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


WASHINGTON,
      D.C. 20549




**FORM
        10-Q/A #1**




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


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




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


**ACT
      OF 1934**




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




*COMMISSION
      FILE NUMBER: 000-24985*









**PACIFICNET
      INC.**


(Exact
      name of registrant in its charter)





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




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




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




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




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




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




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




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




1


EXPLANATORY
          NOTE:
  This
          Quarterly Report on Form 10-Q/A-1 ("Form 10-QSB/A-1") is being filed as
          Amendment No. 1 to our Quarterly Report on Form 10-Q for the period ended
          June 30, 2006, which was originally filed with the Securities and Exchange
          Commission ("SEC") on August 15, 2006, (the "Original Filing"). We are
          amending
          and restating the following specific items in this Amendment No.
          1:


1.
              Part
                  I. Item 1. Financial Statements - to revise and update certain
                  line items
                  inthe
                  Consolidated Balance Sheet, Consolidated Income statement and Consolidated
                  Statement of Cash Flows and to revise certain notes to the financial
                  statements including business acquisitions, convertible debenture,
                  and
                  segment information. 2.
              Part
                  I. Item II. Management’s Discussion And Analysis Or Plan Of
                  Operation. 3.
              Part
                  I. Item 4 - to update our disclosures in Part II, Item 8A. Controls
                  and
                  Procedures. 4.
              Part
                  II. Item 6 - to update the officer certifications for this amended
                  filing.






2




**PACIFICNET
      INC.**


**Form 10-Q/A
        #1 for the Quarterly Period Ended June 30, 2006**




**TABLE
      OF CONTENTS**





**PART I.**
              **FINANCIAL
                  INFORMATION**Item
                  1.
              Financial
                  Statements (Unaudited)
              4Condensed
                  Consolidated Balance Sheets
              4Condensed
                  Consolidated Income Statements
              5Condensed
                  Consolidated Statements of Cash Flows
              7Notes
                  to Condensed Consolidated Financial Statements
              8Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              21Item
                  3.
              Quantitative
                  and Qualitative Disclosures about Market Risk
              29Item
                  4.
              Controls
                  and Procedures
              30**PART II.**
              **OTHER
                  INFORMATION**Item
                  1.
              Legal
                  Proceedings
              35Item
                  1A.
              Risk
                  Factors
              35Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              36Item
                  3.
              Defaults
                  upon Senior Securities
              36Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              36Item
                  5.
              Other
                  Information
              36Item
                  6.
              Exhibits
              36Signatures
              
              37






3


**PART
      I - FINANCIAL INFORMATION**




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




**PACIFICNET
      INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


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







**June
                  30, 2006**
                **(Unaudited)**
              
              **December
                  31, 2005**
                **(Audited)****ASSETS***Current
                  Assets:*Cash
                  and cash equivalents
              
              $
              5,935
              
              $
              9,579Restricted
                  cash - pledged bank deposit
              
              
              230
              
              
              1,652Accounts
                  receivables, net of allowance for doubtful accounts of $33 and
                  $5
              
              
              16,112
              
              
              5,998Inventories
              
              
              2,368
              
              
              1,836Loan
                  receivable from related parties
              
              
              4,753
              
              
              2,520Loan
                  receivable from third parties
              
              
              1,010
              
              
              1,572Other
                  current assets
              
              
              8,444
              
              
              7,973Total
                  Current Assets
              
              
              38,852
              
              
              31,130Property
                  and equipment, net
              
              
              8,361
              
              
              4,300Investments
                  in affiliated companies and subsidiaries
              
              
              463
              
              
              410Marketable
                  equity securities - available for sale
              
              
              539
              
              
              539Goodwill
              
              
              17,285
              
              
              14,824Other
                  assets - debt issuance costs (net)
              
              
              957
              
              
              -**TOTAL
                  ASSETS**
              
              **$**
              **66,457**
              
              **$**
              **51,203****LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  Liabilities:Bank
                  line of Credit
              
              
              889
              
              
              1,060Bank
                  loans-current portion
              
              
              401
              
              
              188Capital
                  lease obligations - current portion
              
              
              88
              
              
              126Accounts
                  payable
              
              
              4,101
              
              
              3,186Accrued
                  expenses and other payables
              
              
              2,558
              
              
              4,620Income
                  tax payable
              
              
              33
              
              
              296Subscription
                  payable
              
              
              390
              
              
              775Loan
                  payable to related party
              
              
              570
              
              
              369Total
                  Current Liabilities
              
              
              9,030
              
              
              10,620Long-term
                  liabilities:Bank
                  loans - non current portion
              
