PacificNet Power. PacifiNet Power Limited
      (PacPower) has enjoyed significant growth beginning in late 2005 and early
      2006.
      The following is a more detailed description of PacPower:





PacificNet
      Power Limited (PacPower) was founded in Hong Kong on January 10, 2005 as a
      subsidiary of PacificNet Limited with 51% ownership by PacificNet. Headquartered
      in Hong Kong, PacPower invests in, develops, markets, distributes, resells,
      and
      manufactures energy saving products for use in commercial, residential and
      industrial settings. PacPower also engages in energy management services (EMS),
      energy savings consultation, analysis and solutions implementation, outsourcing
      energy management services, energy savings performance contract (ESPC).
      PacPower’s energy management services include electrical power management for
      lighting, air conditioning, elevators and escalators, buildings and roads,
      and
      energy related engineering services.





PacPower
      recognizes revenue from product sales under the following two types of
      contracts:


1)
      Equipment sale contract - Under the Equipment sale contract, we recognize
      revenue when persuasive evidence of an arrangement exists, the sales price
      to
      the buyer is fixed or determinable, collectability is reasonably assured,
      delivery has occurred and accepted by the buyers.


2)
      Energy
      Management Contract (EMC) or Energy Savings Sharing Contract - Under this
      contract, we grant customers extended payment terms under contracts of sale.
      These contracts are generally for a period of one to six years at prevailing
      interest rates and are collateralized by the related equipment, which if
      repossessed, may be less than the receivable balance outstanding. We recognize
      revenue under profit sharing agreements when the amounts are fixed and
      determinable and collectability is reasonably assured. Amounts received by
      us in
      excess of the original estimated cost savings on the contract is recorded as
      interest income.







**RESULTS
      OF OPERATIONS**




The
      following table sets forth selected consolidated income statement data as a
      percentage of revenues for the periods indicated.





THREE
                MONTHS ENDED JUNE 30,
            SIX
                MONTHS ENDED JUNE 30,2006
                (%)
            2005
                (%)
            2006
                (%)
            2005
                (%)Revenues
            100
            100
            100
            100Cost
                of Revenues
            (74.53)
            (78.28)
            (66.81)
            (79.69)Gross
                Margin
            25.47
            21.72
            33.19
            20.31Selling,
                general and administrative expense
            (18.38)
            (12.01)
            (23.35)
            (11.16)Earnings
                from operations
            7.09
            9.71
            9.84
            9.15Earnings
                before income taxes, minority interest and discontinued
                operations
            9.26
            12.26
            11.52
            11.03NET
                EARNINGS
            4.92
            4.83
            5.45
            4.69







22




**THREE
      AND SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE AND SIX MONTHS ENDED JUNE
      30, 2005**




REVENUES.
      Revenues for the three and six months ended June 30, 2006 were $19,330,000
      and
      $34,364,000, an increase of 57% and 60% from $12,280,000 and $21,492,000 for
      the
      three and six months ended June 30, 2005, respectively. During the second
      quarter and first half of 2006, revenues of $3,552,000, $5,517,000, $8,914,000
      and $6,579,000, $12,557,000, $11,851,000 were derived from the services rendered
      by the Company's three operating units: Outsourcing Services, Value-Added
      Services, and Communications Products Distribution Services, respectively.
      The
      revenues in product sales during the second quarter and first half of 2006
      increased by 85.1% and 45.2% compared to the same periods of 2005. The revenues
      in services sales during the second quarter and first half of 2006 increased
      by
      28.9% and 79.1% compared to the same periods of 2005.




The
      increase in revenue was mainly due to the following sources:




(1)
            Outsourcing
                services: The year-over-year growth in outsourcing services in the
                second
                quarter and first half of 2006 was primarily due to the higher revenue
                from Call Centre business in Hong Kong. For the second quarter of
                2006,
                Epro’s revenues increased $643,000, or 26.8%, year-over-year, which was
                largely due to a 148% increased in revenues from facilities management
                services, and a 54% increased in revenue from outbound services.
                Its
                revenues accounted for 86% and 85% of total outsourcing services
                revenues
                in the second quarter and first half of 2006, respectively. Due to
                rising
                labor costs, management believes that Business Process Outsourcing
                (BPO)
                has become a firmly-entrenched trend in Hong Kong and the PRC. Demand
                for
                outsourcing services has been steadily increasing, especially in
                sectors
                such as banking, insurance and telecom, and such demand has lead
                to
                continued growth in the first half of 2006. The Company’s combined Hong
                Kong-China operations expanded total contract center capacity to
                host 1000
                working positions and to occupy a total of 53,000 square feet. During
                the
                first half of 2006, the outsourcing contract center in Hong Kong
                was at
                nearly full utilization. With increasing information technology
                expenditures by Hong Kong companies, both the Contact Center (or
                Customer
                Services Center) System and IT Solutions departments enjoyed revenue
                growth. Additionally, EPRO is the Value-added Reseller (VAR) of EPICOR’s
                Customer Relationship Management Solution (CRM) and Enterprise Resource
                Planning Solution (ERP) which led to additional marketing activities
                and
                promotional programs in the first half of 2006. Management retains
                its
                positive outlook on its software operations as companies search for
                tools
                to streamline or automate their business processes. With an experienced
                technical support team, EPRO is able to provide end-to-end solutions
                to
                meet the increasing IT needs of clients.




