**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 MARCH 31, 2007**




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




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




*COMMISSION
      FILE NUMBER: 000-24985*









**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 o NO þ




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 oAccelerated Filer o                   
      Non-accelerated filer þ




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




As
      of May 30, 2007, there were 11,808,993 shares of the issuer’s common stock, par
      value $0.0001 per share, outstanding.





**PACIFICNET
      INC.**


**Form 10-Q
      for the Quarterly Period Ended March 31, 2007**




**TABLE
      OF CONTENTS**





**PART I.**
            **FINANCIAL
                INFORMATION**Report
                of Independent Registered Public Accounting Firm
            3Item
                1.
            Financial
                Statements (Unaudited)
            4Consolidated
                Balance Sheets
            4Consolidated
                Statements of Operations
            5Consolidated
                Statements of Cash Flows
            6Notes
                to Consolidated Financial Statements
            7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            28Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            38Item
                4.
            Controls
                and Procedures
            40**PART II.**
            **OTHER
                INFORMATION**Item
                1.
            Legal
                Proceedings
            41Item
                1A.
            Risk
                Factors
            42Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            56Item
                3.
            Defaults
                upon Senior Securities
            56Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            56Item
                5.
            Other
                Information
            56Item
                6.
            Exhibits
            57Signatures
            
            57




2


**PART
        I - FINANCIAL INFORMATION**
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 The
        Board
        of Directors and Shareholders of Pacific Net Inc.
 
 We
        have
        reviewed the accompanying consolidated balance sheet of Pacific Net Inc.
        (a
        Delaware Corporation) and Subsidiaries as of March 31, 2007, and the related
        statements of income, and cash flows for the three month period then ended.
        These consolidated financial statements are the responsibility of the Company’s
        management. The financial statements of Pacific Net Inc. and Subsidiaries
        for
        the three month period ended March 31, 2006  was reviewed by the Company’s
        prior auditor. The prior auditor has withdrawn their audit
        opinions.
 
 We
        conducted our review in accordance with the standards of the Public Accounting
        Oversight Board (United States). A review of interim financial information
        consists principally of applying analytical procedures to financial data
        and
        making inquiries of persons responsible for financial and accounting matters.
        It
        is substantially less in scope than an audit conducted in accordance with
        the
        standards of the Public Accounting Oversight Board (United States), the
        objective of which is the expression of an opinion regarding the financial
        statements taken as a whole. Accordingly, we do not express such an opinion.
 
 Based
        on
        our review, we are not aware of any material modifications that should be
        made
        to the consolidated condensed financial statements referred to above for
        them to
        be in conformity with U. S. generally accepted accounting
        principles.
 
 The
        accompanying consolidated financial statements have been prepared assuming
        that
        the Company will continue as a going concern. As on March 31, 2007, the
        company’s accumulated deficit was $47,431,000. In addition, the Company is in
        default on its convertible debenture obligation. These factors, among others,
        as
        discussed in Note 1 to the consolidated financial statements, raise substantial
        doubt about the Company’s ability to continue as a going concern. Management’s
        plans in regard to these matters are also described in Note 1.The consolidated
        financial statements do not include any adjustments that might result from
        the
        outcome of this uncertainty.
 
 As
        discussed in Note 16, the financial statements for the two years ended December
        31, 2005 and 2004 have been restated.
 
 We
        have
        previously audited, in accordance with the standards of the Public Company
        Accounting Oversight Board (United States), the consolidated balance sheet
        of
        Pacific Net Inc. and subsidiaries (a Delaware Corporation) as of December
        31,
        2006 and the related consolidated statements of operations, changes in
        stockholders” equity and cash flows for the year then ended (not presented
        herein); and in our report dated March 30, 2007 we expressed an unqualified
        opinion on these consolidated financial statements.
 
 Such
        report includes a paragraph that emphasizes facts that raise substantial
        doubt
        about the Company’s ability to continue as a going concern. In our opinion, the
        information set forth in the accompanying consolidated balance sheet as of
        December 31, 2006, is fairly presented, in all material respects, in relation
        to
        the consolidated balance sheet from which it has been derived.
 
 /s/
        Kabani & Company, Inc.
 
 Los
        Angeles, CA
 May
        30,
        2007 ****
 
 3
 **ITEM
        1. FINANCIAL STATEMENTS**
 
 **PACIFICNET
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        BALANCE SHEETS**
 (In
        thousands of United States dollars, except par values and share
        numbers)
  **ASSETS**
              
              **March
                  31,**
                **2007**
                **(Unaudited)**
              
              **December
                  31,**
                **2006**
                **(Audited)**Current
                  Assets:Cash
                  and cash equivalents
              
              $
              4,041
              
              $
              1,799Restricted
                  cash - pledged bank deposit
              
              
              235
              
              
              234Accounts
                  receivables, net of allowances for doubtful accounts of $1,579
                  and $2,023
              
              
              8,411
              
              
              7,297Inventories
              
              
              428
              
              
              201Loan
                  receivable from related parties
              
              
              713
              
              
              1,706Loan
                  receivable from third parties
              
              
              178
              
              
              128Marketable
                  equity securities - available for sale
              
              
              568
              
              
              558Other
                  current assets
              
              
              4,552
              
              
              4,012Total
                  Current Assets
              
              
              19,126
              
              
              15,935Property
                  and equipment, net
              
              
              6,656
              
              
              4,711Investments
                  in affiliated companies and subsidiaries
              
              
              34
              
              
              115Intangible
                  assets, net
              
              
              400
              
              
              323Goodwill
              
              
              7,400
              
              
              6,552Other
                  assets
              
              
              -
              
              
              471Net
                  assets held for disposition
              
              
              11,795
              
              
              12,822**TOTAL
                  ASSETS**
              
              **$**
              **45,411**
              
              **$**
              **40,929****LIABILITIES
                  AND STOCKHOLDERS’ EQUITY**Current
                  Liabilities:Bank
                  line of Credit
              
              $
              404
              
              $
              855Bank
                  loans-current portion
              
              
              933
              
              
              576Capital
                  lease obligations - current portion
              
              
              110
              
              
              120Accounts
                  payable
              
              
              1,277
              
              
              417Accrued
                  expenses and other payables
              
              
              1,964
              
              
              2,059Income
                  tax payable
              
              
              88
              
              
              17Loans
                  payable to related party
              
              
              577
              
              
              638Convertible
                  Debenture
              
              
              6,909
              
              
              8,000Liquidated
                  damages liability
              
              
              2,697
              
              
              2,837Total
                  Current Liabilities
              
              
              14,959
              
              
              15,519Bank
                  loans - non current portion
              
              
              2,280
              
              
              1,635Capital
                  lease obligations - non current portion
              
              
              104
              
              
              124Convertible
                  debenture- non current portion, net of issuance cost, $193, and
                  $0
              
              
              3,252
              
              
              945Warrant
                  liabilities
              
              
              844
              
              
              904Total
                  long-term liabilities
              
              
              6,480
              
              
              3,608**TOTAL
                  LIABILITIES**
              
              
              **21,439**
              
              
              **19,127**Commitments
                  & contingencies
              
              
              -
              
              
              -Minority
                  interest in consolidated subsidiaries
              
              
              7,126
              
              
              6,874Stockholders’
                  Equity:Preferred
                  stock, par value $0.0001, Authorized - 5,000,000 sharesIssued
                  and outstanding - noneCommon
                  stock, par value $0.0001, Authorized - 125,000,000 shares;Issued
                  and outstanding:March
                  31, 2007 - 14,355,041shares issued, 11,808,993 OutstandingDecember
                  31, 2006 - 14,155,597 issued, 11,538,664 outstanding
              
              
              1
              
              
              1Treasury
                  stock, at cost (2007 Q1: 2,546,048 shares, 2006: 2,616,933)
              
              
              (130
              )
              
              (257
              )Additional
                  paid-in capital
              
              
              64,560
              
              
              63,124Cumulative
                  other comprehensive income (loss)
              
              
              249
              
              
              220Accumulated
                  deficit
              
              
              (47,431
              )
              
              (47,739
              )Less
                  stock subscription receivable
              
              
              (403
              )
              
              (421
              )**TOTAL
                  STOCKHOLDERS’ EQUITY**
              
              
              **16,846**
              
              
              **14,928****TOTAL
                  LIABILITIES AND STOCKHOLDERS’ EQUITY**
              
              **$**
              **45,411**
              
              **$**
              **40,929**
  The
        accompanying condensed notes are an integral part of these unaudited
        consolidated financial statements.
 
 4
 **PACIFICNET
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
 (Unaudited.
        In thousands of United States dollars, except earnings per share and share
        amounts)
  FOR
                  THE THREE MONTH
                PERIODS
                  ENDEDMarch
                  31,2007
              
              2006(unaudited)
              
              (unaudited,
                restated)Net
                  revenuesServices
              
              $
              4,565
              
              $
              3,736Product
                  sales
              
              
              4,702
              
              
              2,936Total
                  net revenues
              
              
              9,267
              
              
              6,672Cost
                  of revenuesServices
              
              
              (3,353
              )
              
              (2,577
              )Product
                  sales
              
              
              (3,375
              )
              
              (2,743
              )Total
                  cost of revenues
              
              
              (6,728
              )
              
              (5,320
              )Gross
                  Profit
              
              
              2,539
              
              
              1,352Operating
                  expenses:Selling,
                  general and administrative expenses
              
              
              (1,567
              )
              
              (1,079
              )Stock-based
                  compensation expenses
              
              
              -
              
              
              (182
              )Depreciation
                  and amortization
              
              
              (172
              )
              
              (29
              )Total
                  operating expenses
              
              
              (1,739
              )
              
              (1,290
              )**Income
                  from continued operations**
              
              
              800
              
              
              62Other
                  income (expenses)Interest
                  expenses, net
              
              
              (200
              )
              
              (52
              )Gain/(loss)
                  in change in fair value of derivatives
              
              
              61
              
              
              -Sundry
                  income, net
              
              
              19
              
              
              15Total
                  other expenses
              
              
              (120
              )
              
              (37
              )**Income
                  from continued operations before income taxes, minority interests**
              
              
              680
              
              
              25Provision
                  for income taxes
              
              
              (68
              )
              
              (17
              )Share
                  of earnings of associated companies
              
              
              -
              
              
              (3
              )Minority
                  interests
              
              
              (534
              )
              
              (86
              )**Income/(loss)
                  from continued operations**
              
              
              78
              
              
              (81
              )Income
                  from discontinued operations
              
              
              230
              
              
              882**Net
                  income**
              
              
              308
              
              
              801**Other
                  comprehensive income/(loss):**Foreign
                  exchange gain/(loss)
              
              
              29
              
              
              (20
              )**Net
                  comprehensive income**
              
              $
              337
              
              $
              781**Basic
                  earnings per share**
              
              $
              0.03
              
              $
              0.07**Diluted
                  earnings per share**
              
              $
              0.03
              
              $
              0.07Weighted
                average number of shares -
                Basic
              
              
              11,719,168
              
              
              10,855,761Weighted
                average number of shares -
                Diluted
              
              
              12,013,109
              
              
              11,526,945
  The
        accompanying condensed notes are an integral part of these unaudited
        consolidated financial statements.
  5
 **PACIFICNET
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 (Unaudited.
        In thousands of United States dollars)
  FOR
                  THE THREE MONTH
                PERIODS
                  ENDEDMarch
                  31,**2006****2007**
              
              **(Restated)****Cash
                  Flows from operating activities**Net
                  income
              
              $
              308
              
              $
              801*Adjustments
                  to reconcile net income to net cash used in operating
                  activities:*Equity
                  loss of associated company
              
              
              -
              
              
              3Provision
                  for allowance for doubtful accounts
              
              
              (378
              )
              
              -Minority
                  Interest
              
              
              534
              
              
              86Depreciation
                  and amortization
              
              
              306
              
              
              196(Gain)
                  loss from discontinued operations
              
              
              (230
              )
              
              (882
              )Stock-based
                  compensation
              
              
              -
              
              
              182Change
                  in fair value of derivatives
              
              
              (61
              )
              
              -Liquidated
                  damages expense
              
              
              -
              
              
              -*Changes
                  in current assets and liabilities net of effects from purchase
                  of
                  subsidiaries:*Accounts
                  receivable and other current assets**
              
              
              307
              
              
              (1,070
              )Inventories
              
              
              (227
              )
              
              (83
              )Accounts
                  payable and other accrued expenses
              
              
              (659
              )
              
              610***Net
                  cash used in operating activities***
              
              
              (100
              )
              
              (157
              )**Cash
                  flows from investing activities**Decrease
                  in restricted cash
              
              
              (1
              )
              
              (1
              )Increase
                  in purchase of marketable securities
              
              
              (10
              )
              
              (24
              )Acquisition
                  of property and equipment
              
              
              (819
              )
              
              (1,142
              )Acquisition
                  of subsidiaries and affiliated companies
              
              
              -
              
              
              (390
              )Loans
                  receivable from third parties
              
              
              (50
              )
              
              37Loans
                  receivable from related party
              
              
              (33
              )
              
              (670
              )***Net
                  cash provided by (used in) investing activities***
              
              
              (913
              )
              
              (2,190
              )**CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Loan
                  payable to related party
              
              
              (61
              )
              
              144Repayments
                  under bank line of credit
              
              
              (451
              )
              
              (49
              )Repayments
                  of amount borrowed under capital lease obligations
              
              
              (30
              )
              
              (34
              )(Purchase)
                  sale of treasury shares
              
              
              282
              
              
              (124
              )Proceeds
                  from subscription received, exercise of stock options and warrants
              
              
              18
              
              
              29Net
                  proceeds from issuance of convertible debenture
              
              
              2,296
              
              
              7,500Advances
                  under bank loans
              
              
              217
              
              
              153***Net
                  cash provided by(used in) financing activities***
              
              
              2,271
              
              
              7,619**Effect
                  of exchange rate change on cash and cash
                  equivalents**
              
              
              29
              
              
              18**Net
                  increase (decrease) in cash from subsidiaries held for
                  disposition**
              
              
              955
              
              
              (1,512
              )**NET
                  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS**
              
              
              2,242
              
              
              3,778**CASH
                  AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD**
              
              
              1,799
              
              
              3,487**CASH
                  AND CASH EQUIVALENTS, END OF THE PERIOD**
              
              $
              4,041
              
              $
              7,265**CASH
                  PAID FOR:**Interest
              
              $
              221
              
              $
              87Income
                  taxes
              
              $
              -
              
              $
              32**NON-CASH
                  INVESTING AND FINANCING ACTIVITIES:**Property
                  & equipment acquired under banking loan
              
              $
              785
              
              $$
              1,082Investments
                  in subsidiaries acquired through the issuance of common stock
              
              $
              190
              
              $
              397
  The
        accompanying condensed notes are an integral part of these unaudited
        consolidated financial statements.
  6
 **PACIFICNET
        INC. AND SUBSIDIARIES**
 **NOTES
        TO UNAUDITED 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") is
        a
        leading provider of gaming technology, e-commerce, and Customer Relationship
        Management (CRM) in China. Our gaming products are specially designed for
        the
        Chinese and Asian gamers, and we focus on integrating localized Chinese and
        Asian themes and content, advanced graphics, digital sound effects and popular
        domestic music, with secondary bonus games and jackpots. Our gaming products
        include: Multi-player Electronic Table Games - Baccarat, Sicbo, Fish-Prawn-Crab,
        and Roulette machines, server based games (SBG) with multiple client betting
        stations, slot and bingo machines, video lottery terminals (VLTs), amusement
        with prices (AWP) machines, gaming cabinet and client/server system designs,
        online i-gaming software design, and multimedia entertainment kiosks.
        PacificNet's gaming clients include the leading hotels, casinos, and gaming
        operators in Macau, Asia, and Europe, and our ecommerce and CRM clients include
        the leading telecom companies, banks, insurance, travel, marketing and business
        services companies and telecom consumers in Greater China such as China Telecom,
        China Mobile, Unicom, PCCW, Hutchison Telecom, Bell24, Motorola, Nokia, SONY,
        TCL, Huawei, American Express, Citibank, HSBC, Bank of China, Bank of East
        Asia,
        DBS, TNT, China and Hong Kong government. PacificNet employs about 1,200
        staff
        in its various subsidiaries throughout China with offices in Hong Kong, Beijing,
        Shanghai, Shenzhen, Guangzhou, Macau and Zhuhai China, USA, and the
        Philippines.
  ***Consolidated
        Interim Financial Statements*** - The
        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-K, as amended, for the year ended
        December 31, 2006, but do not include all disclosures required by GAAP. You
        should read these interim 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-K, as amended,
        for the year ended December 31, 2006. The 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 2006 Annual Report on Form
        10-K 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.
 
 ***Reclassification*** -
        Certain
        items in the accompanied consolidated financial statements have been re-classed
        for comparative purposes.
  7
  ***Going
        Concern***
  As
        shown
        in the accompanying consolidated financial statements, the Company incurred
        accumulated losses of $47 million and $47.7 million as of March 31, 2007
        and
        December 31, 2006, respectively. These matters raise substantial doubt about
        the
        Company’s ability to continue as a going concern.
  In
        view
        of the matters described in the preceding paragraph, recoverability of a
        major
        portion of the recorded asset amounts shown in the accompanying balance sheet
        is
        dependent upon continued operations of the Company, which in turn is dependent
        upon the Company’s ability to raise additional capital, obtain financing and to
        succeed in its future operations. The financial statements do not include
        any
        adjustments relating to the recoverability and classification of recorded
        asset
        amounts or amounts and classification of liabilities that might be necessary
        should the Company be unable to continue as a going concern.
 
 The
        Company has taken certain restructuring steps to provide the necessary capital
        to continue its operations. These steps included, but not limited to: 1)
        accelerate disposal and spin-off of unprofitable or unfavorable
        return-on-investment non-gaming operations; 2) focus on execution of the
        new
        high potential gaming business initiatives; 3) acquisition of profitable
        and/or
        strategic operations through issuance of equity instruments; 4) formation
        of
        strategic relationship with key gaming operators in Asia; 5) issuance and/or
        restructure of new long-term convertible debentures. In this regard, on April
        30, 2007, the Company entered into a sale and purchase agreement to dispose
        of
        its interest in Guangzhou3G for a consideration of US$6 million, on May 5,
        2007,
        the Company entered into a sale and purchase agreement to dispose of the
        real
        estate in HK for approximately US$1 million and on May 18 & 20, 2007,
        the Company entered into various definitive agreements to reduce its equity
        interests in certain unprofitable subsidiaries to 15%, namely: Linkhead,
        PacTelso, PacSo and PacPower.
 
 **2.
        RECENT PRONOUNCEMENTS**
  In
        February 2007, FASB issued FASB Statement No. 159, The Fair Value Option
        for
        Financial Assets and Financial Liabilities. FAS 159 is effective for fiscal
        years beginning after November 15, 2007. Early adoption is permitted subject
        to
        specific requirements outlined in the new Statement. Therefore, calendar-year
        companies may be able to adopt FAS 159 for their first quarter 2007 financial
        statements.
 