              
              1,498
              
              
              6Capital
                  lease obligations - non current portion
              
              
              43
              
              
              78Convertible
                  Debenture
              
              
              8,000Warrant
                  Liability
              
              
              616Compound
                  Embedded Derivatives Liability
              
              
              1,019Interest
                  discount
              
              
              (1,689
              )Total
                  long-term liabilities
              
              
              9,487
              
              
              84Total
                  liabilities
              
              
              18,517
              
              
              10,704Minority
                  interest in consolidated subsidiaries
              
              
              11,898
              
              
              8,714Commitments
                  and contingenciesStockholders'
                  Equity:Preferred
                  stock, par value $0.0001, Authorized - 5,000,000 sharesIssued
                  and outstanding - none
              
              
              --
              
              
              --Common
                  stock, par value $0.0001, Authorized - 125,000,000 shares;
                Issued
                  and outstanding:June
                  30, 2006 - 13,483,497 shares issued, 11,369,336
                  outstandingDecember
                  31, 2005 - 12,000,687 issued, 10,831,024 outstanding
              
              
              1
              
              
              1Treasury
                  stock, at cost (2006 Q2: 2,114,161 shares, 2005: 1,169,663 shares)
              
              
              (243
              )
              
              (119
              )Additional
                  paid-in capital
              
              
              60,678
              
              
              57,690Cumulative
                  other comprehensive income (loss)
              
              
              399
              
              
              247Accumulated
                  deficit
              
              
              (24,271
              )
              
              (25,990
              )Less
                  stock subscription receivable
              
              
              (522
              )
              
              (44
              )Total
                  Stockholders' Equity
              
              
              36,042
              
              
              31,785**TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY**
              
              **$**
              **66,457**
              
              **$**
              **51,203**




4


**PACIFICNET
      INC. AND SUBSIDIARIES**


**CONSOLIDATED
      INCOME STATEMENTS**


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







THREE
                  MONTHS ENDED JUNE 30
              
              SIX
                  MONTHS ENDED JUNE 302006
                (RESTATED)
              
              2005
                (RESTATED)
              
              2006
                (RESTATED)
              
              2005
                (RESTATED)Revenues
              
              $
              19,330
              
              $
              12,280
              
              $
              34,364
              
              $
              21,492Services
              
              
              7,812
              
              
              6,060
              
              
              16,700
              
              
              9,324Product
                  sales
              
              
              11,518
              
              
              6,220
              
              
              17,664
              
              
              12,168Cost
                  of revenues
              
              
              (14,407
              )
              
              (9,613
              )
              
              (22,960
              )
              
              (17,127
              )Services
              
              
              (4,027
              )
              
              (3,880
              )
              
              (7,283
              )
              
              (6,201
              )Product
                  sales
              
              
              (10,380
              )
              
              (5,733
              )
              
              (15,677
              )
              
              (10,926
              )Gross
                  margin
              
              
              4,923
              
              
              2,667
              
              
              11,404
              
              
              4,365Selling,
                  general and administrative expenses
              
              
              (3,177
              )
              
              (1,376
              )
              
              (7,500
              )
              
              (2,257
              )Depreciation
                  and amortization
              
              
              (161
              )
              
              (99
              )
              
              (219
              )
              
              (142
              )Interest
                  expense
              
              
              (368
              )
              
              -
              
              
              (456
              )
              
              -**EARNINGS
                  FROM OPERATIONS**
              
              
              1,217
              
              
              1,192
              
              
              3,229
              
              
              1,966Interest
                  income
              
              
              49
              
              
              -
              
              
              81
              
              
              -Change
                  in fair value of derivatives
              
              
              208
              
              
              
              
              
              208Sundry
                  income
              
              
              161
              
              
              313
              
              
              286
              
              
              406**Earnings
                  before Income Taxes and Minority Interest**
              
              
              1,635
              
              
              1,505
              
              
              3,804
              
              
              2,372Provision
                  for income taxes
              
              
              (85
              )
              
              (37
              )
              
              (200
              )
              
              (64
              )Share
                  of earnings of associated companies
              
              
              52
              
              
              12
              
              
              49
              
              
              4Minority
                  interests
              
              
              (804
              )
              