(2)
            Value-added
                Telecom Services: In the aggregate, revenues received through VAS
                business
                and its subsidiaries accounted for 28.5% and 36.5% of the Company’s total
                revenues for the three and six months ended June 30, 2006,
                respectively, and 38.6% and 28.6 % of the Company’s total revenues for the
                three and six months ended June 30, 2005, respectively. Guangzhou 3G,
                Linkhead, Lion Zone contributed 12.8%, 8.9%, and 6.5%, respectively,
                of
                the total revenues for the three month ended June 30, 2006 and 13.1
                %,
                9.7% and 13.4%, respectively, for the six month ended June 30, 2006,
                respectively. During the second quarter and first half of 2006, China
                accounted for 37.5% and 45.8% of the total revenues, respectively,
                compared to 46.8 % and 37.4% in the same periods of 2005, respectively.
                The significant increase in revenues during the second quarter of
                2006 and
                a small increase during the first half of 2006 in Guangzhou 3G was
                mostly
                attributed to providing new 3G services and through the merger of
                Guangzhou Wanrong, which added approximately $308,000 and $574,000
                to
                three and six months ended June 30, 2006, respectively.On
                a year-over-year basis,the
                Company’s VAS revenue only increased a small percentage, approximately 16%
                in the second quarter, which is primarily attributed to the approximate
                20% decline in the sales of voice cards from Linkhead. During 2006,
                there
                was a general market decline for voice cards in Asia, and a 25% decline
                in
                SMS revenues from Clickcom in whichSMS
                advertising has been restricted by China Information Industry Department.However,
                voice cards revenues had a slight increase of 5% ($81,000)
                quarter-to-quarter. Additionally,the development of WAP and color ring back tone services had growth
                during
                the period to partially offset the decline in SMS business.




Separately,
      stricter guidelines established by the China Securities Regulatory Commission
      (CSRC) led to a decrease in the Company’s ability to market its investment
      consulting services to retail audiences, which resulted in a revenue
      underperformance. Nevertheless, although barriers remain on marketing through
      television, the Company has successfully expanded its use of stored-value cards
      to maintain its market position. Due to its large loyal retail following, the
      Company believes it can work through the current regulatory environment.
      Additionally, the Company has shifted its marketing? emphasis to the internet
      and magazines.




23


(3)
            Communication
                Products Distribution: iMobile added approximately $1,230,000 and
                $2,231,000, or accounted for 13.8% and 18.8% in Communication Products
                Distribution revenues for the three and six months ended June 30,
                2006,
                respectively, in which its major business included internet sales
                of
                mobile phone and accessories. The revenues from the sales of Motorola
                and
                Nokia contributed 95% of iMobile’s total revenues during the second
                quarter and first half of 2006. Additionally, the completion of a
                charging
                platform for new services and content information is in process and
                is
                expected to be rolled out in August of this year.PacCom
                revenues accounted for 54 % and 8 % of total revenues in the Communication
                Products Distribution business in the first half of 2006 and 2005,
                respectively.Revenues
                from PacCom increased by 2535% and 811% year-over-year in the second
                quarter and first half of 2006, respectively, primarily due to
                approximately $1.9million (HK$15million) revenues from providing
                LED
                lighting technology and solution for Galaxy Starworld Hotel of Macau
                and
                approximately $0.23million (HK$1.78million) revenues from Dell computer,
                Fiber Converter, Mirror Finish Steel, Cabling, DCM player, and others
                during the second quarter of 2006.




(4)
            The
                remaining incremental revenues for the three and six months ended
                June 30,
                2006 as compared to respective period was derived from organic growth
                from
                existing subsidiaries, such as PacPower ($894,000 and $2,474,000)
                and
                PacificNet Limited ($407,000 and $825,000). The Light Eco installation
                system project awarded in the second quarter of 2006 posted positive
                revenue increases during the second quarter and first half of 2006.
                Additionally, projects involving $0.13million (HK$1.04million) of
                the
                installation of Central Air-Conditioning Chilled-Water Pump Intelligence
                Control System at the incorporate owner of Goodrich Garden and
                $0.96million (HK$7.50million) of Nan Fung Centre chiller replacement
                project strongly help pushed drive revenues. The Company also received
                two
                services agreements during the second quarter of 2006 including providing
                consulting services in the areas of legal, accounting, finance, management
                and web site design and construction (HK$1million), and providing
                Internet
                e-commerce software application and e-commerce web site development
                service (HK$1.5million).




Acquisitions
      during the first quarter of 2006 also expanded PacificNet’s position as a
      leading provider of e-commerce, customer services and CRM in China's mobile
      distribution market, and increased our e-commerce and VAS revenues and our
      nationwide CRM service coverage. Several of our businesses experienced
      fluctuations in quarterly performance. Revenues from the VAS and IVR segment
      can
      vary from quarter to quarter due to new products and services launches and,
      the
      seasonality of certain product lines.




Summarized
      financial information concerning each of our main operating units is set forth
      in the following table. The "Other Business" column included our other
      insignificant subsidiaries and corporate related items.




FOR
      THE
      THREE MONTHS ENDED


Group
                  3Group
                  1
              
              
              
              CommunicationsOutsourcing
              
              Group
                  2.
              
              Distribution
              
              Group
                  4Business
              
              VAS
                  Business
              
              Business
              
              Other
                  Business
              
              TOTALJUNE
                  30, 2006
              
              ($)
              
              ($)
              
              ($)
              
              ($)
              
              ($)Revenues
              
              
              3,552,000
              
              
              5,517,000
              
              
              8,914,000
              
              
              1,347,000
              
              
              19,330,000Earnings
                  / Loss from Operations
              
              
              283,000
              
              
              1,130,000
              
              
              208,000
              
              
              -250,000
              
              
              1,371,000
  FOR
          THE
          SIX MONTHS ENDED
 Group
                  3Group
                  1
              
              
              
              CommunicationsOutsourcing
              
              Group
                  2.
              