 The
        new
        Statement allows entities to choose, at specified election dates, to measure
        eligible financial assets and liabilities at fair value that are not otherwise
        required to be measured at fair value. If a company elects the fair value
        option
        for an eligible item, changes in that item's fair value in subsequent reporting
        periods must be recognized in current earnings. FAS 159 also establishes
        presentation and disclosure requirements designed to draw comparison between
        entities that elect different measurement attributes for similar assets and
        liabilities. The management is currently evaluating the effect of this
        pronouncement on financial statements.
 
 In
        September 2006, FASB issued SFAS 158 ‘Employers’ Accounting for Defined Benefit
        Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
        88, 106, and 132(R)’ This Statement improves financial reporting by requiring an
        employer to recognize the over funded or underfunded status of a defined
        benefit
        postretirement plan (other than a multiemployer plan) as an asset or liability
        in its statement of financial position and to recognize changes in that funded
        status in the year in which the changes occur through comprehensive income
        of a
        business entity or changes in unrestricted net assets of a not-for-profit
        organization. The requirement to measure plan assets and benefit obligations
        as
        of the date of the employer’s fiscal year-end statement of financial position is
        effective for fiscal years ending after December 15, 2008. The Company currently
        does not have any defined benefit plan and so FAS 158 will not affect the
        financial statements.
 
 8
 In
        September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
        defines fair value, establishes a framework for measuring fair value in
        generally accepted accounting principles (GAAP), and expands disclosures
        about
        fair value measurements. This Statement applies under other accounting
        pronouncements that require or permit fair value measurements, the Board
        having
        previously concluded in those accounting pronouncements that fair value is
        the
        relevant measurement attribute. Accordingly, this Statement does not require
        any
        new fair value measurements. However, for some entities, the application
        of this
        Statement will change current practice. This Statement is effective for
        financial statements issued for fiscal years beginning after November 15,
        2007,
        and interim periods within those fiscal years. The management is currently
        evaluating the effect of this pronouncement on financial
        statements.
 
 In
        March 2007, the Emerging Issues Task Force (“EITF”) reached a consensus on
        issue number 06-10, “Accounting for Deferred Compensation and Postretirement
        Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance
        Arrangements,” (“EITF 06-10”). EITF 06-10 provides guidance to help companies
        determine whether a liability for the postretirement benefit associated with
        a
        collateral assignment split-dollar life insurance arrangement should be recorded
        in accordance with either SFAS No. 106, “Employers’ Accounting for
        Postretirement Benefits Other Than Pensions” (if, in substance, a postretirement
        benefit plan exists), or Accounting Principles Board Opinion No. 12 (if the
        arrangement is, in substance, an individual deferred compensation contract).
        EITF 06-10 also provides guidance on how a company should recognize and measure
        the asset in a collateral assignment split-dollar life insurance contract.
        EITF
        06-10 is effective for fiscal years beginning after December 15, 2007
        (Novell’s fiscal 2008), though early adoption is permitted. The management is
        currently evaluating the effect of this pronouncement on financial
        statements.
 
 **3.
        EARNINGS PER SHARE**
  Basic
        and
        diluted earnings or loss 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
        income/loss 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
        earnings per share for the period ended March 31, 2007 exclude the potential
        dilutive effect of 889,456 warrants because their impact would be anti-dilutive
        based on current market prices. 690,909
        convertible debentures are tested by using if-converted method. The result
        shows
        when convertible debentures are included in the computation, diluted EPS
        increases. According to SFAS No.128, those convertible debentures are ignored
        in
        the computation of diluted EPS. 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 March 312007
              
              
              2006(IN
                  THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND
                  PER SHARE
                  AMOUNTS)Numerator:
                  earnings/(loss)
              
              $
              308
              
              $
              801Denominator:Weighted-average
                  shares used to compute basic EPS
              
              
              11,719,168
              
              
              10,855,761Dilutive
                  potential from assumed exercise of stock options and
                  warrants
              
              
              293,941
              
              
              671,184Weighted-average
                  shares used to compute diluted EPS
              
              
              12,013,109
              
              
              11,526,945Basic
                  earnings per common share:
              
              $
              0.03
              
              $
              0.07Diluted
                  earnings per common share:
              
              $
              0.03
              
              $
              0.07
 
 
 9
 **4.
        GOODWILL AND BUSINESS ACQUISITIONS**
  The
        changes in the carrying amount of goodwill for the following reporting periods
        are summarized below:
  Group
                  1.
              
              Group
                  2.
              
              Group
                  3.
              
              
              
              GoodwillTelecom
              
              
              
              Total
                  goodwill
              
              reclassified
                  to netOutsourcing
              
              Value-Added
              
              Products
                  (Gaming
              
              on
                  the restated
              
              assets
                  for disposal/(US$000s)
              
              Services
              
              Services
              
              and
                  Technology)
              
              balance
                  sheet
              
              to
                  be soldBalance
                  as of December 31, 2005
              
              $
              3,936
              
              $
              -
              
              $
              979
              
              $
              4,915
              
              $
              9,909Goodwill
                  acquired during the year
              
              
              --
              
              
              461
              
              
              1,176
              
              
              1,637Balance
                  as of December 31, 2006
              
              $
              3,936
              
              $
              461
              
              $
              2,155
              
              $
              6,552
              
              $
              3,655Goodwill
                  acquired during the first quarter
              
              
              
              
              
              
              
              
              848Balance
                  as of March 31, 2007
              
              $
              3,936
              
              $
              461
              
              $
              3,003
              
              $
              7,400
              
              $
              3,655
 
 
 
 **5.
        STOCKHOLDERS' EQUITY**
  a)
        COMMON
        STOCK
 
 For
        the three month period ended March 31, 2007, the Company had the following
        equity transactions: (i) 199,444 shares of common stock were issued as the
        monthly principal redemption shares for 8 million convertible debentures
        from
        January to March. Such shares are valued at $ 1,090,914.; (ii) 29,459 shares
        of
        common stock were released from escrow (PACT treasury shares) for acquiring
        additional 31% Ownership in Take 1 Technologies Group Limited valued at
        $190,305.(iii) 41,426 treasury shares were sold to the open market with total
        consideration $282,845.
 
 10
 b)
        STOCK
        OPTION PLAN
  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
        valuation provisions of SFAS 123(R) apply to new grants and unvested grants
        that
        were outstanding as of the effective date. For the three months ended March
        31,
        2007, no new options were granted and no options were vested, thus the
        compensation costs is zero. PacificNet elected the modified prospective method
        and therefore has not restated results for prior periods due to 123R.
 
 The
        status of the Stock Option Plan as of March 31, 2007, is as
        follows:
  OPTIONS
                  OUTSTANDING
              
              WEIGHTED
                  AVERAGE EXERCISE PRICEOUTSTANDING,
                  DECEMBER 31, 2005
              
              
              **1,444,500**
              
              
              $4.29Granted
              
              
              500,000
              
              
              $4.75Cancelled
              
              
              (1,180,000
              )
              
              $5.80Exercised
              
              
              (394,000
              )
              
              $2.12OUTSTANDING,
                  DECEMBER 31, 2006
              
              
              **370,500**
              
              
              $2.00Granted
              
              
              **-**
              
              
              -Cancelled
              
              
              **-**
              
              
              -Exercised
              
              
              **-**
              
              
              -OUTSTANDING
                  MARCH 31, 2007
              
              
              **370,500**
              
              
              $2.00
 
 11
 Following
        is a summary of the status of options outstanding at March 31, 2007:
  Grant
                  Date
              Total
                  Options
                Outstanding
              Aggregate
                Intrinsic
                  Value
              Weighted
                  Average Remaining
                Life
                  (Years)
              Total
                  Weighted
                Average
                Exercise
                  Price
              Option
                Exercisable
              Weighted
                Average
                Exercise
                  Price2004-7-26
              370,500
              $1,237,470
              0.32
              $2.00
              370,500
              $2.00
 
 The
        370,500 outstanding options, which granted during year 2004, will be expired
        at
        July 26 of 2007. Those options were vested from July 1 st of 2005
        with 10 months vesting period, and the corresponding compensation cost have
        been
        recorded within the vesting period. The weighted-average fair value of such
        options was $1.41.The assumptions used in calculating the fair value of options
        granted using the Black-Scholes option- pricing model are as follows:
 
 Risk-free
                  interest rate
              2.75%Expected
                  life of the options
              1.65
                  yearsExpected
                  volatility
              61.33%Expected
                  dividend yield
              0%
 
 No
        options were granted, cancelled and exercised during the three month period
        ended March 31, 2007.
 
 c)
        WARRANTS
  At
        March
        31, 2007, 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 3.09 years and the weighted average exercise price per share is $10.61
        per share.
  Following
        is a summary of the warrant activity:
 
 Warrants
                outstanding
              
              WEIGHTED
                  AVERAGE
                EXERCISE
                  PRICE
              
              Aggregate
                Intrinsic
                  ValueOUTSTANDING,
                  DECEMBER 31, 2005
              
              
              **591,138**
              
              $
              9.50
              
              $
              -Granted
              
              
              416,000
              
              
              -
              
              
              -Forfeited
              
              
              -
              
              
              -
              
              
              -Exercised
              
              
              -
              
              
              -
              
              
              -OUTSTANDING,
                  DECEMBER 31, 2006
              
              
              **1,007,138**
              
              $
              10.61
              
              $
              -Granted
              
              
              **-**
              
              
              **-**
              
              
              **-**Forfeited
              
              
              **-**
              
              
              **-**
              
              
              **-**Exercised
              
              
              **-**
              
              
              **-**
              
              
              **-**OUTSTANDING,
                  MARCH 31, 2007
              
              
              **1,007,138**
              
              $
              10.61
              
              $
              -
 
 Following
        is a summary of the status of warrants outstanding at March 31, 2007:
  Grant
                  Date
              Total
                  warrants
                Outstanding
              Weighted
                  Average
                Remaining
                  Life (Years)
              Total
                  Weighted
                Average
                Exercise
                  Price
              Warrants
                Exercisable
              Weighted
                Average
                Exercise
                  Price2004-1-15
              123,456
              1.79
              $7.15
              123,456
              $7.152004-11-15
              117,682
              2.63
              $3.89
              117,682
              $3.892004-12-9
              350,000
              2.69
              $12.21
              350,000
              $12.212006-3-13
              416,000
              3.95
              $12.20
              416,000
              $12.20
 
 12
 On
        March
        13, 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 another 16,000 warrants to our placement agent for
        the
        transaction. Those warrants have a term of 5 years and immediately vesting.
        The
        assumptions used in calculating the fair value of such warrants granted using
        the Black-Scholes option- pricing model are as follows:
  Risk-free
                  interest rate
              4.78%Expected
                  life of the options
              5.00
                  yearsExpected
                  volatility
              37.08%Expected
                  dividend yield
              0%
 
 No
        warrants were granted, cancelled and exercised during quarterly ended March
        31
        of 2007.
  d)
        TREASURY STOCK
  The
        following is a summary of the movement of the Company's shares held as treasury
        stock as at March 31 of 2007:
  **Number
                  of**
                **shares**Escrowed
                  shares returned to treasury in 2003
              
              
              800,000Shares
                  purchased in the open market
              
              
              2,000Repurchase
                  of shares from Yueshen
              
              
              24,200Cancellation
                  of former employee shares
              
              
              45,000Termination
                  with ChinaGoHi - Returned shares plus Escrow shares
              
              
              825,000Incomplete
                  acquisition of Allink
              
              
              200,000Holdback
                  shares as contingent consideration due to performance targets not
                  yet met
                  - Includes shares related to Clickcom (78,000); Guangzhou Wanrong
                  (138,348); iMobile (153,500); Games (160,000); and Take 1
                  (120,000)
              
              
              649,848Balance,
                  March 31, 2007
              
              
              **2,546,048**Shares
                  outstanding at March 31, 2007
              
              
              11,808,993Shares
                  issued at March 31, 2007
              
              
              14,355,041
 
 From
        January 24 th ,
        2007 to
        Jan 30 th ,
        2007,
        we sold 41,426 treasury shares to the open market with total consideration
        $282,845.
 
 On
        February 4 th of 2007
        (30 days after deal closing), we released 29,459 shares of common stock from
        escrow (PACT treasury shares) for acquiring additional 31% Ownership in Take
        1
        Technologies Group Limited. The remaining 120,000 shares are treated as holdback
        shares and will be released to Take 1 once they met their future performance
        targets.
 
 13
 **6.
        CONVERTIBLE DEBENTURES**
 
 6.1  Eight
        Million 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.
 
 Under
        the
        terms of a registration rights agreement entered into at the time of the
        private
        placement, the Company was obligated to file a registration statement with
        respect to the shares issuable under the debenture and the warrants by April
        30,
        2006, and have the registration statement declared effective by the SEC no
        later
        than June 28, 2006. Due to various factors, the Company did not file the
        registration statement until May 15, 2006, and it was not declared effective
        until December 8, 2006. Therefore, under the terms of the registration rights
        agreement, the Company was obligated to pay liquidated damages to
        the investors at the rate of 2% of the principal amount of the debenture
        each month beginning on June 28, 2006 until the effectiveness of the
        registration statement, which was equal to $1,120,000, in the aggregate.
 
 In
        February 2007, upon reaching an agreement on the amount and payment of accrued
        liquidated damages, the Company signed a Settlement and Release Agreement
        with
        each of the investors. Under the terms of the Settlement and Release Agreements,
        the Company paid an aggregate $140,000 in cash as satisfaction in full of
        liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding
        Fund
        Ltd., and Basso Private Opportunities Holding Fund Ltd. Partial liquidated
        damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of $35,000
        in cash, with the remaining liquidated damages in the amount of $105,000
        paid in
        the form of a new convertible debenture due February 2009, on substantially
        the
        same terms as the original debentures, except that interest only is paid
        on the
        new debentures until October 2008 and beginning in November 2008 until February
        2009, when the new debentures are due, the monthly redemption amount under
        the
        new debentures shall be equal to $315,000. The remaining investors also agreed
        to accept the aggregate $840,000 in liquidated damages owed to them in the
        form
        of the new convertible debentures for the amount of their respective portion
        of
        the liquidated damages. The Company also agreed to amend the original debentures
        to shorten the term for payment of the original principal amount to a 22
        month
        term. As a result the monthly redemption amount for the original debenture
        increased from $320,000 to $ 363,638. All other terms and conditions of the
        original debenture remain in full force and effect. The outstanding original
        principal amount as at March 31, 2007 is $6,909,086.
  14
 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 $28,141. Such amount was
        charged to other assets, net, and credited to additional paid-in capital
        and
        will be amortized over the life of the debentures. 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 $1,106,135
        of issuance costs, which primarily consisted of investment banker fees, legal
        and other professional fees. These costs have been recorded as additional
        expense during year 2006.
 
 The
        gross
        proceeds of $8,000,000 are recorded as a current debenture liability. In
        addition, fair values attributed to the Investors’ warrants in accordance with
        EITF issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to
        and Potentially Settled in a Company’s Own Stock” are recorded as liabilities.
        The initial value related to the Investors’ warrants is $690,642. An aggregate
        gain of $60,694 representing the change in fair value of warrants was recognized
        during the three months ended March 31, 2007.
 
 In
        accordance with recent FASB guidance, due to certain factors, including a
        liquidated damages provision in the registration rights agreement, the Company
        values and accounts for the embedded conversion feature and the warrants
        related
        to the debentures as derivatives. 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.
  PROBABLE
        EVENT OF DEFAULT
  On
        March
        16, 2007 our predecessor auditor withdrew their opinion on our previously
        filed
        financial statements for the years ended December 31, 2005, December 31,
        2004
        and December 31, 2003. As a result, on March 27, 2007, we notified the holders
        of the outstanding convertible debenture that we suspended use of the prospectus
        contained in our Registration Statement on Form S-1 (File No. 333-134127)
        that
        was declared effective on December 8, 2006, due to the lack of fiscal year
        end
        2005 and 2004 audited financial statements and that they must cease selling
        under the prospectus. The suspension of the use of the prospectus after April
        17, 2007, could trigger an event of default under the registration rights
        agreement and the convertible debentures, and if any of the holders so elect,
        they could accelerate and demand payment under the debentures, in accordance
        with the registration rights agreement based on the following
        provisions.
  a)
              "If,
                  during the Effectiveness Period, either the effectiveness of the
                  Registration Statement lapses for any reason or the Holder shall
                  not be
                  permitted to resell Registrable Securities under the Registration
                  Statement for a period of more than 20 consecutive Trading Days
                  or 60
                  non-consecutive Trading Days during any 12 month period, the Company
                  has
                  to pay ‘Mandatory Default Amount’ as the
                  sum of (i) the greater of (A) 130% of the outstanding principal
                  amount of
                  this Debenture, plus all accrued and unpaid interest hereon, or
                  (B) the
                  outstanding principal amount of this Debenture, plus all accrued
                  and
                  unpaid interest hereon, divided by the Conversion Price on the
                  date the
                  Mandatory Default Amount is either (a) demanded (if demand or notice
                  is
                  required to create an Event of Default) or otherwise due or (b)
                  paid in
                  full, whichever has a lower Conversion Price, multiplied by the
                  VWAP on
                  the date the Mandatory Default Amount is either (x) demanded or
                  otherwise
                  due or (y) paid in full, whichever has a higher VWAP, and (ii)
                  all other
                  amounts, costs, expenses and liquidated damages due in respect
                  of this
                  Debenture."
  15
 b)
              "If
                  any Event of Default occurs, the outstanding principal amount of
                  this
                  Debenture plus accrued but unpaid interest, liquidated damages
                  and other
                  amounts owing in respect thereof through the date of acceleration,
                  shall
                  become, at the Holder’s selection, immediately due and payable in cash at
                  the Mandatory Default Amount. Commencing 5 days after the occurrence
                  of
                  any Event of Default that results in the eventual acceleration
                  of this
                  Debenture, the interest rate on this Debenture shall accrue at
                  an interest
                  rate equal to the lesser of 18% per annum or the maximum rate permitted
                  under applicable law."
  Due
        to
        the provisions mentioned above and as per the terms of the Debenture, the
        Company has reclassified the principal amount of the Debenture of $8,000,000
        and
        the principal amount of the new Debenture of $945,000 and the interest accrued
        thereon to current liabilities.
  The
        Company accrued 2% as liquidated damages and 30% as mandatory default amount
        from the date of ineffectiveness of registration statement as
        follows:
  ($,000)
              
              2006Liquidated
                  damages
              
              
              2%
              
              $
              450Mandatory
                  default
              
              
              30%
              
              
              2,247Total
              
              
              
              
              $
              2,697
 
 Such
        amounts have been recorded as liquidated damages liability as of March 31,
        2007.
 