              (887
              )
              
              (1,934
              )
              
              (1,304
              )**Net
                  Earnings Available to Common Stockholders**
              
              $
              798
              
              $
              593
              
              $
              1,719
              
              $
              1,008**BASIC
                  EARNINGS PER SHARE**
              
              $
              0.10
              
              $
              0.06
              
              $
              0.18
              
              $
              0.10**DILUTED
                  EARNINGS PER SHARE**
              
              $
              0.08
              
              $
              0.06
              
              $
              0.16
              
              $
              0.10




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




5
 **PACIFICNET
        INC. AND SUBSIDIARIES**


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







**PREFERRED
                  STOCK**
              
              **COMMON
                  STOCK**
              
              **ADDITIONAL
                  PAID-IN CAPITAL**
              
              **STOCK
                  SUBSCRIPTION**
                **RECEIVABLE**
              
              **CUMULATIVE
                  OTHER COMPREHENSIVE INCOME**
              
              **ACCUMUL**
                **ATED**
                **DEFICIT**
              
              **TREASURY
                  STOCK**
              
              **TOTAL
                  STOCKHOLDERS' EQUITY****BALANCE
                  AT DECEMBER 31, 2005**
                **(10,831,024
                  SHARES)**
              
              
              **--**
              
              **$**
              **1**
              
              **$**
              **57,690**
              
              **$**
              **(44**
              **)**
              **$**
              **247**
              
              
              **($25,990**
              **)**
              
              **($119**
              **)**
              **$**
              **31,785**Net
                  earnings
              
              
              --
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,719
              
              
              
              
              
              1,719Exercise
                  of stock options for cash and receivable (269,000 shares)
              
              
              --
              
              
              
              
              
              564
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              564Issuance
                  of common stock for acquisition of subsidiaries(293,512
                  shares)
              
              
              --
              
              
              
              
              
              2,275
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,275PIPE
                  related expenses
              
              
              --Repurchase
                  of common shares(less
                  24,200 shares)
              
              
              --
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (124
              )
              
              (124
              )Cumulative
                  foreign exchange gain/(loss)
              
              
              --
              
              
              
              
              
              
              
              
              
              
              
              152
              
              
              
              
              
              
              
              
              152Stock-based
                  compensation
              
              
              
              
              
              
              
              
              120
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              120Issuance
                  of warrants for fees of issuing convertible debt (16,000
                  warrants)
              
              
              
              
              
              
              
              
              29
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              29Less
                  stock subscription receivable
              
              
              --
              
              
              
              
              
              
              
              
              (478
              )
              
              
              
              
              
              
              
              
              
              
              (478
              )**BALANCE
                  AT JUNE 30, 2006**
                **(11,369,336
                  SHARES)**
              
              
              **--**
              
              **$**
              **1**
              
              **$**
              **60,678**
              
              **$**
              **(522**
              **)**
              **$**
              **399**
              
              **$**
              **(24,271**
              **)**
              **$**
              **(243**
              **)**
              **$**
              **36,042**







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




6
 **PACIFICNET
        INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


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




SIX
                  MONTHS ENDED JUNE 30**(RESTATED)**
                **2006**
              
              **(RESTATED)**
                **2005****Cash
                  Flows from operating activities**Net
                  earnings
              
              $
              1,719
              
              $
              1,008*Adjustment
                  to reconcile net earnings to net cash used in operating
                  activities:*Equity
                  loss of associated company
              
              
              (49
              )
              
              (4
              )Provision
                  for income taxes
              
              
              33
              
              
              64Provision
                  for allowance for doubtful accounts
              
              
              28
              
              
              -Minority
                  Interest
              
              
              1,934
              
              
              1304Depreciation
                  and amortization
              
              
              768
              
              
              141Stock-based
                  compensation
              
              
              120
              
              
              *-*Change
                  in fair value of derivatives
              
              
              (208
              )
              
              -Amortization
                of interest discount
              
              
              154
              
              
              -*Changes
                  in current assets and liabilities net of effects from purchase
                  of
                  subsidiaries:*Accounts
                  receivable and other current assets**
              
              
              (9,870
              )
              
              (2,027
              )Inventories
              
              
              (415
              )
              
              (891
              )Accounts
                  payable and other accrued expenses
              
              
              (1,745
              )
              
              295***Net
                  cash used in operating activities***
              
              
              **(7,531**
              **)**
              
              **(110**
              **)****Cash
                  flows from investing activities**Decrease
                  in restricted cash
              