              Distribution
              
              Group
                  4Business
              
              VAS
                  Business
              
              Business
              
              Other
                  Business
              
              TOTALJUNE
                  30, 2006
              
              ($)
              
              ($)
              
              ($)
              
              ($)
              
              ($)Revenues
              
              
              6,579,000
              
              
              12,557,000
              
              
              11,851,000
              
              
              3,377,000
              
              
              34,364,000Earnings
                  / Loss from Operations
              
              
              403,000
              
              
              2,844,000
              
              
              265,000
              
              
              -129,000
              
              
              3,383,000




24


COST
      OF
      REVENUES. Cost of revenues for the three and six months ended June 30, 2006
      was
      $14,407,000 and $22,960,000, an increase of 49.9% and 34.1% from $9,613,000
      and
      $17,127,000 for the three and six months ended June 30, 2005,
      respectively.  The
      cost
      of revenues in services and product sales in the second quarter and first half
      of 2006 increased by 3.8% and 81.1%, respectively, and 17.4% and 43.5%,
      respectively, compared with the respective period in 2005. The increase is
      directly associated with the corresponding increase in revenues. In comparison
      to the same period last year, the majority of the costs associated with revenues
      were from PacCom and Epro. For the second quarter and first half of 2006, PacCom
      accounted 34.1% and 26.9% of the total cost of revenues, respectively and
      approximately $1.86million (HK$14.5million) cost of revenue from PacCom is
      the
      IT equipment cost paid for Macau Galaxy Starworld Hotel project during the
      second quarter of 2006. Cost of revenues from Epro accounted for 15.7% and
      18.7%
      of the total cost of revenues in the first half of 2006 and 2005, respectively,
      which was mainly related to 27% increase in staff cost related to software
      sales, 277% increase in occupancy costs such as rents and electricity and 46%
      increase in other operating activity. Additionally, 4% and 8.2% of total cost
      of
      revenues was contributed from PacPower for the second quarter and first half
      of
      2006, respectively, which resulted from a Central Air-Conditioning chiller
      replacement project and a Light Eco installation system project awarded during
      the first and second quarter of 2006 respectively. In addition, PacPower
      received a contract for a frequency inverter energy-saving air-conditioning
      solution project from a client.




GROSS
      PROFIT. Gross profit for the three and six months ended June 30, 2006 was
      $4,923,000 and $11,404,000, a significant increase of 84.6% and 161.3 % as
      compared to $2,667,000 and $4,365,000 for the three and six months ended June
      30, 2005, respectively. Gross margin was 25.5% and 33.2% of total revenues
      for
      the second quarter and first half of 2006, compared to 21.7% and 20.3% for
      the
      second quarter and first half of 2005, respectively. As explained above, the
      improvement on gross margin for three and six months periods from the prior
      periods was primarily due to contributions from higher margin subsidiaries.
      The
      significant increase in gross margin year-over-year came primarily from our
      facilities management and outbound services, and mobile phone sales. One of
      our
      subsidiaries transformed its operation from a resource outsourcing basis to
      more
      of a project outsourcing basis. For resource outsourcing, we had high revenue
      and low profit margin in the second quarter and first half of 2005. As a result
      of the shift in operations, we had lower revenue and higher than normal profit
      margin for project outsourcing in the second quarter and first half quarter
      of
      2006. We believe that our overall gross margins approximate the industry
      standards and we expect our gross margin percentage to increase gradually as
      a
      result of cost reduction and greater efficiencies in our utilization of
      assets.




SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative
      expenses totaled $3,177,000 and $7,500,000 for the three and six months ended
      June 30, 2006, an increase of 131% and 232% from $1,376,000 and $2,258,000
      for
      the three and six months ended June 30, 2005, respectively. General and
      administrative expenses consist primarily of staff salaries, rent, insurance
      and
      traveling costs. The year-over-year increase in total general and administrative
      expenses in the second quarter and first half of 2006 was mainly due to the
      increase of staff cost as well as rent and electricity expenses for the
      expansion of call centre. The marketing expenses from the new 3G service and
      Wanrong’s services also significantly affected the total expenses during the
      second quarter of 2006, increasing approximately 288% compared to the same
      period in 2005. Furthermore, the expenses from project outsourcing services
      included traveling and training expenses.




The
      sharp
      increase in the second quarter and first half of 2006 for PACT SZ was primarily
      due to 25% and 24 % increase of salary cost from the expansion of accounting,
      auditing, SOX internal control and Kingdee software maintenance teams, a 495%
      and 292% increase from staff traveling cost resulting from the annual audit
      and
      the increase in management fees from the regular annual board and audit
      committee meetings in SZ. Most of the subsidiaries had representatives attend
      the meetings to present their previous one year and current period’s business
      financial performance and their forecasts for quarterly financial figures.
      Open
      and transparent communication is essential as it improves the relationship
      between PACT and each subsidiary so that each company can know more about the
      others’ business operation. In order to meet the requirements of Sarbanes-Oxley
      Act (SOX 404), it is essential to have adequate internal controls and procedure,
      and to improve efficiency by using accounting software.




Significant
      general expenses from PacificNet Inc. year-over-year in the second quarter
      and
      first half of 2006 was largely due to $58,334 and $120,043 of vesting option
      expense for compensation cost amortization, $27,500 increase in D&O
      commercial insurance expense (the total prepayment of $110,000 for its insurance
      was from June 2005 to June 2006), $85,996 amortization cost from $8 million
      convertible debt issuance cost (3 years amortization) and depreciation cost
      from
      Beijing Time court (USD1.6m depreciated through 40 years). Additionally, there
      is approximately $148,080 financial expense for PacificNet Inc. Such expense
      consists of (1) convertible debt interest, in which 5% is prepaid interest
      expense, $100,000 is expensed in Q2 2006 and the following three quarters (Q3
      2006, Q4 2006 and Q1 2007); and (2) the bank loan interest for Beijing Time
      Court ($57,969) in which the total amount of its bank loan is
      $1,082,000.







25


EARNINGS
      FROM OPERATIONS. On
      a
      year-over-year basis, earnings from operations increased 15% and 72% in the
      second quarter and first half of 2006, respectively. Operating earnings of
      $283,000, $1,130,000, and $208,000 for the three months ended June 30, 2006
      were
      generated from the Company's three business units: (1) CRM Outsourcing Services,
      (2) Value Added Services (VAS), and (3) Communications Distribution Services,
      respectively. This compares to operating earnings of $305,000, $1,086,000 and
      $118,000 for the three months ended June 30, 2005, respectively. Various factors
      affected operating earnings during the second quarter of 2006, including
      increased capital expenditures resulting in greater non-cash charges such as
      depreciation and amortization expenses. As the Company expanded its call centre
      sites in Hong Kong, amortization and depreciation expenses related to the new
      leasehold improvement, furniture & fixtures, computer equipment and software
      incurred in the second quarter and first half of 2006 also increased. The
      increase in fixed assets also included a recorder monitor system, DVCAM,
      computer equipment. We continued to shift our business from our traditional
      lower-margin distribution business (B2B services) to higher margin value-added
      telecom services and B2C e-commerce which we believe will help drive superior
      bottom-line results. We believe that the Company has made substantial progress
      in a relatively short period of time which has been demonstrated by our increase
      in both gross and operating margins in the second quarter. Furthermore, the
      acquisition of the majority interest in both iMobile and Guangzhou Wanrong
      during the first quarter enhanced our position in this rapidly growing B2C
      market in China.