 6.2
        Five
        Million Convertible Note
 
 On
        February 7, 2007, PacificNet Games Limited (PacGames), a 51% owned subsidiary
        of
        the Company, entered into a definitive $5 million convertible secured note
        financing agreement with Pope Asset Management, LLC (Pope), an institutional
        investor. Proceeds of the financing are to provide PacGames with additional
        working capital to expand its gaming technology operations, to make further
        synergistic acquisitions in China and for general corporate purposes.
  The
        $5
        million convertible secured note issued to Pope matures on February 6, 2010.
        Subject to reaching certain net income milestones during fiscal year 2007,
        the note is convertible into an equity interest of PacGames ranging between
        26%
        to 32% . The interest rate of the convertible note has initially been set
        at 8%,
        and shall increase to 15% if the note is not converted prior to maturity.
        PacGames received the first payment of $2.5 million during the first quarter
        of
        2007.
 
 In
        connection with the issuance of the note, PacGames incurred issuance costs
        of
        $204,121, which primarily consisted of investment banker fees, legal and
        other
        professional fees. These costs have been capitalized and will be amortized
        over
        three years, the life of the note.
 
 **7.
        SEGMENT INFORMATION**
  The
        Company has classified its operating segments in accordance with SFAS No.
        131
“DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.” 
Operating segments comprise 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 four operating segments are as follows:
  16
 (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)
        Telecom Value-Added 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 (discontinued), Linkhead
        (discontinued), Clickcom (discontinued) and Guangzhou 3G/Sunroom. For example,
        Linkhead is a master reseller of NMS hardware and software platforms in China,
        and its voice cards are used as an integral part of voice hardware using
        CPCI
        industry control machines, and also by Media Servers to support access from
        PSTN
        and VoIP, Softswitch and 3G networks.
 
 (3)
        Product (Telecom & Gaming) Services Group - involves communication and
        gaming products, GSM/CDMA/3G Products, Multimedia Communication Kiosks. This
        Group includes the following subsidiaries: PacificNet Communications Limited,
        iMobile, Allink, Take1 and PacificNet Games. PacificNet Games Limited (PacGames)
        is a leading developer of Asian electronic gaming machines, multi-player
        electronic gaming technology solutions and gaming related maintenance, IT,
        and
        distribution services for the leading hotel and casino operators based in
        the
        Macau and other Asian gaming markets.
 
 (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
                March
                  31, 2007 (in thousands, except percentages)
              
              Group
                  1.
                Outsourcing
                  Services
                ($)
              
              Group
                  2.
                Telecom
                  Value-Added Services
                ($)
              
              Group
                  3.
                Products
                  (Telecom & Gaming)
                ($)
              
              Group
                  4.
                Other
                  Business
                
                ($)
              
              Total
                
                ($)Revenues
              
              
              3,963
              
              
              527
              
              
              4,773
              
              
              4
              
              
              9,267(%
                  of Total Rev)
              
              
              (42.8
              %)
              
              (5.7
              %)
              
              (51.5
              %)
              
              (0
              %)
              
              (100
              %)Earnings
                  / (Loss) fromOperations
              
              
              400
              
              
              -3
              
              
              1,196
              
              
              -793
              
              
              800(%
                  of Total Profit)
              
              
              (50.0
              %)
              
              (-0.4
              %)
              
              (149.5
              %)
              
              (-99.1
              %)
              
              (100
              %)Total
                  Assets
              
              
              8,270
              
              
              1,510
              
              
              17,045
              
              
              18,586
              
              
              45,411(%
                  of Total Assets)
              
              
              (18.2
              %)
              
              (3.3
              %)
              
              (37.5
              %)
              
              (40.9
              %)
              
              (100
              %)Goodwill
              
              
              3,936
              
              
              461
              
              
              3,003
              
              
              -
              
              
              7,400Geographic
                  Area
              
              
              HK,
                  PRC
              
              
              HK,
                  PRC
              
              
              HK,
                  PRC, Macau
              
              
              HK,PRC
 
 
 17
 For
                  the three months ended
                March
                  31, 2006 (in thousands, except percentages)
              
              Group
                  1.
                Outsourcing
                Services
                ($)
              
              Group
                  2.
                Telecom
                  Value-Added Services
                ($)
              
              Group
                  3.
                Products
                  (Telecom & Gaming)
                ($)
              
              Group
                  4.
                Other
                  Business
                
                ($)
              
              Total
                (Restated)
                
                ($)Revenues
              
              
              3,022
              
              
              295
              
              
              3,355
              
              
              0
              
              
              6,672(%
                  of Total Rev)
              
              
              (45.3
              %)
              
              (4.4
              %)
              
              (50.3
              %)
              
              (0
              %)
              
              (100
              %)Earnings
                  / (Loss) fromOperations
              
              
              206
              
              
              15
              
              
              359
              
              
              -518
              
              
              62%
                  of Total Profit)
              
              
              (332.3
              %)
              
              (0.0
              %)
              
              (579.0
              %)
              
              (-835.5
              %)
              
              (100
              %)Total
                  Assets
              
              
              7,347
              
              
              1,010
              
              
              14,566
              
              
              35,807
              
              
              58,730(%
                  of Total Assets)
              
              
              (12.5
              %)
              
              (1.7
              %)
              
              (24.8
              %)
              
              (61.0
              %)
              
              (100
              %)Goodwill
              
              
              3,936
              
              
              461
              
              
              979
              
              
              -
              
              
              5,376Geographic
                  Area
              
              
              HK,PRC
              
              
              HK,PRC
              
              
              HK,PRC,
                  Macau
              
              
              HK,PRC
  Product
        and service revenues classified by major geographic areas are as follows
        (in
        thousands):
 
 For
                  the three months ended
                March
                  31, 2007
              Hong
                  Kong, Macau
              PRC
              United
                  States
              TotalProduct
                  revenues
              $2,137
              $1,550
              $1,015
              $
                  4,702Service
                  revenues
              $3,492
              $1,073
              -
              $
                  4,565
 
 For
                  the three months ended
                March
                  31, 2006
              Hong
                  Kong, Macau
              PRC
              United
                  States
              Total
                (Restated)Product
                  revenues
              $2,936
              -
              -
              $2,936Service
                  revenues
              $3,027
              $709
              $
              $3,736
 
 
 **8.
        RELATED PARTY TRANSACTIONS**
 
 LEASE
        AGREEMENT
 
 In
        November 2004, the Company entered into a lease agreement with EPRO for rental
        space in the amount of $1,923 per month. The term of the lease was one year
        and
        renewable by either party.
 
 LOAN
        DUE FROM RELATED PARTIES
 
 At
        March
        31, 2007, there was a total loan receivable of approximately $713,000 due
        from
        related parties. Included in which were $279,000
        from MOABC, an affiliated company that is 15% owned by PacificNet, and $434,000
        from shareholders and directors of certain of the Company’s subsidiaries in
        connection with the acquisition of those subsidiaries. The amounts due from
        shareholders and directors of subsidiaries are comprised of $254,000 due
        from a
        shareholder of Yueshen, $64,000 due from a director of Soluteck and $115,000
        due
        from a director of PACT Communications. Terms of these related parties loan
        receivables and payables are summarized below:
 
 18
 LOAN
        TO
        MOABC
 MOABC
        is
        an affiliated company, 15% owned by PacificNet, as of March
        31 ,
        2007. A
        convertible loan of $279,000 is outstanding from MOABC as of March
        31 ,
        2007.
        Terms of the convertible loan provide PacificNet an option at any time during
        the term of the loan to convert in part or in whole of the then outstanding
        loan
        principle into equity interest of MOABC, at $23,160 for each 1% of MOABC
        shares.
 
 LOAN
        TO
        YUESHEN’S SHAREHOLDER
 As
        of
        March 31, 2007, there was a loan outstanding of $254,000 receivable from
        the
        shareholder of Yueshen. This loan is secured by 106,240 PacificNet shares.
        Further discussion of the Company’s legal dispute with Yueshen can be found
        under Part II of this 10Q document - Item1: Legal Proceedings.
 
 LOAN
        TO
        SOLUTECK’S DIRECTOR
 As
        of
        March 31, 2007, there was a loan outstanding of $64,000 receivable from a
        director of Soluteck, 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.
 
 LOAN
        TO
        COMMUNICATIONS' DIRECTOR
 As
        of
        March 31, 2007, there was a loan outstanding of $115,000 receivable from
        a
        director of Communications, due on August 31, 2007. The interest rate for
        the
        loan is 10% per annum plus 1% penalty interest per month in case of delinquency.
        The loan is secured by 30,000 PacificNet shares.
 
 LOAN
        DUE TO RELATED PARTIES
 
 As
        of March
        31 ,
        2007, there
        was
        an outstanding loan payable of $577,000  due
        to
        related parties. Included in which was a
        loan
        payable of $292,000 to a shareholder of EPRO. The loan was advanced to Epro
        by a
        shareholder of EPRO on behalf of the Company for working capital purposes.
        The
        loan is due on August 4, 2010. Interest is charged at Hong Kong prime lending
        rate.
 
 As
        of March
        31 ,
        2007, a
        loan of $285,000 was payable to a shareholder of Smartime. The loan was advanced
        to Smartime by a shareholder of Smartime on behalf of the Company for working
        capital purposes.
 
 **9.
        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 2007 Q1 amounted to $152,000 (2006
        Q1:
        $128,000). Future minimum lease payments under non-cancelable operating leases
        are $655,000 for the period from January 2007 to December 2008 and $684,000
        for
        the period from January 2008 to December 2011, respectively.
 
 RESTRICTED
        CASH - Term deposit of $235,000 has been pledged to certain financial
        institutions for bank line overdraft protection of Epro.
 
 19
 BANK
        LINE
        OF CREDIT - As of March 31, 2007, the Company’s outstanding bank line of credit
        were as follows:
 (i)
              Epro
                  has an overdraft banking facility of up to $294,000 with certain
                  banking
                  institutions, which is secured by a pledge of its fixed deposits
                  of
                  $235,000. Interest is charged at Hong Kong Prime Rate and payable
                  at the
                  end of each calendar month or the date of settlement, whichever
                  is
                  earlier.
 (ii)
              Smartime
                  has an overdraft banking facility of up to $110,000 with a Hong
                  Kong
                  banking institution. This overdraft facility is secured by a personal
                  deposit account of a director of
                  Smartime.
  BANK
        LOANS - Tabulated below are bank loans outstanding (in
        thousands):
 
 March
                  31, 2007
                (Unaudited)
              
              December
                  31, 2006Secured
                  [1]
              
              $
              2,476
              
              $
              1,668Unsecured
              
              $
              737
              
              $
              543Less:
                  Current portion
              
              $
              (933
              )
              $
              (576
              )Noncurrent
                  portion
              
              $
              2,280
              
              $
              1,635
 
 [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
        $235,000 (2006: $234,000) of a subsidiary of the Company.
 
 Aggregate
        future maturities of borrowing for the next five years are as follows:
 
 **US$**
              **April
                  2007 to March 2008**
              **April
                  2008 to March 2009**
              **April
                  2009 to March 2010**
              **April
                  2010 to March 2011**
              **April
                  2011 to March 2012**
              **Thereafter**
              **TOTAL**Beijing
                  PACT office mortgage (1)
              50,954
              53,806
              56,845
              42,871
              80,635
              761,625
              1,046,736Shenzhen
                  PACT office mortgage (2)
              21,673
              23,045
              24,505
              26,056
              27,706
              648,420
              771,405Sub-total
              72,627
              76,851
              81,350
              68,927
              108,342
              1,410,044
              1,818,141Bank
                  line of credit (3)
              436,841
              403,754
              130,996
              -
              -
              -
              971,590AR
                  factoring loans (3)
              423,802
              -
              -
              -
              -
              -
              423,802Sub-total
              860,642
              403,754
              130,996
              -
              -
              -
              1,395,392**TOTAL**
              933,270
              480,604
              212,346
              68,927
              108,342
              1,410,044
              3,213,533
 
 20
 (1)
              Fixed
                  mortgages expiring in 2012 at interest rate of 5.5% per
                  annum.
 (2)
              Fixed
                  mortgage expiring in 2012 at interest rate of 6.2% per
                  annum.
 (3)
              Interest
                  rates charged range from Hong Kong Prime Lending Rate to Prime
                  +
                  2%.
 
 CAPITAL
        LEASE OBLIGATIONS - The Company leases various equipments under capital leases
        expiring in 2008. Aggregate minimum future lease payments under capital leases
        for each of the next two years are as follows: 2007: $80,000; 2008: $24,000,
        and
        thereafter: none.
 
 Liquidated
        damages: Refer to Note 6 for details
 
 **10.
        OTHER CURRENT ASSETS**
  Other
        current assets comprises of the following (in thousands):
  March
                  31,2007
                (Unaudited)
              
              December
                  31, 2006Loans
                  to employees
              
              $
              367
              
              $
              411Advances
                  to salesrepresentatives
              
              
              1,127
              
              
              358Receivable
                  from Lion Zone Holdings
              
              
              385
              
              
              485Prepayment
              
              
              725
              
              
              887Deposit-utilities
              
              
              1,327
              
              
              1,292Prepaid
                  expense
              
              
              360
              
              
              408Others
              
              
              261
              
              
              171Total
              
              $
              4,552
              
              $
              4,012
 
  **11.
        INCOME TAXES**
  The
        Company is registered in the state of Delaware and has operations in primarily
        three tax jurisdictions - the PRC, Hong Kong and the United States.
 
 The
        income taxes expenses for the Company's subsidiaries were $68,000 for the
        3-month period ended March 31, 2007. The provision of income taxes depends
        on
        the tax rate and tax exemption. 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. Certain subsidiaries and VIEs are qualified for preferred
        high technology or software enterprise tax status, and they are subject to
        preferential tax rate of 15% under PRC Income Tax Rules.
 
 21
 For
        operations in the United States of America and Hong Kong the Company has
        incurred net accumulated operating loss for income tax purposes. The Company
        believes that it is more likely than not that these net accumulated operating
        loss 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 March 31, 2007. Accordingly, the Company has no net
        deferred tax assets as of March 31, 2007.
 
 12.SUBSEQUENT
        EVENTS
 
 **Sale
        of Interest in Linkhead Technology** **Bejing Limited. ("Linkhead")** ****
 On
        May
        20, 2007, the Company entered into a definitive agreement to sell its 36%
        equity
        interest in Linkhead, a PRC limited liability corporation engaged in the
        business of resaling of NMS hardware and software platforms in China, to
        Mr. Mu
        Yingliang, a resident of People’s Republic of China. Consideration for the 36%
        interest of Linkhead was RMB10,000 (or US$1,295), to be paid within 90 days
        after signing of the agreement. The Company’s interest in Linkhead decreased
        from 51% to 15% after the transaction.
 
 **Sale
        of Interest in PacificNet Telecom Solution Inc.
        ("PacTelso")**
 On
        May
        20, 2007, the Company entered into a definitive agreement to sell its 36%
        equity
        interest in PacTelso, an intermediate holding company registered under the
        laws
        of British Virgin Islands, to Mr. Mu Yingliang, a resident of People’s Republic
        of China. Consideration for the 36% interest of PacTelso was RMB10,000 (or
        US$1,295), to be paid within 90 days after signing of the agreement The
        Company’s interest in PacTelso decreased from 51% to 15% after the
        transaction.
 
 **Sale
        of Interest in PacificNet Solutions Limited. ("PacSo")**
 On
        May
        18, 2007, the Company entered into a definitive agreement to sell its 45%
        equity
        interest in PacSo, a company registered under the laws of Hong Kong SAR,
        China
        and engaged in systems integration, software application, and e-business
        solutions services, to Mr. Alex Au, a resident of Hong Kong SAR, China.
        Consideration for the 45% interest of PacSo was HK$4,500 (or US$583), to
        be paid
        within 90 days after signing of the agreement. The Company’s interest in PacSo
        decreased from 60% to 15% after the transaction.
 
 **Sale
        of Interest in PacificNet Power Limited ("PacPower")**
 On
        May
        18, 2007, the Company entered into a definitive agreement to sell its 36%
        equity
        interest in PacPower, a company registered under the laws of Hong Kong SAR,
        China and engaged in air-conditioning contracting and consulting businesses,
        to
        Mr. Alex Au, a resident of Hong Kong SAR, China. Consideration for the 36%
        interest of PacPower was HK$3,600 (or US$466), to be paid within 90 days
        after
        signing of the agreement. The Company’s interest in PacPower decreased from 51%
        to 15% after the transaction.
 
 **Sale
        of Interest in MOABC** **.com
        ("MOABC")** ****
 On
        May
        20, 2007, the Company entered into a definitive agreement to sell its 5%
        equity
        interest in MOABC, a PRC limited liability corporation engaged in the business
        of value-added services platform providing, to Mr. Jack Ou, a resident of
        People’s Republic of China. Consideration for the 5% interest of MOABC was
        RMB5,000 (or US$647), to be paid within 90 days after signing of the agreement.
        The Company’s interest in MOABC decreased from 20% to 15% after the
        transaction.
 
 22
 **Sale
        of Interest in Guangzhou 3G Information Technology Co., Ltd. ("Guangzhou
        3G")**
 On
        April
        30, 2007, the Company entered into a definitive agreement to sell its 51%
        interest in Guangzhou 3G to HeySpace International Limited, a BVI company
        owned
        by founders of Guangzhou 3G, for consideration of US$6 million, to be paid
        in cash in 5 installments over 7 months. The Company acquired a controlling
        interest in Guangzhou 3G, a PRC registered wholly owned foreign enterprise,
        through the purchase of a 51% interest in Guangzhou 3G's parent company,
        Pacific
        3G Information & Technology Co. Limited, a British Virgin Islands Company,
        in March 2005 for a consideration of US$5.5 million, which was paid partly
        in
        cash and partly in PACT stock.
 
 Guangzhou
        3G was one of the largest value-added telecom and information services providers
        in China. It conducts its VAS operations with Guangzhou Sunroom Information
        Industrial Co., Ltd., a PRC registered Domestic Enterprise (DE), through
        a
        series of contractual agreements. Its business and profitability were severely
        impacted by certain adverse billing policies implemented by China Mobile
        during
        2006.
 
 Information
        relating to the operations of the subsidiaries up to the periods of disposal
        during the three month period ended March 31, 2007 is as follows:
 
 (In
                  US$ thousands)
              Linkhead
              G3G
              Clickcom
              Power
              Solutions
              MOABC
              TotalIncome/(loss)
                  from discontinued operations
              ($8)
              $261
              ($1)
              -
              $1
              ($23)
              $230Net
                  assets held for disposition
              $1,387
              $10,230
              $138
              $106
              ($23)
              ($43)
              $11,795
 
 **13.** **ACQUISITION**
 
 TAKE
        1
        TECHNOLOGIES GROUP LIMITED
 
 On
        January 05, 2007, we entered into an agreement for PacificNet to exercise
        the
        option to acquire an additional 31% interest in Take 1. The completion date
        for
        the new Securities Subscription Agreement was January 05, 2007, with a
        consideration of $965,505 (paid entirely with shares of PacificNet: 149,459
        PACT
        Shares, valued at $6.46 per share). As a result, PacificNet has become the
        majority and controlling shareholder of Take1 with our ownership percentage
        increasing from 20% to 51%.
  An
        initial equity investment of 30% in Take 1 was made in April 2004 by the
        Company, through its subsidiary PacificNet Strategic Investment Holdings
        Limited, for a consideration of $1,156,812, comprising $385,604 in cash and
        $771,208 in 149,459 PacificNet shares at $5.16 per share. PacificNet’s interest
        in Take 1 was reduced to 20% in the year 2005 from 30% as a result of PacificNet
        repurchasing an aggregate of 149,459 at nominal value.
 