              
              1,422
              
              
              2,796Increase
                  in purchase of marketable securities
              
              
              -
              
              
              (421
              )Acquisition
                  of property and equipment
              
              
              (3,124
              )
              
              (1,341
              )Acquisition
                  of subsidiaries and affiliated companies
              
              
              (836
              )
              
              (1,183
              )Loans
                  receivable from third parties
              
              
              562
              
              
              (2,081
              )Loans
                  receivable from related party
              
              
              (2,233
              )
              
              (1,157
              )***Net
                  cash used in investing activities***
              
              
              **(4,209**
              **)**
              
              **(3,387**
              **)****CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Increase
                  in loan payable to related party
              
              
              201
              
              
              390Advances
                  (repayments) under bank line of credit
              
              
              (171
              )
              
              142Advances
                  under bank loan
              
              
              623
              
              
              727Increase
                  (repayments) of amount borrowed under capital lease obligations
              
              
              (73
              )
              
              62Repurchase
                  of treasury shares
              
              
              (124
              )
              
              -Proceeds
                  from exercise of stock options and warrants
              
              
              86
              
              
              981Proceeds
                  from issuance of convertible debenture
              
              
              8,000
              
              
              -Payment
                of convertible debenture issuance costs
              
              
              500
              
              
              -***Net
                  cash provided by financing activities***
              
              
              **8,042**
              
              
              **2,302****Effect
                  of exchange rate change on cash and cash
                  equivalents**
              
              
              **54**
              
              
              **-****NET
                  DECREASE IN CASH AND CASH EQUIVALENTS**
              
              
              **(3,644**
              **)**
              
              **(1,195**
              **)****CASH
                  AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD**
              
              
              **9,579**
              
              
              **6,764****CASH
                  AND CASH EQUIVALENTS, END OF THE PERIOD**
              
              **$**
              **5,935**
              
              **$**
              **5,569****CASH
                  PAID FOR:**Interest
              
              $
              292
              
              $
              127Income
                  taxes
              
              $
              463
              
              $
              34**NON-CASH
                  INVESTING AND FINANCING ACTIVITIES:**Issuance
                  of option shares through increase in subscription
                  receivable
              
              
              522
              
              
              -Investments
                  in subsidiaries acquired through the issuance of common stock
              
              
              2,275
              
              $
              1,977




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




7


**PACIFICNET
      INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Amounts
      expressed in United States dollars unless otherwise stated)







**1.
      BASIS OF PRESENTATION**




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




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




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







**2.
      RECENT ACCOUNTING PRONOUNCEMENTS**




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




8


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




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


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







**3.
      EARNINGS PER SHARE**




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




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




Three
                    Months Ended June 30
                
                Six
                    Months Ended June 302006
                
                2005
                
                2006
                
                2005(IN
                    THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND
                    PER SHARE
                    AMOUNTS)
                
                (IN
                    THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND
                    PER SHARE
                    AMOUNTS)Numerator:Net
                    earnings
                
                $
                798
                
                $
                593
                
                $
                1,719
                
                $
                1,008Convertible
                    debenture interest
                
                
                254
                
                
                -
                
                
                254
                
                
                -Net
                    earnings used in computing EPS
                
                
                1,052
                
                
                593
                
                
                1,973
                
                
                1,008Denominator:Weighted-average
                    shares used to compute basic EPS
                
                
                11,022,984
                
                
                9,887,274
                
                
                10,939,834
                
                
                9,840,681Dilutive
                    potential from assumed exercise of stock options and
                    warrants
                
                
                856,713
                
                
                731,501
                
                
                962,185
                
                
                718,383Dilutive
                    potential from convertible debenture
                
                
                800,000
                
                
                -
                
                
                800,000
                
                
                -Weighted-average
                    shares used to compute diluted EPS
                
                
                12,679,697
                
                
                10,618,775
                
                
                12,702,019
                
                
                10,559,064Basic
                    earnings per common share:
                
                $
                0.10
                
                $
                0.06
                
                $
                0.18
                
                $
                0.10Diluted
                    earnings per common share:
                
                $
                0.08
                
                $
                0.06
                
                $
                0.16
                
                $
                0.10




9




**4.
      GOODWILL AND PURCHASED INTANGIBLE ASSETS**




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




(US$000s)
              