INCOME
      TAXES. Income tax provision was $85,000 and $200,000 for the three and six
      months ended June 30, 2006, as compared to $37,000 and $64,000 for the three
      and
      six months ended June 30, 2005. Interim income tax provisions are based upon
      management’s estimate of taxable income and the resulting consolidated effective
      income tax rate for the full year. As a result, such interim estimates are
      subject to change as the year progresses and more information becomes available.
      We expect our income taxes to increase as our net earnings increase and the
      tax
      holidays we have benefited from in Hong Kong and the PRC
      expire.




MINORITY
      INTERESTS. Minority interests for the second quarter and first half of 2006
      totaled $804,000 and $1,934,000 compared with $887,000 and $1,304,000 for the
      same period in the prior year, representing outside ownership interests in
      subsidiaries that is consolidated with the parent for financial reporting
      purposes.




NET
      EARNINGS. Overall net earnings year-over-year increased 60.5% and 85.8% in
      the
      second quarter and first half of 2006, respectively. The Company’s results for
      the six months ended June 30, 2006 included a total of $888,000 in non-cash
      expenses, including depreciation and amortization expense of $768,000 and
      $120,000 non-cash stock-based compensation expense recognized during 2006 as
      a
      result of the implementation of SFAS 123(R), which we adopted effective on
      January 1, 2006, The Company’s quarterly results also included a total of
      $530,000 in non-cash expenses, including depreciation and amortization expense
      of $472,000 and non-cash stock-based compensation expense $58,000 recognized
      during the second quarter as a result of the implementation of SFAS 123(R),
      which we adopted effective on January 1, 2006. Each of our subsidiaries and
      investments, including Epro, Smartime, Guangzhou 3G, Clickcom, ChinaGoHi,
      iMobile, PacificNet Communications, PacificNet Limited and PacificNet Power
      were
      profitable.




In
      the
      outsourcing business, Smartime signed an outsourcing contract with a local
      Bank
      in Hong Kong, Wing Lung Bank, in May which will help drive growth in the
      outsourcing business, and provide a platform for further penetrating this market
      in the region. Smartime provided some senior engineers for the Bank and will
      also jointly recruit some recently-graduated students and train them.
      Furthermore, the Company is constantly seeking new channels to provide lower
      prices for resources, leading to lower operating costs.




Two
      recently acquired subsidiaries, iMobile and Wanrong, also added approximately
      $2
      million and $268,000 net profit, respectively, to the total amount of net profit
      during the second quarter of 2006. With the new operation of 2, 2.5 and 3G
      VAS
      services, net profit has rapidly increased. PacificNet Limited and PacificNet
      Power also added approximately $214,000 and $296,000 net profit, respectively,
      to the Company due to newly obtained projects during the second quarter of
      2006.
      Overall, management is optimistic in our ability to drive revenue and profits
      quarter-to-quarter as a result of cost reductions and efficient utilization
      of
      assets.







26


**LIQUIDITY
      AND CAPITAL RESOURCES**




CASH
      AND
      CASH EQUIVALENTS.




As
      of
      June 30, 2006, cash and cash equivalents were $5,935,000, compared to $9,579,000
      at December 31, 2005 as a result of the decrease of cash and cash equivalents
      of
      more than $3.2million for Lion Zone. The significant reduction for Lion Zone
      was
      primarily attributed to a loan to a related party of approximately $2.1million,
      acquisition of property and equipment, and taxes paid.




WORKING
      CAPITAL.




The
      Company’s working capital increased to $29,822,000 at June 30, 2006, as compared
      to $20,510,000 at December 31, 2005. When compared to balances at December
      31,
      2005, an increase of 45.4% in working capital at June 30, 2006 was primarily
      due
      to the increases in current assets and the decrease in current liabilities
      accounts. The increase of current assets was mainly the result of significant
      increase in accounts receivable which was attributable to our existing
      subsidiaries and a significant increase in loan receivable from related parties.
      The decrease of current liabilities was primarily due to the decrease of accrual
      expense and other payable. The increase of accounts receivable at June 30,
      2006
      was mainly driven from the increase of $2,070,000 from PacPower (due to the
      installation of Central Air-Conditioning and chiller replacement project, and
      two services agreements - see revenues (4) above), the increase of $2,575,000
      from PacCom (see revenues (3) above), the increase of $839,000 from 3G (due
      to
      the expansion of 3G services) and the increase of $574,000 from Epro. The two
      recently acquired subsidiaries, Wanrong and iMobile also added $255,000 and
      $587,000 to accounts receivable at June 30, 2006, respectively.




NET
      CASH
      FROM OPERATING ACTIVITIES.




Net
      cash
      used in operating activities was $8,031,000 for the six months ended June 30,
      2006 as compared to net cash used in operating activities of $110,000 for the
      six months ended June 30, 2005. Net cash used in operating activities in the
      six
      months ended June 30, 2006 was primarily due to net earnings of $1,873,000
      offset by minority interest of $1,934,000, non-cash related expenses of
      $900,000, $208,000 for the change in fair value of our derivatives as of the
      balance sheet date, and a net increase in working capital items of $12,530,000.
      The increase in working capital was mainly due to an increase in accounts
      receivable of $10,370,000 and an increase in inventories of $415,000 which
      mainly resulted from higher revenues and a net decrease in account payables
      and
      accrued expenses of $1,745,000 which was primarily due to the decrease in
      accrued expenses and income tax payable.