 Summarized
        below is the assets acquired and liabilities assumed for Take 1 in the
        acquisition:
 
 Estimated
                  fair values:Current
                  Assets
              
              
              $106,422Intangible
                  asset
              
              
              $64,665Total
                  Assets Acquired
              
              
              $171,087Liabilities
                  assumed
              
              
              ($728,156
              )Net
                  assets acquired
              
              
              ($557,069
              )Investment
                  on equity method (20%)
              
              
              $385,604Loss
                  from Investment
              
              
              $(285,260
              )Additional
                  Consideration (31%)-partially paid
              
              
              $190,305Goodwill
              
              
              $847,718
 
 23
 At
        March
        31, 2007, goodwill of $847,718 represents the excess of the purchase price
        over
        the fair value of the net tangible and identifiable intangible assets acquired
        and is not deductible for tax purposes and the total amount of goodwill is
        reported under reportable segment for Products (Telecom &
Gaming)..
 
 In
        accordance with SFAS 142, goodwill is not amortized but is tested for impairment
        at least annually. The purchase price allocation for Take 1 acquisition is
        based
        on a management's estimates and overall industry experience. Immediately
        after
        the signing of the definitive agreement, the Company obtained effective control
        over Take 1. Accordingly, the operating results of Take 1 have been consolidated
        with those of the Company starting January 05, 2007. Pursuant to SFAS 141
        "Business Combinations", the earn-out consideration is considered contingent
        consideration, which will not become certain until the audited combined
        after-tax profit of US$128,205 for the quarter ended March 31, 2007 is
        available. Accordingly, the contingent consideration of 120,000 shares has
        not
        been reflected in the consolidated financial statements of the Company as
        of
        March 31, 2007.
 
 **UNAUDITED
        PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE QUARTER ENDED
        MARCH 31, 2007 AND 2006**
  The
        following is an un-audited pro forma consolidated financial information for
        the
        quarter ended March 31, 2006 and 2007, as presented below, reflects the
        results of operations of the Company assuming the acquisition occurred on
        January 1, 2006 and 2007, respectively, and after giving effect to the
        purchase accounting adjustments. These pro forma results have been prepared
        for
        information purposes only and do not purport to be indicative of what operating
        results would have been had the acquisitions actually taken place on January
        1, 2006 and 2007, respectively, and may not be indicative of future
        operating results.
  Quarter
                  ended March 312007
              
              2006(un-audited
                  and in thousands of U.S. dollarsexcept
                  for earnings per share)Revenue
              
              
              $9,267
              
              
              $6,916Operating
                  income
              
              
              $800
              
              
              $47Net
                  profit
              
              
              $308
              
              
              $796Earnings
                  per share - basic
              
              
              $0.03
              
              
              $0.07Earnings
                  per share - diluted
              
              
              $0.03
              
              
              $0.07
 
 Accordingly,
        PacificNet included the financial results of Take 1 in its consolidated 2007
        financial results from January 5, 2007 through March 31, 2007.
 
 24
 **14** **INVESTMENTS IN AFFILIATED COMPANIES**
 
 Investments
        in affiliated companies consists of the following as of March 31,
        2007:
 
 (US$
                  thousands)
              COLLATERAL/OWNERSHIP
                  % AND BUSINESS DESCRIPTIONAMOUNT
              DESCRIPTIONINVESTMENTS
                  IN AFFILIATED COMPANIES:Glad
                  Smart
              $30
              15%
                  ownership interestCommunity
                  media co.
              $4
              5%
                  ownership interestTotal
              $
                  34
 
 **15.
        LEGAL PROCEEDINGS.**
 
 1.
        Legal
        Proceeding and Judgment Against Guangzhou Yueshen Taiyang Network Science
        and
        Technology Limited, Ms. Li Yan Kuan, and Mr.Wu Yi Wen
 
 On August
        12, 2006, we commenced a law suit in the High Court of the Hong Kong Special
        Administrative Region ("HKSAR") against Guangzhou Yueshen Taiyang Network
        Science and Technology Limited ("Yueshen"), Ms. Li Yan Kuan and Mr.Wu Yi
        Wen for failure to pay amounts owed under a promissory note.  On May 15,
        2005, we loaned RMB2,000,000 ("Debt Sum") to Yueshen to cover operating costs,
        evidenced by a promissory note due on November 15, 2005.  Ms. Kuan and Mr.
        Wen guaranteed repayment of the note by Yueshen.  The Debt Sum together
        with the agreed interest rate calculated at 6% per annum was due on November
        15,
        2005.
 
 On
        March
        28, 2007, the High Court of HKSAR had adjudged that the three defendants
        should
        pay us the Debt Sum together with interest sum at the rate of 6% per annum
        from
        May 15, 2005 to March 28, 2007, and additional interest charged at the rate
        of
        5% per annum for the Debt Sum and accrued interest within 90 days overdue
        and
        thereafter at the judgment rate until payment and fixed costs of
        HK$3,405.
 
 2.
        Lawsuit between PacificNet Power Limited and Johnson Controls Hong Kong Limited
        (JCHKL), a subsidiary of Johnson Controls Inc.  (NYSE:JCI)
        (www.jci.com )
 
 On
        January 19, 2007, Johnson Controls Hong Kong Limited filed a claim against
        PacificNet Power Limited (a 51% owned subsidiary of PacificNet) in the High
        Court of the Hong Kong Special Administrative
        Region seeking HK$4,800,000 as payment for services rendered to
        replace 3 sets of rane water-cooled chillers, together with energy saving
        performance (the "Chiller System"), at the Fortress Tower in Hong
        Kong.
 
 25
 In
        connection with the claim, PacificNet Power reviewed a letter
        from its client, China Weal Property Management Ltd., dated January
        22, 2007 stating that the construction work by JCHKL had not been completed
        as
        of the date of the letter, and that certain violations itemized in a letter
        issued by the Hong Kong Environment Protection Department  (EPD) (Noise
        Abatement Notice No. N806030) addressed to JCHKL with respect to acoustic
        problems with JCHKL’s equipment had not been abated.  Further, JCHKL was to
        pay penalties between HK$100,000 and HK$200,000 assessed by the
        JCHKL for failing to fix the noise problem on the roof of Fortress
        Tower.
 
 The
        board
        of directors of PacificNet Power Limited has reviewed the case
        with its client, China Weal Property Management Ltd., and our
        Hong Kong legal counsel and it is our belief that the project
        work undertaken JCHKL is defective in numerous aspects, as evidenced by the
        letter from government letter issued by EPD.  As a result, we believe the
        construction work was not been completed by JCHKL, and therefore,
        JCHKL is not entitled to payment for its services.
 
 On
        February 7, 2007, we instructed our Hong Kong legal counsel to issue a
        Defense and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's
        construction work has not complied with the applicable rules and regulations
        of
        various government authorities in Hong Kong; (ii) the Chiller System provided
        by
        JCHKL was defective and merchantable unfit and JCHKL has failed
        and/or refused to rectify such defective works; and (iii) JCHKL shall return
        the work deposit in the amount of  HK$1,500,000 to PacificNet Power
        Limited and shall compensate and keep PacificNet Power Limited indemnified
        against all the loss and damages suffered as a result of any claims from
        the
        China Weal Property Management Ltd, the employer and the potential tenants
        of
        Fortress Tower.
 The
        case
        is under review by Hong Kong High Court and we have not received any judgment
        from the High Court of the Hong Kong Special Administrative Region as of
        date of
        this report. We are currently proceeding with discovery and counter-claims,
        and
        we intend to vigorously defend ourselves against the allegations. We are
        unable
        to predict the outcome of these actions, or a reasonable estimate of the
        range
        of possible loss, if any.
 
 **16.**  **RESTATEMENT**
 
 On
        March
        19, 2007 our predecessor auditor withdrew their opinion on our previously
        filed
        financial statements for the years ended December 31, 2005 and 2004 due to
        uncertainties around certain option grants during the said period. An
        independent investigation in this connection has been performed by our Audit
        Committee to address this matter.
 
 In
        its
        May 3, 2007 Report, the Audit Committee concluded that, “...the Audit Committee
        did indeed find that, although the number and terms of option grants were
        being
        fixed by the Compensation Committee who deferred to the Board merely for
        a
        secondary review approval; whereby the Board of Directors still maintained
        the
        authority to cancel a prerequisite grant consummated by the Compensation
        Committee, therefore that Grant could likely be interpreted only as final
        at the
        date of approval of the company’s Board of Directors. Hence, with this approach
        which seems to be more aligned with the SEC interpretation, financial
        restatement would be required to account for the granting of options that
        were
“in the money” due to procedural administrative delay and the difference in the
        Compensation Committee grant date and the Board of Directors approval date.
        Accordingly, the Audit Committee recommended to the Board of Directors of
        Pacificnet, Inc. to charge additional stock based compensation expense to
        the
        company’s financial statements for the fiscal years ended December 31, 2003,
        2004 and 2005 respectively...”
 
 Based
        on
        the Audit Committee Recommendations, extra stock-based compensation charges
        of
        approximately $0.3 million, $1.2 million and $0.1 million were charged to
        each
        of the years ended December 31, 2005, 2004 and 2003, respectively, Also,
        for the
        years ended December 31, 2005 and 2004, approximately $2.4 million and $0.2
        million have been reclassified from Selling, General & Administrative
        expenses to Discontinued Operations for financial statement presentation
        purposes. Following are the effects of the restatement:
 
 26
 Fiscal
                  years ended December 31(In
                  thousands, except share and share amounts)
              
              **2005**
              
              **2005**
              
              **2004**
              
              **2004**
              
              **2003**
              
              **2003**As
                  reported
              
              As
                  restated
              
              As
                  reported
              
              As
                  restated
              
              As
                  reported
              
              As
                  restatedConsolidated
                  balance sheets:Additional
                  paid-in capital
              
              $
              57,690
              
              $
              59,346
              
              $
              53,916
              
              $
              55,290
              
              $
              31,790
              
              $
              31,918Accumulated
                  deficit
              
              
              (25,990
              )
              
              (27,646
              )
              
              (28,479
              )
              
              (29,853
              )
              
              (29,253
              )
              
              (29,381
              )TOTAL
                  STOCKHOLDERS' EQUITY
              
              
              31,785
              
              
              31,785
              
              
              25,310
              
              
              25,310
              
              
              2,509
              
              
              2,509TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              $
              51,203
              
              $
              44,598
              
              $
              33,250
              
              $
              32,660
              
              $
              7,770
              
              $
              7,740Consolidated
                  income statements:Selling,
                  General and Administrative expenses
              
              $
              (5,811
              )
              $
              (3,411
              )
              $
              (3,435
              )
              $
              3,245
              
              $
              (1,572
              )
              $
              (1,569
              )Stock-based
                  compensation expenses
              
              
              -
              
              
              (282
              )
              
              -
              
              
              (1,246
              )
              
              -
              
              
              (128
              )**Income/(loss)
                  from operations**
              
              
              4,569
              
              
              289
              
              
              1,937
              
              
              (904
              )
              
              (1,337
              )
              
              (1,475
              )**Income/(loss)
                  before income taxes, minority interest and discontinued
                  operations**
              
              
              5,645
              
              
              783
              
              
              2,438
              
              
              (989
              )
              
              (1,256
              )
              
              (1,394
              )**Income/(loss)
                  before discontinued operations**
              
              
              -
              
              
              (81
              )
              
              817
              
              
              (1,537
              )
              
              (1,281
              )
              
              (1,414
              )**Net
                  income available to common stockholders**
              
              $
              2,489
              
              $
              2,207
              
              $
              774
              
              $
              (472
              )
              $
              (1,281
              )
              $
              (1,409
              )Earnings/(loss)
                  per common share:Basic
              
              $
              0.25
              
              $
              0.22
              
              $
              0.11
              
              $
              (0.06
              )
              $
              (0.24
              )
              $
              (0.27
              )Diluted
              
              $
              0.23
              
              $
              0.21
              
              $
              0.09
              
              $
              (0.06
              )
              $
              (0.24
              )
              $
              (0.27
              )Shares
                  used in computing earnings per shareBasic
              
              
              10,154,271
              
              
              10,154,271
              
              
              7,268,374
              
              
              7,268,374
              
              
              5,234,744
              
              
              5,234,744Diluted
              
              
              10,701,211
              
              
              10,701,211
              
              
              8,241,996
              
              
              8,241,996
              
              
              5,234,744
              
              
              5,234,744Consolidated
                  statements of cash flowsNet
                  earnings (loss)
              
              $
              2,489
              
              $
              2,207
              
              $
              774
              
              $
              (472
              )
              $
              (1,281
              )
              $
              (1,409
              )Stock-based
                  compensation
              
              
              -
              
              
              282
              
              
              -
              
              
              1,246
              
              
              -
              
              
              128Net
                  cash provided by (used in) operating activities
              
              $
              9,250
              
              $
              2,980
              
              
              (4,431
              )
              
              (2,491
              )
              
              (905
              )
              
              (905
              )NET
                  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              $
              2,815
              
              $
              (2,866
              )
              $
              2,941
              
              $
              2,572
              
              $
              129
              
              $
              87
 
 27
 **17.
        CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS**
  The
        Company's operations are carried out in the PRC. Accordingly, the Company's
        business, financial condition and results of operations may be influenced
        by the
        political, economic and legal environments in the PRC, by the general state
        of
        the PRC's economy. The Company's business may be influenced by changes in
        governmental policies with respect to laws and regulations, anti-inflationary
        measures, currency conversion and remittance abroad, and rates and methods
        of
        taxation, among other things.







ITEM
      2.MANAGEMENT
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.




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-K FOR THE
      YEAR
      ENDED DECEMBER 31, 2006, AS AMENDED.





**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.


28


**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:




—
            the
                impact of competitive products;—
            changes
                in laws and regulations;—
            adequacy
                and availability of insurance coverage;—
            limitations
                on future financing;





—
            increases
                in the cost of borrowings and unavailability of debt or equity
                capital;—
            the
                inability of the Company to gain and/or hold market
                share;—
            exposure
                to and expense of resolving and defending liability claims and other
                litigation;—
            consumer
                acceptance of the Company's
                products;





—
            managing
                and maintaining growth;—
            customer
                demands;—
            market
                and industry conditions,—
            the
                success of product development and new product introductions into
                the
                marketplace;





—
            the
                departure of key members of management, and—
            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:




—
            insufficient
                sales forces for business development & account
                servicing;—
            lack
                of PRC management team in operation;—
            less
                familiarity on partners' product knowledge;—
            deployment
                costs of a new HR application and the costs to upgrade the call center
                computer system;





—
            increasing
                operations costs (cost of salaries, rent, interest rates & inflation)
                under rising economy in Hong Kong;—
            insufficient
                brand awareness initiatives in the market;—
            salary
                increases due to an active labor market in Hong Kong and GuangZhou;
                and—
            increasing
                competition of call center solutions in the Hong Kong and PRC
                markets.




29


**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.




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.





In
      the
      beginning of the third quarter of 2006, the Chinese government announced that
      it
      would implement several new policies regarding mobile phone value-added service
      providers effective from July 10, 2006. These policies include a “double
      confirmation” policy and the requirement that value-added service providers
      provide one-month trial subscriptions. By requiring that mobile phone customers
      “double-confirm” their intention to purchase services, and by requiring free
      subscriptions, the Chinese government has negatively affected value-added
      service providers.





*Inventory*





Our
      inventory purchases and commitments are made in order to build inventory to
      meet
      forecasted demand for our products. We perform a detailed assessment of
      inventory for each period, which includes a review of, among other factors,
      demand requirements, product life cycle and development plans, component cost
      trends, product pricing and quality issues. Based on this analysis, we record
      adjustments to inventory for excess, obsolescence or impairment, when
      appropriate, to reflect inventory at net realizable value. Revisions to our
      inventory adjustments may be required if actual demand, component costs or
      product life cycles differ from our estimates. In the event we were unable
      to
      sell our products, the demand for our products diminished, and/or other
      competitors offered similar or better products, we would be forced to record
      an
      adjustment to inventory for impairment or obsolescence to reflect inventory
      at
      net realizable value. The accounting effect of this entry would be a charge
      to
      earnings, thereby reducing our net earnings.


30


*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.





*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.


31


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 the 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.**





PacificNet
      Inc. (http://www.PacificNet.com) is a leading provider of gaming technology,
      e-commerce, and Customer Relationship Management (CRM) in China. Our gaming
      products are specially designed for the Chinese and Asian gamers, and we focus
      on integrating localized Chinese and Asian themes and content, advanced
      graphics, digital sound effects and popular domestic music, with secondary
      bonus
      games and jackpots. Our gaming products include: Multi-player Electronic Table
      Games - Baccarat, Sicbo, Fish-Prawn-Crab, and Roulette machines, server based
      games (SBG) with multiple client betting stations, slot and bingo machines,
      video lottery terminals (VLTs), amusement with prices (AWP) machines, gaming
      cabinet and client/server system designs, online i-gaming software design,
      and
      multimedia entertainment kiosks. PacificNet's gaming clients include the leading
      hotels, casinos, and gaming operators in Macau, Asia, and Europe, and our
      ecommerce and CRM clients include the leading telecom companies, banks,
      insurance, travel, marketing and business services companies and telecom
      consumers in Greater China such as China Telecom, China Mobile, Unicom, PCCW,
      Hutchison Telecom, Bell24, Motorola, Nokia, SONY, TCL, Huawei, American Express,
      Citibank, HSBC, Bank of China, Bank of East Asia, DBS, TNT, China and Hong
      Kong
      government. PacificNet employs about 1,200 staff in its various subsidiaries
      throughout China with offices in Hong Kong, Beijing, Shanghai, Shenzhen,
      Guangzhou, Macau and Zhuhai China, USA, and the Philippines.





**PacificNet's
      Gaming Products:**


Our
      gaming products are specially designed for the Chinese and Asian gamers, and
      we
      focus on integrating localized Chinese and Asian themes and content, advanced
      graphics, digital sound effects and popular domestic music, with secondary
      bonus
      games and jackpots. Our gaming products include:





•
      Multi-player Electronic Table Games: Baccarat, Sicbo, Fish-Prawn-Crab, and
      Roulette Machines, server based games (SBG) with multiple client betting
      stations.


•
Slot
      Machines


•
Bingo
      and Keno Machines


•
Video
      Lottery Terminals (VLTs)


•
      Server-Based Gaming Machines (SBG)


•
      Amusement With Prices (AWP) Machines


•
Online
      iGaming Software Development


•
      Client-Server Gaming Systems


•
CMM
      Level 3 Certified Gaming Software Development Center in China with 200
      Professional Software Developers


•
Gaming
      Systems, Cabinet Design and Sales, Parts Sales, OEM Games. We design and sell
      gaming machine cabinets, replacement parts.