              Group
                  1.
                Outsourcing
                Services
              
              Group
                  2.
                Value-Added
                Services
              
              Group
                  3.
                Distribution
                  of
                Communications
              
              TotalBalance
                  as of December 31, 2005
              
              $
              3,936
              
              $
              9,788
              
              $
              1,100
              
              $
              14,824Goodwill
                  acquired during the first quarter
              
              
              --
              
              
              461
              
              
              --
              
              
              461Impairment
                  losses
              
              
              --
              
              
              --
              
              
              --
              
              
              --Goodwill
                  written off related to sale of business unit
              
              
              --
              
              
              --
              
              
              --
              
              
              --Balance
                  as of March 31, 2006
              
              $
              3,936
              
              $
              10,249
              
              $
              1,100
              
              $
              15,285Goodwill
                  acquired during the second quarter
              
              
              --
              
              
              1,571
              
              
              429
              
              
              2,000Impairment
                  losses
              
              
              --
              
              
              --
              
              
              --
              
              
              --Goodwill
                  written off related to sale of business unit
              
              
              --
              
              
              --
              
              
              --
              
              
              --Balance
                  as of June 30, 2006
              
              $
              3,936
              
              $
              11,820
              
              $
              1,529
              
              $
              17,285






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




a)
      COMMON
      STOCK




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







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




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





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




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




10


c)
      WA RRANTS




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




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




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






d)
      TREASURY STOCK




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





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




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




11


**6.
      STOCK-BASED COMPENSATION**




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




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




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





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






**7.
      CONVERTIBLE DEBENTURES**




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




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




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




12


The
          gross
          proceeds of $8,000,000 are recorded as a debenture
          liability. In addition, fair values attributed to the Investors’ warrants and to
          the embedded conversion feature in accordance with EITF issue No. 00-19
          “Accounting for Derivative Financial Instruments Indexed to and Potentially
          Settled in a Company’s Own Stock” are recorded as liabilities. The debt discount
          consisted of an initial $693,278 value related to the Investors’ warrants and a
          $1,149,077 value attributed to the compound embedded derivatives liability,
          as
          well as the warrants liability. An aggregate gain of $207,679 representing
          the
          change in fair value of these derivative liabilities was recognized during
          the
          six months ended June 30, 2006.
  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.


**8.
      SEGMENT INFORMATION**




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




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




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




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




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




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





For
                  the three months ended June 30, 2006
              Group
                  1.
                Outsourcing
                Business
                ($)
              Group
                  2.
                VAS
                  Business
                
                ($)
              Group
                  3.
                Communications
                Distribution
                Business
                  ($)
              Group
                  4.
                Other
                  Business
                
                ($)
              Total
                
                
                ($)Revenues
              3,552,000
              5,517,000
              8,914,000
              1,347,000
              19,330,000(%
                  of Total Revenues)
              18%
              29%
              46%
              7%
              100%Earnings
                  / (Loss) from Operations
              283,000
              1,130,000
              208,000
              -404,000
              1,217,000(%
                  of Total Earnings)
              23%
              93%
              17%
              -33%
              100%Total
                  Assets
                (%
                  of Total Assets)
              8,503,000
                13%
              20,382,000
                31%
              12,626,000
                19%
              24,946,000
                37%
              66,457,000
                100%Goodwill
              3,936,000
              11,820,000
              1,529,000
              -
              17,285,000Geographic
                  Area
              HK,
                  PRC
              PRC
              HK,
                  PRC
              HK,PRC,USA




13





For
                  the three months ended June 30, 2005
              Group
                  1.
                Outsourcing
                Business
                ($)
              Group
                  2.
                VAS
                  Business
                
                ($)
              Group
                  3.
                Communications
                Distribution
                Business
                  ($)
              Group
                  4.
                Other
                  Business
                
                ($)
              Total
                
                ($)Revenues
              3,403,000
              4,744,000
              4,055,000
              78,000
              12,280,000(%
                  of Total Revenues)
              28%
              39%
              33%
              1%
              100%Earnings
                  / (Loss) from Operations
              305,000
              1,086,000
              118,000
              -317,000
              1,192,000(%
                  of Total Earnings)
              26%
              91%
              10%
              -27%
              100%Total
                  Assets
                (%
                  of Total Assets)
              5,468,000
                13%
              11,261,000
                27%
              13,661,000
                32%
              12,627,000
                28%
              43,017,000
                100%Goodwill
              3,936,000
              8,602,000
              1,100,000
              -
              13,245,000Geographic
                  Area
              HK,
                  PRC
              PRC
              HK,
                  PRC
              HK,PRC,USA