NET
      CASH
      FROM INVESTING ACTIVITIES.




Net
      cash
      used in investing activities was $4,209,000 for the six months ended June 30,
      2006 compared to $3,387,000 for the comparative prior period. Net cash used
      in
      investing activities in the six months ended June 30, 2006 was primarily due
      to
      the acquisition of property and equipment from the company, Dragon Roar, Lion
      Zone and Epro totaling $3,124,000, and cash payment totaling $836,000 related
      to
      the ChinaGoHi, Wanrong and iMobile acquisitions, and an increase of $2,233,000
      in loan receivable from related parties, offset by the release of the restricted
      cash of $1,422,000 from ChinaGoHi and an decrease of $562,000 for loan
      receivables from third parties.




NET
      CASH
      FROM FINANCING ACTIVITIES.




Net
      cash
      provided by financing activities for the six months ended June 30, 2006 was
      $8,542,000, which was mainly due to the proceeds from issuance of convertible
      debenture of $8,000,000 and the exercise of the share options and warrants
      of
      $86,000, an increase in bank loan of $623,000 which was due to the purchase
      of
      our Beijing office, and an increase in loans payable to related party of
      $201,000 by Epro. The amount was partially offset by the repayment of banking
      facilities of $171,000 from Epro and Smartime, the repayment of amount borrowed
      under capital lease of $73,000, and repurchase of treasury shares of $124,000.
      Net cash provided by financing activities for the six months ended June 30,
      2005
      was $2,302,000, which was primarily a result of an increase in loans payable
      to
      related party of $390,000, an increase in advances from banking facilities
      of
      $142,000 primarily by EPRO, an increase in bank loan of $727,000, and an
      increase from the exercise of share options and warrants of
      $981,000.




INFLATION.
      Inflation has not had a material impact on the Company's business in recent
      years.




27


CURRENCY
      EXCHANGE FLUCTUATIONS.




All
      of
      the Company's revenues are denominated either in U.S. dollars or Hong Kong
      dollars, while its expenses are denominated primarily in Hong Kong dollars
      and
      Renminbi ("RMB"), the currency of the People's Republic of China. The value
      of
      the RMB-to-U.S. dollar or Hong Kong dollar-to-United States dollar and other
      currencies may fluctuate and is affected by, among other things, changes in
      political and economic conditions. Since 1994, the conversion of Renminbi into
      foreign currencies, including U.S. dollars, has been based on rates set by
      the
      People's Bank of China, which are set daily based on the previous day's
      interbank foreign exchange market rates and current exchange rates on the world
      financial markets. Since 1994, the official exchange rate generally has been
      stable. Recently there has been increased political pressure on the Chinese
      government to decouple the RMB from the United States dollar. Although a
      devaluation of the Hong Kong dollar or RMB relative to the United States dollar
      would likely reduce the Company's expenses (as expressed in United States
      dollars), any material increase in the value of the Hong Kong dollar or RMB
      relative to the United States dollar would increase the Company's expenses,
      and
      could have a material adverse effect on the Company's business, financial
      condition and results of operations. The Company has never engaged in currency
      hedging operations and has no present intention to do so.




OFF-BALANCE
      SHEET ARRANGEMENTS.




We
      had no
      off-balance sheet guarantees, interest rate swap transactions or foreign
      currency forward contracts. We did not engage in trading activities involving
      non-exchange traded contracts during the second quarter of 2006.






**CONTRACTUAL
      OBLIGATIONS**




We
      have
      significant cash resources to meet our contractual obligations as of June 30,
      2006, as detailed below:




**Payments
      Due by Period**





Contractual
                Obligations
            Total
            Less
                than 1 year
            1-5
                years
            After
                5 yearsLink
                of credit
            $889,000
            $889,000
            0
            0Bank
                Loans
            $1,899,000
            $401,000
            $725,000
            $773,000Operating
                leases
            $1,805,000
            $819,000
            $986,000
            0Capital
                leases
            $131,000
            $88,000
            $43,000
            0Total
                cash contractual obligations
            $4,724,000
            $2,197,000
            $1,754,000
            $773,000






**CONCENTRATION
      OF CREDIT RISK**




All
      of
      the Company's revenues are derived in Asia and Greater China. The Company does
      not have any single customer that accounts for more than 10% of its revenues
      or
      10% of its purchases. If the Company was unable to derive any revenue from
      Asia
      and Greater China, it would have a significant, financially disruptive effect
      on
      the normal operations of the Company. Based on the current economic environment
      in China, the Company does not expect any material adverse impact to its
      business, financial condition and results of operations.






**SEASONALITY
      AND QUARTERLY FLUCTUATIONS**




Several
      of our businesses experience fluctuations in quarterly performance.
      Traditionally, the first quarter from January to March is a low season for
      our
      call center business due to the long Lunar New Year holidays in China. Revenues
      and income from operations for the call center and VAS tend to be higher in
      the
      fourth quarter due to special holiday promotions. Internet sales, telemarketing
      and direct marketing revenues also tend to be higher in the fourth quarter
      due
      to increased consumer spending during that period. Revenues from the VAS and
      IVR
      segment can vary from quarter to quarter due to new product launches and the
      seasonality of certain product lines.






**ITEM
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




We
      are
      exposed to various market risks arising from adverse changes in market rates
      and
      prices, such as foreign exchange fluctuations and interest rates, which could
      impact our results of operations and financial position. We do not currently
      engage in any hedging or other market risk management tools, and we do not
      enter
      into derivatives or other financial instruments for trading or speculative
      purposes.