32


**PacificNet's
      Business Units:**


1.
      Gaming
      Technology: Electronic Gaming Machines, Mobile Games, i-Gaming
      Software.


2.
      Legacy
      Business: CRM, E-commerce and Telecom Products


Our
      goal
      is to take a leading role in providing customer relationship management (CRM)
      and gaming technology, which are rapidly expanding business sectors in Asia.





**PaificNet’s
      Major Operating Subsidiaries**


—
            **PacificNet
                Games Limited (PacGames)**,
                is a leading provider of Asian multi-player electronic gaming machines,
                gaming technology solutions, gaming related maintenance, IT and
                distribution services for the leading hotel, casino and slot hall
                operators based in Macau, China and other Asian gaming markets.


—
            Take1
                Technologies (www.take1technologies.com) , is in the business of
                designing
                and manufacturing electronic multimedia entertainment kiosks, coin-op
                kiosks and machines, electronic gaming machines (EGM), bingo and
                slot
                machines, AWP (Amusements With Prizes) games, server-based downloadable
                games systems, and Video Lottery Terminals (VLT) such as Keno and
                Bingo
                machines, including hardware, software, and cabinets.


—
            Pacific
                Solutions Technology, is a CMM Level 3 certified software development
                center with over 200 software programmers located in Shenzhen, China,
                and
                specializes in the development of client-server systems, internet
                e-commerce software, online and casino gaming systems and slot machines,
                banking and telecom applications using Microsoft Visual C++, Java,
                and
                other rapid application development
                tools.


—
            PacificNet
                Epro (www.EproTel.com.hk): CRM Call Center and Customer Services
                Outsourcing


—
            PacificNet
                Clickcom (www.clickcom.com.cn), MOABC.com : VAS,SP,( SMS,
                WAP)


—
            Guangzhou
                Wanrong (www.my2388.com) : VAS, SP, (SMS,MMS,IVR,WAP, Java
                Games)


—
            PacificNet
                Communications Limited,


—
            iMobile,
                (www.imobile.com.cn, www.18900.com,
                wap.17wap.com)





**PacificNet
      Gaming Technology**




**1.
      Participation games** :
      company-owned gaming machines that we lease based upon any of the following
      payment methods are referred to as participation games: (1) a percentage of
      the
      net win of the gaming machines, (2) fixed daily fees, or (3) in the case of
      wide-area progressive gaming machines, a percentage of the amount wagered or
      a
      combination of a fixed daily fee and a percentage of the amount
      wagered.


**2.
      Wide Area Game Network, Community Gaming** :
      electronically link gaming machines that are located across multiple casinos
      within a gaming jurisdiction. The linked gaming machines contribute to and
      compete for large, system-wide progressive jackpots and are designed to increase
      gaming machine play for participating casinos by giving the players the
      opportunity to win a larger jackpot than on a stand-alone gaming
      machine.


**3.
      Local Area Progressive Jackpots (LAP) participation games** :
      electronically links gaming machines that are located within a single casino
      to
      a progressive jackpot for that specific casino.


**4.
      Video Lottery Terminals** :
      video
      gaming machines featured with localized Chinese and Asian themes and contents,
      advanced graphics, digital sound effects and music and incorporate many of
      the
      same features from our other gaming machines.


**5.
      Server-based Gaming** :
      a
      gaming system in which game content and peripherals are configured, maintained
      and refreshed over a network that links groups of gaming machines to a remote
      server that also enables custom configuration by operators and central
      determination of game outcomes.


33


**Gaming
      Market Overview on Macau, China**


As
      of the
      end of 2006, Macau (a Special Administrative Region of the People's Republic
      of
      China) has become the largest and fastest-growing gaming market in the world,
      and surpassed the Las Vegas Strip in total revenues. According to statistics
      provided by Macau government, in 2006, Macau's gaming revenues exceeded US$7
      billion (MOP 56.2 billion patacas), surpassing the Las Vegas Strip gaming
      revenues of US$6.6 billion. Macau borders Zhuhai City of Guangdong Province
      of
      China, one of the country's wealthiest and most developed regions and is an
      hour
      away from Hong Kong via ferry. In 2006, the number of tourists visiting Macau
      reached an all-time record of 22 million, an increase of 17 percent compared
      with 2005, of which 55% or 12 million visitors were from mainland China. At
      the
      end of 2006, there were 22 casinos, 83 hotels and similar establishments in
      Macau with close to 13,000 rooms. By 2010, the number of tourists is expected
      to
      nearly double to nearly 30 million visitors per year. Approximately one billion
      people live within a three-hour flight of Macau. Numerous hotel, gaming, and
      other projects are in the works in Macau which are expected to add over 10,000
      guest rooms and over 20,000 live entertainment seats in eight separate venues.
      The number of hotel-casinos in operation and in development in Macau continues
      to grow, including well-known Chinese names such as Galaxy and Melco, and famous
      Las Vegas names such as the Sands, the Venetian, Wynn Resort and Crown Macau.
      With the disposable income of the average Chinese on the rise, Macau's gaming
      and entertainment market is expected to grow for years to come. Macau is the
      only area in China where gambling is legal.





**RESULTS
      OF OPERATIONS**





REVENUES.
      Revenues for the three months ended March 31, 2007 were amounted to $9,267,000,
      which represented a quarter-over-quarter increase of 39% from $6,672,000 for
      the
      three months ended March 31, 2006. The
      increase in revenues was mainly due to the Products (Telecom & Gaming),
      primarily driven by the Company’s high growth gaming technology businesses, and
      organic growth in Outsourcing Services Group, which posted a
      quarter-over-quarter increase of 42.3% and 31.1% respectively. The
      revenues in services and product sales during the first quarter of 2007
      increased by 60.1% and 22.2% compared to the same periods of 2006. Segmented
      financial information of the three business operating groups is set out below
      followed by a brief discussion of each business group.




THREE
      MONTHS ENDED MARCH 31, 2007 COMPARED TO THREE MONTHS ENDED MARCH 31,
      2006





FOR
                THE THREE MONTHS ENDED
            
            Group
                1
              Outsourcing
              Services
            
            Group
                2
              Telecom
                Value-Added Services
            
            Group
                3
              Products
              (Telecom
                & Gaming)
            
            Other
            
            TOTALMARCH
                31, 2007(in
                thousands, except percentages)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)Revenues
            
            
            3,963
            
            
            527
            
            
            4,773
            
            
            4
            
            
            9,267Earnings
                / (Loss) from Operations
            
            
            400
            
            
            -3
            
            
            1,196
            
            
            -793
            
            
            800




34


Group
                  1
              
              Group
                  2
              
              Group
                  3FOR
                    THE THREE MONTHS ENDED
              
              Outsourcing
                  Services
              
              Telecom
                  Value-Added Services
              
              Products
                  (Telecom & Gaming)
              
              Other
              
              TOTAL


MARCH
                31, 2006(in
                thousands, except percentages)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)Revenues
            
            
            3,022
            
            
            295
            
            
            3,355
            
            
            0
            
            
            6,672Earnings
                / (Loss) from Operations
            
            
            206
            
            
            15
            
            
            359
            
            
            -518
            
            
            62





(1)
            Outsourcing
                services: The quarter-over-quarter increase of 31.1% in outsourcing
                services for the three months ended March 31, 2007 was primarily
                due to
                the growth in outsourcing contact center in Hong Kong. Pricing was
                highly
                competitive but demand for outbound calling lists, in-sourcing operators
                and sub-contract call center facilities management, for American
                Express
                and MetLife, remained strong. Outsourcing revenues made up 42.8%
                of the
                Company's total revenues for the first quarter of the
                year.


(2)
            Telecom
                Value-added Services (VAS): Revenue for the three months ended March
                31,
                2007 was $527,000, a quarter-over-quarter increase of 78.6% as compare
                to
                the same period of 2006. VAS revenues made up 5.7% of the Company's
                total
                revenues for the first quarter of the
                year.


(3)
            Products
                (Telecom & Gaming): Revenue for the three months ended March 31, 2007
                was $4,773,000, a quarter-over-quarter increase of 42.3% as compare
                to the
                same period of 2006. Products revenues made up 51.5% of the Company's
                total revenues for the first quarter of the year. During the quarter,
                the
                Company’s mobile phone distribution business in Greater China remained
                steady. The Company owned one of the largest on-line mobile phone
                distribution portals in China and was one of the top five largest
                mobile
                phone wholesalers in Hong Kong. Increase is primarily due to buildup
                of
                revenues derived from the Company’s emerging gaming technology businesses.
                Significant traction has been gained from continued winning of high
                profile gaming orders from the fast growing Asian gaming technology
                provider market. Company managed to continue build up excellent
                relationships with leading casino operators in Macau and the rest
                of Asia
                with its world class multi-player electronic table game machines
                customized to the taste of Asian gaming customers. In addition, winning
                the bid of providing electronic slot machines to various leading
                gaming
                operators’ slot halls in Europe also pushed revenues during the
                quarter.





COST
      OF
      REVENUES. Cost of revenues for the three months ended March 31, 2007 was
      $6,728,000, an increase of 26% from $5,320,000 for the three months ended March
      31, 2006, respectively. The cost of revenues in services sales and
      product sales for the three months ended March 31, 2007 increased by 30% and
      23%, respectively, in each case compared with the respective period in 2006.
      The
      increase in cost of revenues lagged behind the corresponding increase in
      revenues, which amounted to approximately 39%. Cost of revenues savings were
      primarily due to the contribution from higher margin gaming technology
      businesses.




GROSS
      PROFIT. Gross profit for the three months ended March 31, 2007 was $2,539,000,
      a
      significant increase of 88% as compared to $1,352,000 for the three months
      ended
      March 31, 2006. Gross margin was 27% for the three months ended March 31, 2007,
      compared to 20% for the three months ended March 31, 2006.  The
      improvement in gross margin for the quarter was primarily due to increased
      contributions from higher margin gaming technology subsidiaries. Out of their
      19% revenue mix, gross profit of the Company’s gaming technology businesses
      represented 39% of the quarter’s total gross profit. Gross margins of the
      Company’s gaming technology businesses averaged more than 50%.


35


SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative
      expenses totaled $1,567,000 for the three months ended March 31, 2007, an
      increase of 45% from $1,079,000 for the three months ended March 31, 2006.
      Selling, general and administrative expenses as a percentage of revenue,
      however, recorded only a small quarter-over-quarter increase from 16% to 17%.
      Selling, general and administrative expenses consist primarily of staff
      salaries, rent, insurance and traveling costs. The quarter-over-quarter increase
      in total general and administrative expenses during the three months ended
      March
      31, 2007 was mainly due to the increase in consultant and labor costs as a
      result of new product development as well as rental and utilities expenses
      for
      the expansion of the Company’s gaming technology subsidiaries and call centers
      in Hong Kong and China.


SELLING,
                  GENERAL AND ADMINISTRATIVE EXPENSES
                (in
                  thousands, except percentages)
              
              Total
                  for the three months ended
                March
                  31, 2007
                ($)
              
              Total
                  for the three months ended
                March
                  31, 2006
                ($)
              
              Percentage
                  Change
                (%)Remuneration
                  and related
              
              
              1,041
              
              
              581
              
              
              79Office
              
              
              300
              
              
              215
              
              
              40Travel
              
              
              91
              
              
              40
              
              
              128Entertainment
              
              
              40
              
              
              16
              
              
              150Professional
                  (legal and consultant)
              
              
              290
              
              
              65
              
              
              346Audit
              
              
              20
              
              
              18
              
              
              11Selling
              
              
              111
              
              
              52
              
              
              113Other
              
              
              52
              
              
              94
              
              
              (45
              )Recovery
                  of provisions for doubtful accounts
              
              
              (378
              )
              
              -
              
              
              N/ATotal
              
              
              1,567
              
              
              1,081
              
              
              45




INCOME
      /
      (LOSS) FROM OPERATIONS. On a quarter-over-quarter basis, income from operations
      increased 1,100% for the three months ended March 31, 2007. Segmented operating
      incomes of $400,000, $3,000, and $1,196,000 for the three months ended March
      31,
      2007 were generated from the Company's three business groups: (1) CRM
      Outsourcing Services, (2) Telecom Value-Added Services, and (3) Products
      (Telecom & Gaming) Services, respectively. This compares to operating
      incomes of $206,000, $15,000 and $359,000 from the same groups for the same
      period last year, respectively. Improved profitability of continuing operations
      evidenced the success of the Company’s new gaming technology strategy, as
      reflected by the significant gaming technology operating income.





INCOME
      TAXES. Income tax provision was $68,000 for the three months ended March 31,
      2007, as compared to $17,000 for the three months ended March 31, 2006. 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 income increases and the tax holidays we have benefited from in Hong
      Kong and the PRC expire.




MINORITY
      INTERESTS. Minority interests for the three months ended March 31, 2007 totaled
      $534,000 compared with $86,000 for the same period of the prior year,
      representing minority ownership interests in subsidiaries consolidated in the
      Company’s consolidated financial statements.




NET
      INCOME. Net income recorded a quarter-over-quarter decrease of 62% for the
      three
      months ended March 31, 2007 as compared to the same period of prior year. This
      was solely due to diminishing income from discontinued operations as a result
      of
      the Company shifting from VAS businesses that are highly susceptible to adverse
      billing policy changes administered by China Mobile.


36


**CASH**





Net
      cash
      and cash equivalents at March 31, 2007 were approximately $4.04 million, an
      increase of approximately $1.80 million compared to December 31, 2006. This
      was primarily due to successful collection of certain doubtful debts of
      approximately $300,000 and 50% net proceeds ($2.3 million) from issuance of
      convertible debenture for the Company’s gaming technology business, net of
      acquisition of property and equipment of approximately $900,000.





**CONTRACTUAL
      OBLIGATIONS**





Contractual
      obligations as of March 31, 2007 are detailed below:




**Payments
      Due by Period**


Contractual
                Obligations
            
            Total
            
            Less
                than 1 year
            
            1-5
                years
            
            After
                5 yearsLine
                of credit
            
            $
            404,000
            
            $
            404,000
            
            
            0
            
            
            0Bank
                Loans
            
            $
            3,213,000
            
            $
            933,000
            
            $
            870,000
            
            $
            1,410,000Operating
                leases
            
            $
            1,339,000
            
            $
            655,000
            
            $
            684,000
            
            
            0Capital
                leases
            
            $
            214,000
            
            $
            110,000
            
            $
            104,000
            
            
            0Total
                cash contractual obligations
            
            $
            5,170,000
            
            $
            2,102,000
            
            $
            1,658,000
            
            $
            1,410,000





In
      addition to above, as previously disclosed in the paragraph under the
      sub-heading of PROBABLE EVENT OF DEFAULT under Item 7 - CONVERTIBLE DEBENTURES,
      the terms of the convertible note obligate the Company to pay monthly 2% of
      outstanding principal as liquidated damages and 30% of the outstanding principal
      as mandatory default amount from the date of ineffectiveness of registration
      statement. As of March 31, 2007, the Company has accrued three months of
      liquidated damages and mandatory amount or approximately $2,697,000, although
      the Company may not have to pay the full amount of liquidated damages The amount
      has been reflected in the consolidated financial statements as a separate line
      item on the consolidated balance sheet as “liquidated damages
      liability”.





OFF-BALANCE
      SHEET ARRANGEMENTS.




There
      were no off-balance sheet guarantees, interest rate swap transactions, foreign
      currency forward contracts or long term purchase commitments outstanding as
      of March
      31,
      2007 .
      Further, the Company had not engaged in any non-exchange trading activities
      during first quarter of 2007.


37


**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.





***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 US. 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.





***Inflation.***


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


38


***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
      Chinese renminbi ("RMB"). 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 inter-bank foreign exchange market rates
      and current exchange rates on the world financial markets. Since 1994, the
      official exchange rate for the conversion of renminbi to U.S. dollars had
      generally been stable and the renminbi had appreciated slightly against the
      U.S.
      dollar. However, on July 21, 2005, the Chinese government changed its policy
      of
      pegging the value of Chinese renminbi to the U.S. dollar. Under the new policy,
      Chinese renminbi may fluctuate within a narrow and managed band against a basket
      of certain foreign currencies. Recently there has been increased political
      pressure on the Chinese government to decouple the renminbi from the United
      States dollar. At the recent quarterly regular meeting of People's Bank of
      China, its Currency Policy Committee affirmed the effects of the reform on
      Chinese renminbi exchange rate. Since February 2006, the new currency rate
      system has been operated; the currency rate of renminbi has become more flexible
      while basically maintaining stable and the expectation for a larger appreciation
      range is shrinking. Although a devaluation of the Hong Kong dollar or renminbi
      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 renminbi 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. For
      fluctuations in period to period exchange rates, the translation adjustment
      is
      required to translate from local functional currency to the USD reporting
      currency (not RMB to HKD to USD). The Company has never engaged in currency
      hedging operations and has no present intention to do so.





***Concentration
      of Credit Risk.***


Credit
      risk represents the accounting loss that would be recognized at the reporting
      date if counterparties failed completely to perform as contracted.
      Concentrations of credit risk (whether on or off balance sheet) that arise
      from
      financial instruments exist for groups of customers or counterparties when
      they
      have similar economic characteristics that would cause their ability to meet
      contractual obligations to be similarly affected by changes in economic or
      other
      conditions as described below:




·
            The
                Company's business is characterized by rapid technological change,
                new
                product and service development, and evolving industry standards
                and
                regulations. Inherent in the Company's business are various risks
                and
                uncertainties, including the impact from the volatility of the stock
                market, limited operating history, uncertain profitability and the
                ability
                to raise additional capital.




·
            All
                of the Company's revenue is derived from Asia and Greater China.
                Changes
                in laws and regulations, or their interpretation, or the imposition
                of
                confiscatory taxation, restrictions on currency conversion, devaluations
                of currency or the nationalization or other expropriation of private
                enterprises could have a material adverse effect on our business,
                results
                of operations and financial
                condition.




·
            If
                the Company is unable to derive any revenues from Greater China,
                it would
                have a significant, financially disruptive effect on the normal operations
                of the Company.




*
      A
      substantial portion of the operations of business operations depend on mobile
      telecommunications operators (operators) in China and any loss or deterioration
      of such relationship may result in severe disruptions to their business
      operations and the loss of a significant portion of the Company's revenue.
      The
      VIEs rely entirely on the networks and gateways of these operators to provide
      its wireless value-added services. Specifically these operators are the only
      entities in China that have platforms for wireless value-added services. The
      Company's agreements with these operators are generally for a period of less
      than one year and generally do not have automatic renewal provisions. If neither
      of them is willing to continue to cooperate with the Company, it would severely
      affect the Company's ability to conduct its existing wireless value-added
      services business.


39


***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 gaming products, call center and telecom value-added services
      tend to be higher in the fourth quarter due to special holiday promotions.
      Internet/Direct Commerce revenues also tend to be higher in the fourth quarter
      due to increased consumer spending during that period. Revenues from the gaming
      and VAS can vary from quarter to quarter due to new product launches and the
      seasonality of certain product lines.