28





***Foreign
      Currency Exchange Rate Risk.***


Fluctuations
      in the rate of exchange between the U.S. dollar and foreign currencies,
      primarily the Hong Dollar and the Chinese Renminbi, could adversely affect
      our
      financial results. During the quarter ended June 30, 2006, approximately all
      of
      our sales are denominated in foreign currencies. We expect that foreign
      currencies will continue to represent a similarly significant percentage of
      our
      sales in the future. Selling, marketing and administrative costs related to
      these sales are largely denominated in the same respective currency, thereby
      mitigating our transaction risk exposure. We therefore believe that the risk
      of
      a significant impact on our operating income from foreign currency fluctuations
      is not substantial. However, for sales not denominated in U.S. dollars, if
      there
      is an increase in the rate at which a foreign currency is exchanged for U.S.
      dollars, it will require more of the foreign currency to equal a specified
      amount of U.S. dollars than before the rate increase. In such cases and if
      we
      price our products in the foreign currency, we will receive less in U.S. dollars
      than we did before the rate increase went into effect. If we price our products
      in U.S. dollars and competitors price their products in local currency, an
      increase in the relative strength of the U.S. dollar could result in our price
      not being competitive in a market where business is transacted in the local
      currency. All of our sales denominated in foreign currencies are denominated
      in
      the Hong Dollar and the Chinese Renminbi. Our principal exchange rate risk
      therefore exists between the U.S. dollar and these two currencies. Fluctuations
      from the beginning to the end of any given reporting period result in the
      re-measurement of our foreign currency-denominated receivables and payables,
      generating currency transaction gains or losses that impact our non-operating
      income/expense levels in the respective period and are reported in other
      (income) expense, net in our combined consolidated financial statements. We
      do
      not currently hedge our exposure to foreign currency exchange rate fluctuations.
      We may, however, hedge such exposure to foreign currency exchange rate
      fluctuations in the future.





All
      of
      our sales denominated in foreign currencies are denominated in the Hong Dollar
      and the Chinese Renminbi. Our principal exchange rate risk therefore exists
      between the U.S. dollar and these two currencies. Fluctuations from the
      beginning to the end of any given reporting period result in the re-measurement
      of our foreign currency-denominated receivables and payables, generating
      currency transaction gains or losses that impact our non-operating
      income/expense levels in the respective period and are reported in other
      (income) expense, net in our combined consolidated financial statements. We
      do
      not currently hedge our exposure to foreign currency exchange rate fluctuations.
      We may, however, hedge such exposure to foreign currency exchange rate
      fluctuations in the future.




***Interest
      Rate Risk.***


Changes
      in interest rates may affect the interest paid (or earned) and therefore affect
      our cash flows and results of operations. We are exposed to interest rate change
      risk with respect to Epros' (one of our subsidiaries) credit facility with
      a
      commercial lender. However, we do not believe that this interest rate change
      risk is significant.






**ITEM
      4. CONTROLS AND PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures** ****




PacificNet
      Inc. (the "Company") maintains disclosure controls and procedures that are
      designed to ensure that information required to be disclosed in the reports
      the
      Company files or submits under the Securities Exchange Act of 1934, as amended
      (the "Exchange Act"), is recorded, processed, summarized and reported within
      the
      time periods specified in the Securities and Exchange Commission's rules and
      forms, and that such information is accumulated and communicated to the
      Company's management, including its Chief Executive Officer ("CEO") and Interim
      Chief Financial Officer ("CFO"), as appropriate, to allow timely decisions
      regarding required financial disclosure.




In
      connection with the preparation of this Quarterly Report on Form 10-Q, the
      Company carried out an evaluation under the supervision and with the
      participation of the Company's management, including the CEO and Interim CFO,
      as
      of end of the period covered by this report of the effectiveness of the design
      and operation of the Company's disclosure controls and procedures, as such
      term
      is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon
      this evaluation the CEO and Interim CFO concluded that as of June 30, 2006,
      the
      Company's disclosure controls and procedures contained significant deficiencies
      and material weaknesses. Also, as previously reported in our Annual Report
      on
      Form 10-KSB for the year ended December 31, 2005 (the "2005 Form 10-KSB") and
      as
      of the end of the period covered by this report, significant deficiencies and
      material weaknesses with respect to the Company's internal controls over
      financial reporting were identified and communicated to us by our independent
      auditors.




29


The
      Company has implemented and continues to implement remediation initiatives
      and
      interim measures during the quarter ended June 30, 2006 and through the current
      date.




In
      the
      absence of full implementation of the remediation initiatives in the second
      quarter of 2006, the Company has undertaken additional measures described below
      in the interim to ensure that the Company's consolidated financial statements
      included in this Quarterly Report on Form 10-Q were prepared in accordance
      with
      accounting principles generally accepted in the United States. Accordingly,
      the
      Company's management believes that the consolidated financial statements
      included in this Quarterly Report on Form 10-Q fairly present in all material
      respects the Company's financial condition, results of operations and cash
      flows
      for the periods presented and that this Quarterly Report on Form 10-Q does
      not
      contain any untrue statement of a material fact or omit to state a material
      fact
      necessary to make the statements made, in light of the circumstances under
      which
      such statements were made, not misleading with respect to the period covered
      by
      this report.





**Management’s
      Remediation Initiatives and Interim Measures**




Management
      has reviewed and begun to implement changes to the overall design of the
      Company's control environment, which includes formalizing the roles, duties
      and
      responsibilities of each functional group within the organization and putting
      in
      place a process by which each subsidiary's accounting staff must report and
      communicate required financial disclosures to the Company's primary accounting
      groups for review and oversight, as well as new procedures to monitor internal
      controls over financial reporting, which the CEO and Interim CFO believe will
      greatly improve the current process.




The
      following is a description of the Company’s remediation initiatives with respect
      to each deficiency identified in the 2005 Form 10-KSB and at the end of the
      period covered by this report:





***1.***
            ***The
                current organization of the accounting department does not provide
                PacificNet with the adequate skills to accurately account for and
                disclose
                significant transactions or
                disclosures.***





***Remediation
      Initiatives***





Beginning
      in the first quarter of 2006, the Company streamlined its reporting procedures
      by requiring all accounting groups within each subsidiary, which includes tax,
      treasury, financial planning and analysis groups, to directly report information
      and communicate to their respective accounting group at the Company’s financial
      accounting headquarters in Shenzhen. Each accounting group at Shenzhen is now
      responsible for overseeing the reporting results delivered for each subsidiary
      within their group to ensure that the material transactions and financial
      disclosures provided by such group are accurate, complete and correct and do
      not
      contain any material misstatements or omit material information.





The
      Company plans to retain the services of outside consultants, other than the
      Company’s independent registered public accounting firm, with relevant
      accounting experience, skills and knowledge, working under the supervision
      and
      direction of the Company’s management, to supplement the Company’s existing
      accounting personnel.




The
      Company plans to expand the size of its internal audit group, and has determined
      to retain  an
      outside independent consulting firm with relevant accounting experience. In
      connection with this expansion the Company will give the internal audit group
      the added responsibility to monitor its wholly owned subsidiaries and partially
      owned subsidiaries and joint venture operations through reviews and audits
      at
      such locations a minimum of three times a quarter.





The
      Company believes that this new responsibility of the internal audit group is
      critical upon each new acquisition, as the newly acquired subsidiary must
      quickly become familiar with the Company's policies and procedures for
      processing, summarizing, reporting and disclosing material information and
      ensuring that financial information about the new subsidiary is properly
      accounted for and communicated to management.





30


***2.***
            *********Certain
                key managers in the accounting department do not appear to have the
                knowledge and experience required for their
                responsibilities.***





***Remediation
      Initiatives***





As
      indicated in the Company’s 10-K filed on April 28, 2006, PacificNet has greatly
      expanded its Finance and Accounting staff in China in the last six months.
      In
      January, the Company promoted Mary Ma to the new position of Vice President
      of
      Finance, a position which will be permanently stationed in China. The Company
      has gradually transitioned the roles, responsibilities and job function of
      the
      CFO role to Mary May, the new VP of Finance. In May 2006, the Company announced
      the resignation of Mr. ShaoJian Wang as the CFO effective May 26, 2006.
      Concurrently, Mr. Wang announced that he had accepted a new position at Hurray!
      Holding Co. Ltd. (Nasdaq:HRAY) as their President and Chief Operating Operator.
      Mr. Victor Tong, PacificNet’s President, has taken the position of Interim CFO
      during the Company’s search for a permanent CFO. PacificNet has been actively
      seeking a new permanent CFO through job ads and headhunting firms.





The
      Company created a new position, Vice President of Finance for China Operations,
      and has appointed Mary Ma to fill the position. Ms. Ma has the prior business
      experience required to act in a supervisory capacity for the Company, including
      experience with Chinese Accounting Standards, IAS and US GAAP, corporate
      finance, finance analysis and operation. Ms. Ma and Mr. Joe Levinson, the
      Company's outside financial advisor, with assistance from other senior members
      of the financial staff, have reviewed and will continue to review and adapt
      the
      overall design of the Company's financial reporting structure, including the
      roles and responsibilities of each functional group within the
      Company.





The
      Company has plans to hire managers experienced in several key areas of
      accounting, including primarily persons with experience in US GAAP consolidation
      requirements, SEC financial reporting requirements and international tax skills,
      who will include the following:





·
            a
                consolidation manager with relevant accounting experience, skills
                and
                knowledge;


·
            several
                senior managers familiar with SEC financial reporting requirements
                with
                relevant accounting experience, skills and knowledge;
                and


·
            a
                senior manager with relevant PRC and international tax and accounting
                skills, experience and knowledge.





In
      September 2005, the Company implemented a formal training process to train
      its
      accounting and financial staff and plans to continue this process to ensure
      that
      personnel have the necessary competency, training and supervision for their
      assigned level of responsibility and the nature and complexity of the Company’s
      business. The Company plans to conduct a training seminar regarding revenue
      recognition, including identification of non-standard contracts in China.




The
      Company has allocated resources to continue to hire additional accounting
      personnel in the U.S., Hong Kong and China, in the areas of tax, external
      financial reporting, revenue recognition, treasury, financial planning and
      analysis and corporate accounting with relevant accounting experience, skills
      and knowledge.





***3.***
            ***Substantive
                matters are not being addressed appropriately by the Board and Audit
                Committee resulting in inadequate oversight from the Board and Audit
                Committee.***





***Remediation
      Initiatives***




The
      Company has proposed to set forth a schedule and increase the frequency of
      Board
      of Director meetings and Audit Committee meetings. The Company, its Board of
      Directors and the Audit Committee have recognized that communication is required
      earlier and more frequently to ensure that substantive matters are addressed
      as
      early as possible in both the review and audit process and to allow for more
      detailed financial accounting reports and findings to be prepared and presented
      to the Audit Committee in a timely manner.




***4.***
            ***The
                process that PacificNet is currently using to monitor the ongoing
                quality
                of internal controls performance, identify deficiencies and trigger
                timely
                corrective action is not working
                effectively.***





***Remediation
      Initiatives***





Utilization
      of Computerized Automated Controls:




Beginning
      in the third quarter of 2005, the Company started to deploy a company-wide
      unified financial accounting system using the Kingdee K/3 Financial Accounting
      & ERP Software, provided by Kingdee International Software Group Company
      Limited (www.Kingdee.com), one of the top two financial accounting and ERP
      system providers in China. From Q3 2005 through Q1 2006, the Company rolled
      out and has successfully implemented the Kingdee K/3 Software for all its wholly
      owned subsidiaries. Commencing in the second quarter of 2006, the Company
      plans to roll out the Kingdee K/3 Software for its other partially owned
      subsidiaries and joint ventures in China.





31




When
      fully operational, the Kingdee Software allows the Company and its subsidiaries
      to easily manage and monitor all financial and accounting processes within
      the
      group, which will assist the Company in collecting all material information
      necessary for its financial reports easily and accurately. During the first
      quarter of 2006, the Company implemented, and plans to continue to enhance,
      its
      month-end closing procedures, including reconciliations and controls over
      spreadsheets, and standardized checklists to ensure such procedures are
      consistently and effectively applied throughout the organization in order to
      improve the financial review time and quality to ensure that U.S. GAAP reviewers
      monitor financial information from non-U.S. locations in a consistent manner,
      through such measures as use of standardized reporting packages and review
      procedures.




The
      Company plans to deploy a document management system with secured intranet
      access during the third quarter of 2006 to ensure that all material contracts
      are collected, retained and available for review by all at one
      site.