Sales
      of
      our gaming machines to Macau and other Asian casinos and gaming operators are
      generally strongest in Q3 and Q4 and slowest in the Chinese New Year holiday
      season in Q1. In addition, quarterly revenues and net income may increase when
      we receive a larger number of approvals for new games from regulators and gaming
      operators than in other quarters, when a game or platform that achieves
      significant player appeal is introduced or if gaming is permitted in a
      significant new jurisdiction. In addition, as further technology advancements
      become available for the gaming industry, replacement or conversion of gaming
      machines will be impacted once any such advanced technology is approved by
      regulators.





**ITEM
      4.  CONTROLS AND PROCEDURES**





We
      maintain controls and procedures designed to ensure that information required
      to
      be disclosed in the reports that we file or submit under the Securities Exchange
      Act of 1934 is recorded, processed, summarized and reported within the time
      periods specified in the rules and forms of the Securities and Exchange
      Commission. Based upon the evaluation of those controls and procedures performed
      as of the period ended December 31, 2006, our chief executive officer and our
      former chief financial officer concluded that our disclosure controls and
      procedures were inadequate, need to be strengthened and were not sufficiently
      effective to ensure that information required to be disclosed by us in our
      reports that we filed or submitted under the Exchange Act was recorded,
      processed, summarized and reported within the time periods specified in SEC
      rules and forms.





During
      the year, the Company had taken various steps to maintain the accuracy of our
      financial disclosures, and improve company internal control. An internal control
      team lead by senior managers had been set up to review the entire internal
      control system of the Company, including but not limited to risks
      identification, control procedure setup, staff training, segregation of
      incompatible job duties, design of management reporting system, definition
      and
      delegation of signing authority, establishment of documentation system and
      implementation of a company-wide ERP system.


40


**PART
      II - OTHER INFORMATION**





**ITEM
      1.   LEGAL PROCEEDINGS.**





1.
      Legal
      Proceeding and Judgment Against Guangzhou Yueshen Taiyang Network Science and
      Technology Limited, Ms. Li Yan Kuan, and Mr.Wu Yi Wen





On August
      12, 2006, we commenced a law suit in the High Court of the Hong Kong Special
      Administrative Region ("HKSAR") against Guangzhou Yueshen Taiyang Network
      Science and Technology Limited, Ms. Li Yan Kuan and Mr.Wu Yi Wen for
      failure to pay amounts owed under a promissory note.  On May 15, 2005, we
      loaned RMB2,000,000 ("Debt Sum") to Yueshen to cover operating costs, evidenced
      by a promissory note due on November 15, 2005.  Ms. Kuan and Mr. Wen
      guaranteed repayment of the note by Yueshen.  The Debt Sum together with
      the agreed interest rate calculated at 6% per annum was due on November 15,
      2005.





On
      March
      28, 2007, the High Court of HKSAR had adjudged that the three defendants should
      pay us the Debt Sum together with interest sum at the rate of 6% per annum
      from
      May 15, 2005 to March 28, 2007, and additional interest charged at the rate
      of
      5% per annum for the Debt Sum and accrued interest within 90 days overdue and
      thereafter at the judgment rate until payment and fixed costs of
      HK$3,405.





2.
      Lawsuit between PacificNet Power Limited and Johnson Controls Hong Kong Limited
      (JCHKL), a subsidiary of Johnson Controls Inc.  (NYSE:JCI)
      (www.jci.com )





On
      January 19, 2007, Johnson Controls Hong Kong Limited filed a claim against
      PacificNet Power Limited (a 51% owned subsidiary of PacificNet) in the High
      Court of the Hong Kong Special Administrative
      Region seeking HK$4,800,000 as payment for services rendered to
      replace 3 sets of rane water-cooled chillers, together with energy saving
      performance (the "Chiller System"), at the Fortress Tower in Hong
      Kong.





In
      connection with the claim, PacificNet Power reviewed a letter
      from its client, China Weal Property Management Ltd., dated January
      22, 2007 stating that the construction work by JCHKL had not been completed
      as
      of the date of the letter, and that certain violations itemized in a letter
      issued by the Hong Kong Environment Protection Department  (EPD) (Noise
      Abatement Notice No. N806030) addressed to JCHKL with respect to acoustic
      problems with JCHKL’s equipment had not been abated.  Further, JCHKL was to
      pay penalties between HK$100,000 and HK$200,000 assessed by the
      JCHKL for failing to fix the noise problem on the roof of Fortress
      Tower.





The
      board
      of directors of PacificNet Power Limited has reviewed the case
      with its client, China Weal Property Management Ltd., and our
      Hong Kong legal counsel and it is our belief that the project
      work undertaken JCHKL is defective in numerous aspects, as evidenced by the
      letter from government letter issued by EPD.  As a result, we believe the
      construction work was not been completed by JCHKL, and therefore,
      JCHKL is not entitled to payment for its services.


41


On
      February 7, 2007, we instructed our Hong Kong legal counsel to issue a
      Defense and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's
      construction work has not complied with the applicable rules and regulations
      of
      various government authorities in Hong Kong; (ii) the Chiller System provided
      by
      JCHKL was defective and merchantable unfit and JCHKL has failed
      and/or refused to rectify such defective works; and (iii) JCHKL shall return
      the work deposit in the amount of  HK$1,500,000 to PacificNet Power
      Limited and shall compensate and keep PacificNet Power Limited indemnified
      against all the loss and damages suffered as a result of any claims from the
      China Weal Property Management Ltd, the employer and the potential tenants
      of
      Fortress Tower.




The
      case
      is under review by Hong Kong High Court and we have not received any judgment
      from the High Court of the Hong Kong Special Administrative Region as of date
      of
      this report. We are currently proceeding with discovery and counter-claims,
      and
      we intend to vigorously defend ourselves against the allegations. We are unable
      to predict the outcome of these actions, or a reasonable estimate of the range
      of possible loss, if any.





**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-K for the year ended December 31, 2006, and in Part II, Item IA Risk Factors
      in our Amendment to Quarterly Report on Form 10-Q for the period ended March
      31,
      2007 which could materially affect our business, financial condition or future
      results. The risks described in our Annual Report on Form 10-K and the Amendment
      to our Quarterly Report on Form 10-Q 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.




THE
      FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL
      CONDITION, AND LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR
      OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A
      FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT
      ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER
      MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR
      STATEMENTS.





**RISKS
      RELATED TO OUR BUSINESS**





**We
      have a limited operating history and recently experienced a significant increase
      in revenue that may not be sustained.**


Our
      business operations commenced in 1994, and subsequently the business was
      incorporated as a Delaware corporation in 1999. Our operating history may be
      insufficient to evaluate our business and future prospects. Although our
      revenues have grown rapidly in the past three years, primarily as a result
      of
      our increased acquisition activity, we cannot assure investors that we will
      maintain our profitability or that we will not incur net losses in the future.
      We expect that our operating expenses will increase as we expand. Any
      significant failure to realize anticipated revenue growth could result in
      significant operating losses. We will continue to encounter risks and
      difficulties in implementing our business model, including our potential failure
      to:





·
            Increase
                awareness of our brands, protect our reputation and develop customer
                loyalty




·
            Manage
                our expanding operations and service offerings, including the integration
                of any future acquisitions




·
            Maintain
                adequate control of our expenses




·
            Anticipate
                and adapt to changing conditions in the markets in which we operate
                as
                well as the impact of any changes in government regulation, mergers
                and
                acquisitions involving our competitors, technological developments
                and
                other significant competitive and market
                dynamics




If
      we are
      not successful in addressing any or all of these risks, our business may be
      materially and adversely affected.


42


**The
      acquisition of new businesses is costly and such acquisitions may not enhance
      our financial condition.**


Our
      growth strategy is to acquire companies and identify and acquire assets and
      technologies from businesses in greater China that have services, products,
      technologies, industry specializations or geographic coverage that extend or
      complement our existing business. The process to undertake a potential
      acquisition is time-consuming and costly. We expend significant resources to
      undertake business, financial and legal due diligence on our potential
      acquisition target and there is no guarantee that we will acquire the company
      after completing due diligence. Any future acquisitions will be subject to
      a
      number of challenges, including:





·
            Diversion
                of management time and resources and the potential disruption of
                our
                ongoing business




·
            Difficulties
                in maintaining uniform standards, controls, procedures and
                policies




·
            Potential
                unknown liabilities associated with acquired
                businesses




·
            Difficulty
                of retaining key alliances on attractive terms with partners and
                suppliers




·
            Difficulty
                of retaining and recruiting key personnel and maintaining employee
                morale




Our
      acquisitions could result in the use of substantial amounts of cash, potentially
      dilutive issuances of equity securities, significant amortization expenses
      related to goodwill and other intangible assets and exposure to undisclosed
      or
      potential liabilities of acquired companies. During the fiscal year ended
      December 31, 2006, we acquired controlling interests in Guangzhou Wanrong,
      iMobile and PacGames. We expect that these acquisitions will strengthen our
      position as a provider of VAS communication products: internet mobile phone
      distribution and gaming technology in Asia. Although our agreements provide
      that
      the consideration is payable upon the acquired company attaining certain income
      milestones annually, there is no guarantee that these milestones will be
      reached. If they are not reached as anticipated, the time, cost and capital
      to
      acquire the company may outweigh the anticipated benefits from consolidation
      of
      their income. To the extent that the goodwill arise from the acquisitions
      carried on the financial statements do not pass the annual goodwill impairment
      test, excess goodwill will be charged to future earnings.





**We
      intend to operate each of our acquired businesses on a standalone
      basis.**


We
      do not
      intend to integrate the information or communications systems, management,
      or
      other aspects of the businesses we acquire. If we integrated the businesses,
      we
      might be able to reduce expenses by eliminating duplicative personnel,
      facilities, or technology and other costs. In addition, facilities and
      technology integration might make inter-company communications and transactions
      more efficient. By declining to integrate the acquired businesses, we might
      forego opportunities to operate more profitably. Furthermore, our decision
      not
      to integrate these businesses might result in difficulties in evaluating the
      effectiveness of our internal control over financial reporting, which could
      complicate compliance with Section 404 of the Sarbanes-Oxley Act of
      2002.





**Because
      we do not have employment agreements with management of the acquired companies,
      our business operations might be interrupted if they were to
      resign.**


As
      part
      of our acquisition strategy, we do not use our own employees or members of
      our
      management team to operate the acquired companies. Key management at these
      companies has been in place for several years and has established solid
      relationships with their customers. Competition in our industry for
      executive-level personnel is strong and we can make no assurance that we will
      be
      able to retain the highly effective executive employees. Although we provide
      incentives to management to stay with the acquired business, we have not entered
      into employment agreements with them. If such key persons were to resign we
      might face impairment of relationships with remaining employees or customers,
      which might result in further resignation by employees, and might cause
      long-term clients to terminate their relationship with us. Furthermore, we
      have
      not entered into any non-competition and confidentiality agreements with these
      employees and management. Due to the limited enforceability of these types
      of
      agreements in China, we face the risk that employees of the acquired
      subsidiaries might divulge our software and other protected intellectual
      property secrets to competitors.


43


**We
      may not be able to attract or retain the management or employees necessary
      to
      remain competitive in our industries.** Tony
      Tong, our Chairman and Chief Executive Officer, and Victor Tong, our President,
      are essential to our ability to continue to grow through acquisitions Messrs.
      Tong and Tong have established relationships within our industry. Their business
      contacts have been critical in identifying, and negotiating with acquisition
      candidates and in developing and expanding our gaming operations.


Our
      future success depends on the retention and continued contributions of our
      key
      management, finance, marketing, and staff personnel, many of whom would be
      difficult or impossible to replace. Our success is also tied to our ability
      to
      recruit additional key personnel in the future. We may not be able to retain
      our
      current personnel or recruit any additional key personnel required. The loss
      of
      services of any of our personnel could have a material adverse effect on our
      business, financial condition, results of operations and prospects. If either
      of
      them were to leave our employ, our growth strategy might be hindered, which
      could limit our ability to increase revenue.





**The
      establishment and expansion of international operations requires significant
      management attention.**


All
      of
      our current, as well as any anticipated future revenue, are or are expected
      to
      be derived from Asia. Our international operations are subject to risks,
      including the following, which, if not planned and managed properly, could
      materially adversely affect our business, financial condition and operating
      results:





·
            Legal
                uncertainties or unanticipated changes regarding regulatory requirements,
                liability, export and import restrictions, tariffs and other trade
                barriers




·
            Longer
                customer payment cycles and greater difficulties in collecting accounts
                receivable




·
            Uncertainties
                of laws and enforcement relating to the protection of intellectual
                property and potentially uncertain or adverse tax
                consequences




**Our
      operations could be curtailed if we are unable to obtain required additional
      financing.**


Since
      inception our investments and operations primarily have been financed through
      sales of our common stock. During the fiscal year ended December 31, 2006,
      we
      completed a financing in which we placed $8,000,000 in convertible debentures
      and issued warrants to purchase up to 400,000 shares of common stock. In the
      future we may need to raise additional funds through public or private
      financing, which may include the sale of equity securities, including securities
      convertible into our common stock. The issuance of these equity securities
      could
      result in dilution to our stockholders. If we are unable to raise capital when
      needed, our business growth strategy may slow, which could severely limit our
      ability to increase revenue.





**Fluctuations
      in the value of the Hong Kong Dollar or RMB relative to foreign currencies
      could
      affect our operating results.**


We
      have
      historically conducted transactions with customers outside the United States
      in
      United States dollars. Payroll and other costs of foreign operations are payable
      in foreign currencies, primarily Hong Kong dollars and Chinese renminbi. To
      the
      extent future revenue is denominated in foreign currencies, we would be subject
      to increased risks relating to foreign currency exchange rate fluctuations
      that
      could have a material adverse affect on our business, financial condition and
      operating results. The value of Hong Kong dollars and Chinese renminbi against
      the U.S. dollar and other currencies may fluctuate and is affected by changes
      in
      the PRC's political and economic conditions. As our operations are primarily
      in
      Asia, any significant revaluation of Hong Kong dollars or the Chinese renminbi
      may materially and adversely affect our cash flows, revenue and financial
      condition. For example, we may need to convert U.S. dollars into Hong Kong
      dollars or Chinese renminbi as appreciation of either currency against the
      U.S.
      dollar could have a material adverse effect on results of our business,
      financial condition and operations. Conversely, if we decide to convert our
      Hong
      Kong dollars or Chinese renminbi into U.S. dollars for other business purposes
      and the U.S. dollar appreciates against either currency, the U.S. dollar
      equivalent of the respective currency we convert would be reduced. To date,
      we
      have not engaged in any hedging transactions in connection with our
      international operations.


44


**We
      have never paid cash dividends and are not likely to do so in the foreseeable
      future.**


We
      have
      never declared or paid any cash dividends on our common stock. We currently
      intend to retain any future earnings for use in the operation and expansion
      of
      our business. We do not expect to pay any cash dividends in the foreseeable
      future but will review this policy as circumstances dictate.





**RISKS
      RELATED TO OUR GAMING BUSINESS**





**If
      we fail to keep pace with rapid innovations in product design and related
      marketing strategies, or if we are unable to quickly adapt our development
      and
      manufacturing processes to release innovative products or systems, our business
      could be negatively impacted.**





Our
      future success depends to a large extent upon our ability to continue to rapidly
      design and market technologically sophisticated and entertaining products that
      achieve high levels of player acceptance. Our revenues depend on the earning
      power and life span of our games. Newer game themes tend to have a shorter
      life
      span than more legacy game themes, and as a result, we face pressure to design
      and deploy successful game themes to maintain our revenue stream and to remain
      competitive. Our ability to develop new and innovative products could be
      adversely affected by :an inability to roll out new games, services or systems
      on schedule as a result of delays in connection with regulatory product approval
      in the applicable jurisdictions, or otherwise.




Our
      future success also depends upon our ability to adapt our manufacturing
      capabilities and processes to meet the demands of producing new and innovative
      products. Because our newer products are generally more technologically
      sophisticated than those we have produced in the past, we must continually
      refine our production capabilities to meet the needs of continuing product
      innovation. In addition, the shorter lifespan of newer products means that
      we
      must update our production capabilities more frequently and rapidly than in
      the
      past. If we cannot adapt our manufacturing infrastructure to meet the needs
      of
      our product innovations, or if we are unable to make upgrades to our production
      capacity in a timely manner, our business could be negatively
      impacted.





**If
      the current popularity and acceptance of gaming declines, our business plans
      and
      operation could be would be negatively impacted.**





The
      gaming industry can be affected by public opinion of gaming. Our success depends
      on continually developing and successfully marketing new games and gaming
      machines with strong and sustained player appeal. A new game or gaming machine
      will be accepted by casino operators only if we can show that it is likely
      to
      produce more revenues to the operator than competitors’ products. Gaming
      machines can be installed in casinos on a trial basis, and only after a
      successful trial period are the machines purchased by the casinos. Participation
      gaming machines are replaced by casino operators if the gaming machines do
      not
      meet and sustain revenue and profitability expectations. Therefore, these gaming
      machines are particularly susceptible to pressure from competitors, declining
      popularity, changes in economic conditions and increased taxation and are at
      risk of replacement by the casinos, which would end our recurring revenues
      from
      these machines.





We
      cannot
      assure you that the new products that we introduce will achieve any significant
      degree of market acceptance, that the acceptance will be sustained for any
      meaningful period. In the event that there is a decline in public acceptance
      of
      gaming, either through unfavorable legislation affecting the introduction of
      gaming into emerging markets, or through legislative and regulatory changes,
      including tax increases, in existing gaming markets, our ability to continue
      to
      sell and lease our gaming machines in those markets and jurisdictions would
      be
      adversely affected.


45


**The
      gaming industry is intensely competitive. We face competition from a number
      of
      companies, some of which have greater resources, and if we are unable to compete
      effectively, our business could be negatively impacted.**


Competition
      among gaming machine manufacturers is based on, among other things, competitive
      pricing and financing terms made available to customers, appeal of game themes
      and features to the end player and product quality, features and functionality
      of hardware and software. The gaming technology provider market is saturated,
      with IGT, Aristocrat, WMS, Bally Gaming and Systems, and, to a lesser extent,
      Konami and Progressive Gaming Corporation comprising the primary competition.
      The competition is intense due to the number of providers, as well as the
      limited number of casino operators and jurisdictions in which they operate.
      Pricing, product feature and function, accuracy and reliability are amongst
      the
      factors in determining a provider’s success in selling its system. While there
      are a number of established, well-financed companies producing machines in
      the
      field, a single competitor, IGT, dominates the PRC domestic market for gaming
      machines. Certain of these competitors have access to greater financial,
      marketing and product development resources we. do, and as a result, may be
      better positioned to compete in the marketplace.




In
      addition, new competitors may enter our key markets. Obtaining space and
      favorable placement on casino gaming floors is a competitive factor in our
      industry. Competitors with a larger installed base of gaming machines than
      ours
      have an advantage in retaining the most space and best positions in casinos.
      These competitors may also have the advantage of being able to convert their
      installed machines to newer models in order to maintain their share of casino
      floor space. In addition, some of our competitors have developed and sell or
      otherwise provide to customers centralized player tracking and accounting
      systems which allow operators to accumulate accounting and performance data
      about the operation of gaming machines. We do not offer a centralized player
      tracking and accounting system and that has put us at a competitive
      disadvantage.





**The
      unpredictable growth of non-legacy gaming markets may affect our business and
      prospects.**


The
      continued growth of non-legacy gaming markets for gaming machines and systems
      depends heavily on the public’s acceptance of gaming in these markets, as well
      as the ongoing development of the regulatory approval process by national and
      local governmental authorities. A portion of our growth is directly tied to
      our
      ability to access these new markets. We cannot predict which new jurisdictions
      or markets, if any, will approve the operation of electronic gaming machines,
      the timing of any such approval, the public’s acceptance of our gaming machines
      in these markets or our market share or profitability in these markets. Any
      decline in the popularity of our gaming products with players, or if we are
      unsuccessful in developing new products, services or systems, will have a
      negative impact on our revenues.





**The
      gaming industry is heavily regulated and changes in regulation by gaming
      authorities may adversely impact our ability to operate the
      business.**


The
      manufacture and distribution of gaming machines, development of systems and
      the
      conduct of gaming operations are subject to extensive national, provincial
      local
      and foreign regulation by various gaming authorities.





Our
      ability to continue to operate in certain jurisdictions could be adversely
      affected by:




·
            Unfavorable
                public referendums




·
            Unfavorable
                legislation affecting or directed at manufacturers or gaming operators,
                such as Referendums to increase taxes on gaming
                revenues




·
            Adverse
                changes in or finding of non-compliance with applicable governmental
                gaming regulations




·
            Delays
                in approvals from regulatory
                agencies




·
            Limitations,
                conditioning, suspension or revocation of any of our gaming
                licenses




·
            Unfavorable
                determinations or challenges of suitability by gaming regulatory
                authorities with respect to our officers, directors, major stockholders
                or
                key personnel




46


Although
      the laws, rules and regulations of the various jurisdictions in which we operate
      vary in their technical requirements, virtually all jurisdictions require
      licenses, permits, qualification documentation, including evidence of integrity
      and financial stability, and other forms of approval to engage in gaming
      operations or the manufacture and distribution of gaming machines. Delays in,
      amendments to, or repeals of legislation approving gaming in jurisdictions
      in
      which we operate or plan to commence operations, or delays in approvals of
      our
      customers’ operations, may adversely affect our operations





Our
      officers, directors, major stockholders and key personnel are also subject
      to
      significant regulatory scrutiny. In the event that gaming or governmental
      authorities determine that any person is unsuitable to act in such capacity
      with
      respect to the Company, we could be required to terminate our relationship
      with
      such person. To our knowledge, the Company and our key personnel have obtained,
      or applied for, all government licenses, registrations, findings of suitability,
      permits and approvals necessary to conduct their respective activities in the
      various jurisdictions that we operate. However, there can be no assurance those
      licenses, registrations, findings of suitability, permits or approvals will
      be
      renewed in the future, or that new forms of approval necessary to operate in
      emerging or existing markets will be granted.





Furthermore,
      some jurisdictions require gaming manufacturers to obtain government approval
      before engaging in some transactions, such as business combinations,
      reorganizations, borrowings, stock offerings and repurchases. Obtaining licenses
      and approvals can be time consuming and costly. We cannot assure you that we
      will be able to obtain or maintain all necessary registrations, licenses,
      permits, approvals or findings of suitability or that the approval process
      will
      not result in delays or changes to our business plans.





**Our
      intellectual property protections may be insufficient to properly safeguard
      our
      technology.**


The
      gaming industry is constantly employing new technologies in both new and
      existing markets. We rely on a combination of patent and other technical
      security measures to protect our products, and we intend to file patents for
      protection of such technologies.  Our
      success may depend in part on our ability to obtain trademark protection for
      the
      names or symbols under which we market our products and to obtain copyright
      protection and patent protection of our proprietary software and other game
      innovations. We also rely on trade secrets and proprietary know-how. We enter
      into confidentiality agreements with our employees regarding our trade secrets
      and proprietary information. We cannot assure you that we will be able to build
      and maintain goodwill in our trademarks or obtain trademark or patent
      protection, that any trademark, copyright or issued patent will provide
      competitive advantages for us or that our intellectual properties will not
      be
      successfully challenged or circumvented by competitors. Furthermore, despite
      various confidentiality agreements and other trade secret protections, our
      trade
      secrets and proprietary know-how could become known to, or independently
      developed by, competitors.


Notwithstanding
      these safeguards, our competitors may still be able to obtain our technology
      or
      to imitate our products. Furthermore, others may independently develop products
      similar or superior to ours.





**Expenses
      incurred with respect to monitoring, protecting and defending our intellectual
      property rights could adversely affect our business.**


Competitors
      and other third parties may infringe on our intellectual property rights, or
      may
      allege that we have infringed on their intellectual property rights. Monitoring
      infringement and/or misappropriation of intellectual property can be difficult
      and expensive, and we may not be able to detect any infringement or
      misappropriation of our proprietary rights. We may also incur significant
      litigation expenses protecting our intellectual property or defending our use
      of
      intellectual property, reducing our ability to fund product initiatives. These
      expenses could have an adverse effect on our future cash flow and results of
      operations. Litigation can also divert management focus from running the
      day−to−day operations of the business. There can be no assurances that certain
      of our products, including those with currently pending patent applications,
      will not be determined to have infringed upon an existing third party
      patent.


47


**The
      intellectual property rights of others may prevent us from developing new
      products or entering new markets.**


The
      gaming industry is characterized by the rapid development of new technologies,
      which requires us to continuously introduce new products using these
      technologies and innovations, as well as to expand into new markets that may
      be
      created. Therefore, our success depends in part on our ability to continually
      adapt our products and systems to incorporate new technologies and to expand
      into new markets that may be created by new technologies. However, to the extent
      technologies are protected by the intellectual property rights of others,
      including our competitors, we may be prevented from introducing products based
      on these technologies or expanding into new markets created by these
      technologies. If our products use processes or other subject matter that is
      claimed under existing patents, or if other companies obtain patents claiming
      subject matter that we use, those companies may bring infringement actions
      against us. We might then be forced to discontinue the affected products or
      be
      required to obtain licenses from the company holding the patent, if it is
      willing to give us a license, to develop, manufacture or market our products.
      We
      also might then be limited in our ability to market new products. We might
      also
      be found liable for treble damage claims relating to past use of the patented
      subject matter if the infringement is found to be willful.





If
      the
      intellectual property rights of others prevent us from taking advantage of
      innovative technologies, our financial condition, operating results or prospects
      may be harmed.





**The
      discontinuation or limitation of any existing licenses from third parties could
      adversely affect our business.**


Some
      of
      our most popular games and gaming machine features, including certain branded
      games and ticket-in, ticket-out cashless gaming functionality, are based on
      trademarks and other intellectual properties licensed from third parties. Our
      future success may depend upon our ability to obtain, retain and/or expand
      licenses for additional popular intellectual properties in a competitive market.
      In the event that we cannot renew and/or expand this or other existing licenses,
      we may be required to discontinue the games using the licensed technology or
      bearing the licensed marks, or limit our use of such items.





**Our
      gaming technology, particularly our wide area progressive networks and centrally
      determined systems, may experience**  **losses
      due to technical difficulties or fraudulent activities.**


Our
      success depends on our ability to avoid, detect, replicate and correct software
      and hardware errors and fraudulent manipulation of our gaming machines and
      associated software. To the extent any of our gaming machines or software
      experience errors or fraudulent manipulation, our customers may replace our
      products and services with those of our competitors. In addition, the occurrence
      of errors in, or fraudulent manipulation of, our gaming machines or software
      may
      give rise to claims for lost revenues and related litigation by our customers
      and may subject us to investigation or other action by gaming regulatory
      authorities, including suspension or revocation of our gaming licenses or
      disciplinary action. Additionally, in the event of such issues with our gaming
      machines or software, substantial engineering and marketing resources may be
      diverted from other areas to rectify the problem.





**Our
      business is subject to other economic, market, and regulatory risks:**


We
      face
      risks associated with doing business in international markets related to
      political and economic instability and related foreign currency fluctuations.
      Unstable governments and changes in current legislation may affect the gaming
      market with respect to gaming regulation, taxation, and the legality of gaming
      in some markets, as we experienced with the Russian market in fiscal 2006.




Customer
      financing is becoming an increasing prevalent component of the sales process
      and
      therefore increases business risk of non-payment, especially in emerging
      markets. In some instances, our gaming machines are installed in casinos on
      a
      trial basis, and only after a successful trial period are the machines purchased
      by the customers. These customer financing arrangements delay our receipt of
      cash and can negatively impact our ability to enforce our rights upon default
      if
      the customer is from a foreign country.




Our
      competitors have begun to provide free game theme conversions to customers
      in
      connection with product sales. While we intend to continue to charge our
      customers for game theme conversions including CPU-NXT upgrade kits, we cannot
      be sure that competitive pressure will not cause us to increase the number
      of
      free game theme conversions we offer to our customers, which would decrease
      the
      revenue we expect to receive for game theme conversions.


48


**RISKS
      RELATED TO OUR CRM AND TELECOM VAS PRODUCTS AND SERVICES**





**A
      substantial portion of our business depends on mobile telecommunications
      operators in China and any loss or deterioration of such relationships may
      result in severe disruptions to our business operations.**


We
      rely
      entirely on the networks and gateways of China Mobile and China Unicom to
      provide our wireless value-added services. Thus, we face certain risks in
      conducting our wireless value-added services business. Currently, China Mobile
      and China Unicom are the only mobile telecommunications operators in China
      that
      have platforms for wireless value-added services. Our agreements with them
      are
      generally for a period of less than one year and generally do not have automatic
      renewal provisions. If neither of them is willing to continue to cooperate
      with
      us, we will not be able to conduct our existing wireless value-added services
      business. Furthermore, our agreements with China Mobile and China Unicom are
      subject to negotiation upon expiration. If any of the mobile telecommunications
      operators decides to change its content or transmission fees or its share of
      revenue, or does not comply with the terms of the agreement, our revenue and
      profitability could be materially adversely affected.





**The
      mobile telecommunications operations may launch and may have already launched
      competing services or could discontinue the use of external content aggregators
      such as ourselves entirely at any time.**


Due
      to
      our reliance on the mobile telecommunications operators for our wireless
      value-added services, any loss or deterioration of our relationship with any
      of
      the mobile telecommunications operators may result in severe disruptions to
      our
      VAS business operations and the loss of a significant portion of our
      revenue.





**Our
      financial condition and results of operations may be materially affected by
      the
      changes in policies or guidelines of the mobile telecommunications
      operators.**


The
      mobile telecommunications operators in China may, from time to time, issue
      certain operating policies or guidelines, requesting or stating its preference
      for certain actions to be taken by all wireless value-added service providers
      using their platforms. Due to our reliance on the mobile telecommunications
      operators, a significant change in their policies or guidelines may have a
      material adverse effect on us. For example, some mobile telecommunications
      operators recently revised their billing policies to request all wireless
      value-added service providers to confirm the subscription status of those users
      who have not been active for three months. Such change in policies or guidelines
      may result in lower revenue or additional operating costs for us, and we cannot
      assure investors that our financial condition and results of operations will
      not
      be materially adversely affected by any policy or guideline change by the mobile
      telecommunications operators in the future.





**We
      may be subject to adverse actions for any breach or perceived breach by us
      of
      the policies or guidelines imposed by the mobile telecommunications operator
      with respect to content provided on or linked through our
      websites.**


The
      mobile telecommunications operators in China may impose policies or guidelines
      to govern or restrict the content provided by all wireless value-added service
      providers, including content developed by us or content supplied by others
      to
      us. The mobile telecommunications operators from time to time have requested
      wireless value-added services providers, including us, to remove objectionable
      content or links to or from websites with certain categories of content,
      including content that they may deem to be sexually explicit. We aggregate
      and
      develop content that we consider attractive to our targeted user base, and
      we
      cannot assure investors that the mobile telecommunications operators will not
      from time to time find certain portions of our content to be objectionable.
      In
      the case of a breach or perceived breach of such policies or guidelines, the
      mobile telecommunications operators may require us to reduce or curtail the
      content on our Internet portal, which may reduce our portal traffic, and the
      mobile telecommunications operators may have the right to impose monetary fines
      upon us, or terminate our cooperation with them. In addition, we would be liable
      to the mobile telecommunications operators for their economic losses pursuant
      to
      our agreements with these operators if we were found to be in breach of the
      policies or guidelines promulgated by them. As a result of the occurrence of
      any
      of the above, our financial condition and results of operations may be
      materially adversely affected.


49


**Our
      dependence on the substance and timing of the billing systems of the mobile
      telecommunications operators may require us to estimate portions of our reported
      revenue for wireless value-added services from time to time. As a result,
      subsequent adjustments may have to be made to our wireless value-added services
      revenue in our financial statements.**


As
      we do
      not bill our wireless value-added services users directly, we depend on the
      billing systems and records of the mobile telecommunications operators to record
      the volume of our wireless value-added services provided, charge our users
      through mobile telephone bills and collect payments from our users and pay
      us.
      In addition, we do not generally have the ability to independently verify or
      challenge the accuracy of the billing systems of the mobile telecommunications
      operators. Generally, within 20 to 60 days after the end of each month, a
      statement from each of the mobile telecommunications operators confirming the
      value of wireless value-added services they bill to users in that month will
      be
      delivered to us, and generally within 60 days after such delivery, we will
      be
      paid by the mobile telecommunications operators for the wireless value-added
      services, net of their revenue share, transmission fees and applicable business
      taxes, for that month based on such statements.





**Our
      communication products are provided cash-on-delivery, which leaves us vulnerable
      to theft and employee embezzlement.**


The
      purchase of calling cards, SIM cards and other mobile phone products are made
      with cash. Although there is a low risk that clients will not pay for these
      services when delivered, our retail stores maintain large sums of money which
      might make them robbery targets. We also face the risk that employees who
      collect the cash and others who may be aware that cash is available at these
      sites might embezzle the money. Theft or embezzlement could have a material
      adverse effect on the revenue generated and the financial condition of our
      business operations.





**Our
      customers are concentrated in a limited number of
      industries.**


Our
      clients are concentrated primarily in the telecommunications, telemarketing
      and
      technology industries, and to a lesser extent, the insurance and financial
      services industries, where the current trend is to outsource certain CRM and
      VAS. Our ability to generate revenue depends on the demand for our services
      in
      these industries. An economic downturn, or a slowdown or reversal of the
      tendency in any of these industries to rely on outsourcing could have a material
      adverse effect on our business, results of operations or financial
      condition.





**The
      market in which we compete is highly competitive and fragmented and we may
      not
      be able to maintain market share.**


We
      expect
      competition to persist and intensify in the future. Our competitors are mainly
      leaders in the CRM services market, such as PCCW Teleservices (Hong Kong)
      Limited, China Motion Telecom International Limited, and Teletech (Hong Kong)
      Limited. Our competitors also include small firms offering specific
      applications, divisions of large entities and other large independent firms.
      We
      face the risk that new competitors with greater resources than ours will enter
      our market. Furthermore, increasing competition among telecom companies in
      greater China has led to a reduction in telecommunication services fees that
      can
      be charged by such companies. If a reduction in telecommunication services
      fees
      negatively impacts revenue generated by our clients, they may require us to
      reduce the price of our services, or seek competitors of ours that charge less.
      If we must significantly reduce the price of our services, the decrease in
      revenue could adversely affect our profitability.





**RISKS
      ASSOCIATED WITH DOING BUSINESS IN GREATER CHINA**


There
      are
      substantial risks associated with doing business in greater China, as set forth
      in the following risk factors.





**Our
      operations and assets in Greater China are subject to significant political
      and
      economic uncertainties.**


Changes
      in laws and regulations, or their interpretation, or the imposition of
      confiscatory taxation, restrictions on currency conversion, imports and sources
      of supply, devaluations of currency or the nationalization or other
      expropriation of private enterprises could have a material adverse effect on
      our
      business, results of operations and financial condition. Under its current
      leadership, the Chinese government has been pursuing economic reform policies
      that encourage private economic activity and greater economic decentralization.
      There is no assurance, however, that the Chinese government will continue to
      pursue these policies, or that it will not significantly alter these policies
      from time to time without notice.


50


**Currency
      fluctuations and restrictions on currency exchange may adversely affect our
      business, including limiting our ability to convert Chinese renminbi into
      foreign currencies and, if Chinese renminbi were to decline in value, reducing
      our revenue in U.S. dollar terms.**


Our
      reporting currency is the U.S. dollar and our operations in China and Hong
      Kong
      use their respective local currencies as their functional currencies. The
      majority of our revenue derived and expenses incurred are in Chinese renminbi
      with a relatively small amount in Hong Kong dollars and U.S. dollars. We are
      subject to the effects of exchange rate fluctuations with respect to any of
      these currencies. For example, the value of the renminbi depends to a large
      extent on Chinese government policies and China's domestic and international
      economic and political developments, as well as supply and demand in the local
      market. Since 1994, the official exchange rate for the conversion of renminbi
      to
      U.S. dollars had generally been stable and the renminbi had appreciated slightly
      against the U.S. dollar. However, on July 21, 2005, the Chinese government
      changed its policy of pegging the value of Chinese renminbi to the U.S. dollar.
      Under the new policy, Chinese renminbi may fluctuate within a narrow and managed
      band against a basket of certain foreign currencies. As a result of this policy
      change, Chinese renminbi appreciated approximately 2.5% against the US. dollar
      in 2005. It is possible that the Chinese government could adopt a more flexible
      currency policy, which could result in more significant fluctuation of Chinese
      renminbi against the U.S. dollar. We can offer no assurance that Chinese
      renminbi will be stable against the U.S. dollar or any other foreign
      currency.




The
      income statements of our international operations are translated into U.S.
      dollars at the average exchange rates in each applicable period. To the extent
      the U.S. dollar strengthens against foreign currencies, the translation of
      these
      foreign currencies denominated transactions results in reduced revenue,
      operating expenses and net income for our international operations. Similarly,
      to the extent the U.S. dollar weakens against foreign currencies, the
      translation of these foreign currency denominated transactions results in
      increased revenue, operating expenses and net income for our international
      operations. We are also exposed to foreign exchange rate fluctuations as we
      convert the financial statements of our foreign subsidiaries into U.S dollars
      in
      consolidation. If there is a change in foreign currency exchange rates, the
      conversion of the foreign subsidiaries' financial statements into U.S dollars
      will lead to a translation gain or loss which is recorded as a component of
      other comprehensive income. In addition, we have certain assets and liabilities
      that are denominated in currencies other than the relevant entity's functional
      currency. Changes in the functional currency value of these assets and
      liabilities create fluctuations that will lead to a transaction gain or loss.
      We
      have not entered into agreements or purchased instruments to hedge our exchange
      rate risks, although we may do so in the future. The availability and
      effectiveness of any hedging transaction may be limited and we may not be able
      to successfully hedge our exchange rate risks.