***5.*** ***There
      is no adequate means of accurately capturing and recording certain significant
      and complex business transactions*** ***:***


******


***Remediation
      Initiatives***




In
      2006
      the Company began requiring centralized retention of documentation evidencing
      proof of delivery of products and services and final acceptance for revenue
      recognition purposes. The Company believes the document management system it
      plans to deploy as described above will be the primary tool to ensure that
      its
      business transactions are accurately recorded and evaluated for the purposes
      of
      legal and financial disclosure. The Company plans to design a contract review
      process in China requiring financial and legal staff to provide input during
      the
      contract negotiation process to ensure timely identification and accurate
      accounting treatment of non-standard contracts and to ensure proper revenue
      recognition with adequate documentation.







32




**PART
      II - OTHER INFORMATION**







**ITEM
      1. LEGAL PROCEEDINGS.**




None.







**ITEM
      1A. RISK FACTORS.**




In
      addition to the other information set forth in this report, you should carefully
      consider the factors discussed in “Risk Factors” in our Annual Report on Form
      10-KSB for the year ended December 31, 2005, which could materially affect
      our
      business, financial condition or future results. The risks described in our
      Annual Report on Form 10-KSB are not the only risks facing us. Additional risks
      and uncertainties not currently known to us or that we currently deem to be
      immaterial also may materially adversely affect our business, financial
      condition and/or operating results.




SINCE
      THE
      FILING OF OUR ANNUAL REPORT ON FORM 10-KSB, WE HAVE IDENTIFIED THE FOLLOWING
      ADDITIONAL RISKS:





*Our
      multinational operations subject us to various economic, political, regulatory
      and legal risks.*


**


We
      market
      and sell our products globally, with significant portion of our sales
      historically made in China. The expansion of our existing multinational
      operations and entry into new markets will require significant management
      attention and financial resources. Multinational operations are subject to
      a
      variety of risks, such as:





•
            the
                burden of complying with a variety of foreign laws and regulations;


•
            the
                burden of complying with United States laws and regulations for foreign
                operations, including the Foreign Corrupt Practices Act;


•
            difficulty
                complying with continually evolving and changing global product and
                communications standards and regulations for both our end products
                and
                their component technology;


•
            market
                acceptance of our new products, including longer product acceptance
                periods in new markets into which we enter;


•
            reliance
                on local original equipment manufacturers (“OEMs”), third party
                distributors and agents to effectively market and sell our products;


•
            unusual
                contract terms required by customers in developing markets;


•
            changes
                in local governmental control or influence over our customers;


•
            changes
                to import and export regulations, including quotas, tariffs, licensing
                restrictions and other trade barriers;


•
            evolving
                and unpredictable nature of the economic, regulatory, competitive
                and
                political environments;


•
            reduced
                protection for intellectual property rights in some countries;


**•**
            unproven
                business operation models developed or operated in specific countries
                or
                regions;


•
            longer
                accounts receivable collection periods; and


•
            difficulties
                and costs of staffing and managing multinational operations, including
                but
                not limited to internal controls and compliance.








*Failure
      to achieve and maintain effective internal controls in accordance with
      Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse
      effect on our business and stock price.*





Section 404
      of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires that we
      establish and maintain an adequate internal control structure and procedures
      for
      financial reporting and include a report of management on our internal control
      over financial reporting in our annual report on Form 10-K. That report
      must contain an assessment by management of the effectiveness of our internal
      control over financial reporting and must include disclosure of any material
      weaknesses in internal control over financial reporting that we have identified.
      In addition, our independent registered public accounting firm must attest
      to
      and report on management’s assessment of the effectiveness of our internal
      control over financial reporting.





33


We
      have
      identified material weaknesses in our internal control over financial reporting.
      See “Item 8A—Controls and Procedures—Management’s Report on Internal Control
      Over Financial Reporting” in our Annual report on Form 10-KSB for the year
      ended December 31, 2005 for a discussion of these material weaknesses. As
      of the date of the filing of this quarterly report on Form 10-Q, we are
      still in the process of implementing remedial measures related to the material
      weaknesses identified. If our efforts to remedy the weaknesses we identified
      are
      not successful, our business and operating results could be harmed and the
      reliability of our financial statements could be impaired, which could adversely
      affect our stock price. The requirements of Section 404 of the
      Sarbanes-Oxley Act are ongoing and also apply to future years. We expect that
      our internal control over financial reporting will continue to evolve as we
      continue in our efforts to transform our business. Although we are committed
      to
      continue to improve our internal control processes and we will continue to
      diligently and vigorously review our internal control over financial reporting
      in order to ensure compliance with the Section 404 requirements, any
      control system, regardless of how well designed, operated and evaluated, can
      provide only reasonable, not absolute, assurance that its objectives will be
      met. Therefore, we cannot be certain that in the future additional material
      weaknesses or significant deficiencies will not exist or otherwise be
      discovered.







**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**




None.






**ITEM
      3. DEFAULTS UPON SENIOR SECURITIES.**




None.







**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**




None.







**ITEM
      5. OTHER INFORMATION.**




None.







**ITEM
      6. EXHIBITS**




The
      following exhibits are filed as part of this report:




EXHIBIT




NUMBER
            DESCRIPTION




31.1
            Rule
                13a-14(a) Certification of Chief Executive
                Officer




31.2
            Rule
                13a-14(a) Certification of Chief Financial
                Officer




32.1
            18
                U.S.C. Section 1350 Certifications







34




SIGNATURES




In
      accordance with the requirements of the Securities Exchange Act of 1934, as
      amended, the Registrant has duly caused this report to be signed on its behalf
      by the undersigned, thereunto duly authorized.





PACIFICNET
              INC.Date: August
              15, 2006
            By:
            /s/ TONY
              TONGTony
                Tong
              Chief
                Executive Officer
              (Principal
                Executive Officer)


Date: August
              15, 2006
            By:
            /s/ VICTOR
              TONGVictor
                Tong
              President
                and Interim Chief Financial Officer
              (Principal
                Financial Officer)








35