Although
      Chinese governmental policies were introduced in 1996 to allow the
      convertibility of Chinese renminbi into foreign currency for current account
      items, conversion of Chinese renminbi into foreign exchange for capital items,
      such as foreign direct investment, loans or securities, requires the approval
      of
      the State Administration of Foreign Exchange, or SAFE, which is under the
      authority of the People's Bank of China. These approvals, however, do not
      guarantee the availability of foreign currency. We cannot be sure that we will
      be able to obtain all required conversion approvals for our operations or that
      Chinese regulatory authorities will not impose greater restrictions on the
      convertibility of Chinese renminbi in the future. Because a significant amount
      of our future revenue may be in the form of Chinese renminbi, our inability
      to
      obtain the requisite approvals or any future restrictions on currency exchanges
      could limit our ability to utilize revenue generated in Chinese renminbi to
      fund
      our business activities outside China, or to repay foreign currency obligations,
      including our debt obligations, which would have a material adverse effect
      on
      our financial condition and results of operation.





**We
      are required to obtain licenses to expand our business into mainland
      China.**


Our
      activities must be reviewed and approved by various national and local agencies
      of the Chinese government before they will issue business licenses to us. There
      can be no assurance that the current Chinese government, or successors, will
      continue to approve and renew our licenses. If we are unable to obtain licenses
      or renewals we will not be able to continue our business operations in mainland
      China, which would have a material adverse effect on our business, financial
      condition and results of operations.


51


**We
      may have limited legal recourse under PRC law if disputes arise under our
      contracts with third parties.**


The
      Chinese government has enacted some laws and regulations dealing with matters
      such as corporate organization and governance, foreign investment, commerce,
      taxation and trade. However, their experience in implementing, interpreting
      and
      enforcing these laws and regulations is limited, and our ability to enforce
      commercial claims or to resolve commercial disputes is unpredictable. If our
      new
      business ventures are unsuccessful, or other adverse circumstances arise from
      these transactions, we face the risk that the parties to these ventures may
      seek
      ways to terminate the transactions, or, may hinder or prevent us from accessing
      important information regarding the financial and business operations of these
      acquired companies. The resolution of these matters may be subject to the
      exercise of considerable discretion by agencies of the Chinese government,
      and
      forces unrelated to the legal merits of a particular matter or dispute may
      influence their determination. Any rights we may have to specific performance,
      or to seek an injunction under PRC law, in either of these cases, are severely
      limited, and without a means of recourse by virtue of the Chinese legal system,
      we may be unable to prevent these situations from occurring. The occurrence
      of
      any such events could have a material adverse effect on our business, financial
      condition and results of operations.





**We
      must comply with the Foreign Corrupt Practices Act.**


We
      are
      required to comply with the United States Foreign Corrupt Practices Act, which
      prohibits United States companies from engaging in bribery or other prohibited
      payments to foreign officials for the purpose of obtaining or retaining
      business. Foreign companies, including some of our competitors, are not subject
      to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and
      other
      fraudulent practices occur from time-to-time in mainland China. If our
      competitors engage in these practices they may receive preferential treatment
      from personnel of some companies, giving our competitors an advantage in
      securing business or from government officials who might give them priority
      in
      obtaining new licenses, which would put us at a disadvantage. Although we inform
      our personnel that such practices are illegal, we cannot assure that our
      employees or other agents will not engage in such conduct for which we might
      be
      held responsible. If our employees or other agents are found to have engaged
      in
      such practices, we could suffer severe penalties.





**PRC
      laws and regulations restrict foreign investment in China’s telecommunications
      services industry and substantial uncertainties exist with respect to our
      contractual agreements with Dianxun-DE, Sunroom-DE, Wanrong-DE and iMobile-DE
      to
      uncertainties regarding the interpretation and application of current or futures
      PRC laws and regulations.**


Since
      we
      are deemed to be foreign persons or foreign funded enterprises under PRC laws
      and cannot directly invest in telecommunications companies, we operate our
      IVR,
      call center and telecom value-added services business in China through operating
      companies or variable interest entities (VIEs) owned by PRC citizens. We control
      these companies and operate these businesses through contractual arrangements
      with the respective operating companies and their individual shareholders,
      but
      we have no equity control over these companies. Although we believe we are
      in
      compliance with current PRC regulations, we cannot be sure that the PRC
      government would view these operating arrangements to be in compliance with
      PRC
      licensing, registration or other regulatory requirements, with existing policies
      or with requirements or policies that may be adopted in the future. In the
      opinion of our in-house PRC legal counsel, our current ownership structure,
      the
      contractual arrangements among our wholly owned subsidiaries and the operating
      company and their shareholders comply with all existing applicable PRC laws,
      rules and regulations. Because this structure has not been challenged or
      examined by PRC authorities, they have not commented on it and uncertainties
      exist as to whether the PRC government may interpret or apply the laws governing
      these arrangements in a way that is contrary to the opinion of our in-house
      PRC
      counsel. If we, or the operating companies, were found to be in violation of
      any
      existing PRC laws or regulations, the relevant regulatory authorities would
      have
      broad discretion to deal with such violation, including, but not limited to
      the
      following:




·
            Levying
                fines




·
            Confiscating
                income




·
            Revoking
                licenses




·
            Shutting
                down servers or blocking websites




·
            Requiring
                a restructure of ownership or
                operations




·
            Requiring
                the discontinuance of wireless VAS and online advertising
                businesses




52


We
      may
      also encounter difficulties in obtaining performance under or enforcement of
      related contracts. Any of these or similar actions could cause significant
      disruption to our business operations or render us unable to conduct a
      substantial portion of our business operations and may materially adversely
      affect our business, financial condition and results of operations.





**Our
      contractual agreements with Dianxun-DE or Sunroom-DE, Wanrong-DE and iMobile-DE
      may not be as effective in providing operational control as direct ownership
      of
      these businesses.**


We
      depend
      on operating companies in which we have little or no equity ownership interest
      and must rely on contractual agreements to control and operate these businesses.
      Our contractual agreements with each of the operating companies may not be
      as
      effective in providing and maintaining control over the operating companies
      and
      their business operations as direct ownership of these businesses. For example,
      we may not be able to take control of the operating company upon the occurrence
      of certain events, such as the imposition of statutory liens, judgments, court
      orders, death or capacity. Furthermore, if the operating companies fail to
      perform as required under those contractual agreements, we will have to rely
      on
      the PRC legal system to enforce those agreements and due to the uncertainties
      that exist under PRC Law about the structure of our acquisition, and there
      is no
      guarantee that we will be successful in an enforcement action. In addition,
      the
      PRC government may propose new laws or amend current laws that may be
      detrimental to our current contractual agreements with our operating companies,
      which may in turn have a material adverse effect on our business
      operations.





**The
      PRC government may prevent us from advertising or distributing content that
      it
      believes is inappropriate.**


China
      has
      enacted regulations governing Internet access and the distribution of news
      and
      other information. In the past, the Chinese government has stopped the
      distribution of information over the Internet or through VAS that it believes
      to
      violate PRC law, including content that it believes is obscene, incites
      violence, endangers national security, is contrary to the national interest
      or
      is defamatory. In addition, we may need the permission of the Chinese government
      prior to publishing certain news items, such as news relating to national
      security. Furthermore, the Ministry of Public Security has the authority to
      cause any local Internet service provider to block any website maintained
      outside China at its sole discretion. If the PRC government were to take any
      action to limit or prohibit the distribution of information through our network
      or via our VAS, or to limit or regulate any current or future content or
      services available to users on our network, our business could be significantly
      harmed. We are also subject to potential liability for content on our website
      that is deemed inappropriate and for any unlawful actions of our subscribers
      and
      other users of our systems. Furthermore, we are required to delete content
      that
      clearly violates the laws of China and report content that we suspect may
      violate PRC law. It is difficult to determine the type of content that may
      result in liability for us, and if we are wrong, we may be prevented from
      operating our website.





**RISKS
      RELATED TO OUR TECHNOLOGY AND EQUIPMENT**





**Our
      insurance may not be sufficient to restore our call center if operations are
      interrupted by natural disaster or other destruction of our facilities or
      equipment.**


Our
      operations depend on our ability to protect our call centers, data centers,
      CRM
      information, customer database, data warehouse, computer and telecommunications
      equipment and software systems against damage from fire, power loss,
      telecommunications interruption or failure, hacker attacks, natural disaster,
      epidemic, terrorism, act of war and other similar events. In the event we
      experience a temporary or permanent interruption at one or more of our call
      centers, through casualty, operating malfunction or otherwise, our business
      could be materially adversely affected and we may be required to pay contractual
      damages to some clients or allow some clients to terminate or renegotiate their
      contracts with us. While we maintain certain property and business interruption
      insurance, such insurance may not adequately compensate us for all losses that
      we may incur and may not be adequate to cover the costs of rebuilding these
      centers. If we are unable to restore our operations, our business activities
      would cease.





53


**We
      must respond quickly and effectively to new technological
      developments.**


Our
      gaming, telecom and VAS businesses are highly dependent on our computer and
      telecommunications equipment and software systems. Our failure to maintain
      the
      superiority of our technological capabilities or to respond effectively to
      technological changes could adversely affect our business, results of operations
      or financial condition. Our future success also depends on our ability to
      enhance existing software and systems and to respond to changing technological
      developments. If we are unable to successfully develop and bring to market
      new
      software and systems in a timely manner, our competitors’ technologies or
      services may render our products or services noncompetitive or
      obsolete.





**RISKS
      RELATED TO OUR COMMON STOCK**





**Efforts
      to comply with recently enacted changes in securities laws and regulations
      will
      increase our costs and require additional management resources. Our failure
      to
      comply could adversely affect our stock price.**


We
      have
      rapidly grown by acquisition during 2004 and 2005. We do not integrate the
      business operations of our target companies and therefore have separate
      administration and accounting personnel at each subsidiary location. Due to
      the
      number of new subsidiaries we have acquired, we have faced significant
      challenges with the timely reporting of information necessary to complete the
      financial statements to be filed with the Securities and Exchange Commission.
      Furthermore, concerns about our stock option granting practices and recording
      of
      such grants, have led to the withdrawal of the previously issued audit reports
      for December 31, 2005 and 2004 by our previous independent auditors, Clancy
      and
      Co., P.L.L.C. These actions have required us to re-evaluate our disclosure
      controls and procedures and conclude that they are ineffective. We have sought
      to improve our existing disclosure controls and procedures and to that end,
      have
      substantially increased our accounting and administrative resources. Our failure
      to timely file our annual and quarterly reports may have an adverse affect
      on
      our stock price and may put our common stock in jeopardy of being
      delisted.





As
      directed by Section 404 of the Sarbanes-Oxley Act of 2002, public companies
      are
      required to include a report of management on the company's internal controls
      over financial reporting in their annual reports on Form 10-K and the public
      accounting firm auditing a company's financial statements must attest to and
      report on management's assessment of the effectiveness of the company's internal
      controls over financial reporting. This requirement will first apply to our
      annual report on Form 10-K for our fiscal year ending December 31, 2007. We
      have
      only recently begun to evaluate our internal controls over financial reporting.
      Given the status of our efforts, coupled with the fact that guidance from
      regulatory authorities in the area of internal controls continues to evolve,
      substantial uncertainty exists regarding our ability to comply by applicable
      deadlines. If we are unable to conclude that we have effective internal controls
      over financial reporting, or if our independent auditors are unable to provide
      us with an unqualified report as to the effectiveness of our internal controls
      over financial reporting as of December 31, 2007 and future year ends, as
      required by Section 404 of the Sarbanes-Oxley Act, we could experience delays
      or
      inaccuracies in our reporting of financial information, or non-compliance with
      SEC reporting and other regulatory requirements. This could subject us to
      regulatory scrutiny and result in a loss of public confidence in our management,
      which could, among other things, adversely affect our stock price.





**If
      the audit reports for the fiscal years ended December 31, 2005 and 2004 are
      not
      reinstated by our previous auditors, or re-issued by our new auditors, in a
      timely manner, our common stock may be delisted.**





In
      March
      2007, our prior independent registered accountants, Clancy and Co., PL.L.C.,
      withdrew its audit reports for the fiscal years ended December 31, 2005 and
      2004. As a result, our Annual Report on Form 10-KSB for the fiscal year ended
      December 31, 2005, is deficient for lack of audited reports, and on March 30,
      2007, we received a notice of delisting and deficiency from The NASDAQ Stock
      Market addressing notifying us of such deficiency. If we are unable to provide
      restated financial statements for the relevant periods that are satisfactory
      to
      enable Clancy to reinstate its audit reports, or we are unable to have the
      financial statements for the relevant periods re-audited by our new auditors,
      Kabani & Company, Inc., to be included in our Annual Reports for the fiscal
      year ended December 31, 2006 and 2005, within the time frame required by NASDAQ,
      our common stock could be delisted.


54


**We
      issued $8,000,000 in convertible debentures due in 2009, or possibly earlier,
      which we may not be able to repay in cash and could result in dilution of our
      basic earnings per share.**





In
      March
      2006, we issued $8 million in convertible debentures due March 2009. 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 events. 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 or other amounts, which shall become immediately
      due and payable. In 2007, we began to redeem up to $363,638 every month, plus
      accrued, but unpaid interest, liquidated damages and penalties. We may choose
      to
      pay such redemption amount in cash, or, subject to meeting certain conditions,
      we may pay all or a part of the redemption amount in shares of common stock.
      We
      may not have enough cash on hand or have the ability to access cash to pay
      the
      redemption amount, or upon acceleration of the debenture in the case of an
      event
      of default, or at maturity. In addition, the redemption of the debentures with
      our shares or the conversion of the debentures into shares of common stock
      could
      result in dilution of our basic earnings per share.





**We
      may have to pay liquidated damages and our debenture may be declared in default
      if we are unable to re-instate use of the prospectus contained in our
      Registration Statement on Form S-1.**





On
      March
      27, 2007, we suspended use of the prospectus contained in our Registration
      Statement on Form S-1 (File No. 333-134127) that was declared effective on
      December 8, 2006, due to the lack of fiscal year end 2005 and 2004 audited
      financial statements. As a result 3,152,228 shares of common stock registered
      there under, are not freely tradable upon resale. Under the terms of our
      registration rights agreement with the holders of the debentures, we are subject
      to paying liquidated damages equal to 2% of the debenture amount on a monthly
      basis, up to a maximum of 20% per holder, in the event we suspend use of the
      prospectus for longer than 15 consecutive calendar days or more than an
      aggregate of 30 calendar days during any 12-month period. Moreover, at the
      election of the debenture holder, our debenture could be declared in default,
      resulting in acceleration of the amounts due, if such suspension continues
      more
      than 20 consecutive trading days or 60 non-consecutive trading days during
      any
      12-month period. We cannot assure you that none of the debenture holders will
      declare our debentures in default and demand acceleration of the debenture.
      We
      may not have cash on hand, or have the ability to access cash to pay the
      debenture in full if such a demand is made. If the debenture holders refuse
      to
      negotiate with us, our failure to pay upon, demand could result in the debenture
      holders bringing claims against us for payment, which may include severe penalty
      payments. If they are successful in such claims, we may suffer significant
      losses, which may severely curtail our ability to continue business
      operations.





**The
      price of our stock has fluctuated in the past and may continue to do
      so.**




Our
      stock
      price has fluctuated dramatically. There is a significant risk that the market
      price of our common stock will decrease in the future in response to any of
      the
      following factors, some of which are beyond our control:




·
            Variations
                in our quarterly operating results




·
            Announcements
                that our revenue or income are below analysts'
                expectations




·
            General
                economic slowdowns




·
            Changes
                in market valuations of similar
                companies




·
            Sales
                of large blocks of our common stock




·
            Announcements
                by us or our competitors of significant contracts, acquisitions,
                strategic
                partnerships, joint ventures or capital
                commitments




·
            Fluctuations
                in stock market prices and volumes, which are particularly common
                among
                highly volatile securities of companies with primarily international-based
                operations




55


**Future
      sales of shares could have an adverse effect on the market price of our common
      stock.**




As
      of
      March 31, 2007, we had 11,808,993 shares of common stock outstanding, which
      shares will be available to be sold in the public market in the near future,
      subject to, with respect to shares of common stock held by affiliates and shares
      issued between 12 and 24 months ago, the volume restrictions and/or manner
      of
      sale requirements of Rule 144 under the Securities Act. On March 27, 2007,
      we
      suspended the use of the prospectus contained in our Registration Statement
      on
      Form S-1 that was declared effective with respect to 3,152,228 shares of our
      common stock was suspended. These shares are no longer freely tradable without
      restriction or further registration, unless such sales can be made pursuant
      to
      an available exemption under the Securities Act. Sales by our current
      shareholders of a substantial number of shares could significantly reduce the
      market price of our common stock.




As
      of
      March 31, 2007, we had stock options outstanding to purchase an aggregate of
      370,500 shares of common stock, those options were all exercisable. We also
      have
      warrants outstanding to purchase 1,007,138 shares of our common stock To the
      extent that the options and warrants are exercised, they may be exercised at
      prices below the price of our shares of common stock on the public market,
      resulting in a significant number of shares entering the public market and
      the
      dilution of our common stock. Further, in March 2006, we completed a private
      placement of $8,000,000 in convertible debentures. The debentures are
      convertible into shares of common stock at an initial fixed conversion price
      of
      $10.00, subject to adjustments. In the event that any future financing should
      also be in the form of securities convertible into, or exchangeable for, equity
      securities, investors may experience additional dilution upon the conversion
      or
      exchange of such securities.





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




None.




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




On
      March
      19, 2007 our predecessor auditor withdrew their opinion on our previously filed
      financial statements for the years ended December 31, 2005, December 31, 2004
      and December 31, 2003. As a result, on March 27, 2007, we notified the holders
      of the outstanding convertible debenture that we suspended use of the prospectus
      contained in our Registration Statement on Form S-1 (File No. 333-134127) that
      was declared effective on December 8, 2006, due to the lack of fiscal year
      end
      2005 and 2004 audited financial statements and that they must cease selling
      under the prospectus. Under
      the
      terms of the registration rights agreement, the Company was obligated to pay
      liquidated damages to the convertible debenture investors at the rate of 2%
      of
      the principal amount of the debenture each month beginning on March
      27,
      2007 until
      the registration statement returns to effect.




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




None.




**ITEM
      5.   OTHER INFORMATION.**




None.




56


**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 (Principal Executive
                Officer)




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




32.1
            18
                U.S.C. Section 1350 Certifications






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: May
                31 , 2007
            By:
            /s/ TONY
                TONGTony
                Tong
              Chief
                Executive Officer
              (Principal
                Executive Officer)Date: May
                31 , 2007
            By:
            /s/ Daniel
                LuiDaniel
                Lui
              Chief
                Financial Officer
              (Principal
                Financial Officer)






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