For
                  the six months ended June 30, 2006
              Group
                  1.
                Outsourcing
                Business
                ($)
              Group
                  2.
                VAS
                  Business
                
                ($)
              Group
                  3.
                Communications
                Distribution
                Business
                  ($)
              Group
                  4.
                Other
                  Business
                
                ($)
              Total
                
                
                ($)Revenues
              6,579,000
              12,557,000
              11,851,000
              3,377,000
              34,364,000(%
                  of Total Revenues)
              19%
              37%
              34%
              10%
              100%Earnings
                  / (Loss) fromOperations
              403,000
              2,844,000
              265,000
              -283,000
              3,229,000(%
                  of Total Earnings)
              12%
              88%
              8%
              -48%
              100%Total
                  Assets
              8,503,000
              20,382,000
              12,626,000
              24,946,000
              66,457,000(%
                  of Total Assets)
              13%
              31%
              19%
              37%
              100%Goodwill
              3,936,000
              11,820,000
              1,529,000
              -
              17,285,000Geographic
                  Area
              HK,
                  PRC
              PRC
              HK,
                  PRC
              HK,PRC,USA







For
                  the six months ended June 30, 2005
              Group
                  1.
                Outsourcing
                Business
                ($)
              Group
                  2.
                VAS
                  Business
                
                ($)
              Group
                  3.
                Communications
                Distribution
                Business
                  ($)
              Group
                  4.
                Other
                  Business
                
                ($)
              Total
                
                ($)Revenues
              6,492,000
              6,154,000
              8,731,000
              115,000
              21,492,000(%
                  of Total Revenues)
              30%
              29%
              41%
              1%
              100%Earnings
                  / (Loss) fromOperations
              649,000
              1,589,000
              236,000
              -508,000
              1,966,000(%
                  of Total Earnings)
              33%
              81%
              12%
              -26%
              100%Total
                  Assets
              5,468,000
              11,261,000
              13,661,000
              12,627,000
              43,017,000(%
                  of Total Assets)
              13%
              27%
              32%
              28%
              100%Goodwill
              3,936,000
              8,602,000
              1,100,000
              -
              13,245,000Geographic
                  Area
              HK,
                  PRC
              PRC
              HK,
                  PRC
              HK,PRC,USA







14




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





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






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






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






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






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




*LOAN
      DUE TO AND FROM RELATED PARTIES*




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




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




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




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




15


*LOAN
      TO**YUESHEN'S
      SHAREHOLDER*




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




*LOAN
      TO SOLUTEK'S DIRECTOR*




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




*L**OAN
      TO DIRECTOR OF CLICKCOM*




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




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




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




*L**OAN
      PAYABLE TO RELATED PARTY*




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






**10.
      COMMITMENTS AND CONTINGENCIES**




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




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




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




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




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




16


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




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




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




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




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




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




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






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




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







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




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





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






**12.
      INVENTORY**




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




17


**13.
      SUBSCRIPTION RECEIVABLE**




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







**14.
      INCOME TAXES**




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




The
      components of income before income taxes are as follows:




United
      States of America




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




As
        of
        June 30, 2006, the Company’s subsidiary in the United States of America had
        approximately $5,000,000 in net operating loss carryforwards available to
        offset
        future taxable income. Federal net operating losses can generally be carried
        forward 20 years. The Tax Reform Act of 1986 limits the use of net operating
        loss and tax credit carryforwards in certain situations when changes occur
        in
        the stock ownership of a company. In the event the Company has a change in
        ownership, utilization of carryforwards could be restricted. The deferred
        tax
        assets for the United States subsidiary at June 30, 2006 consists mainly
        of net
        operating loss carryforwards and were fully reserved as the management believes
        it is more likely than not that these assets will not be realized in the
        future.




Hong
      Kong




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




China




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




Composition
      of income tax expenses for China operation




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




Deferred
      Tax Assets


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


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




18




**15.
        RESTATEMENT AND CORRECTION OF ERROR**




**Consolidated
        Statement of Cash
        Flows**




The
        consolidated statement of cash flows has been
        restated for the six months ended June 30, 2006. The nature of the revisions
        can
        be classified into two categories:




1.
              Reclassification
                  of payment of convertible debenture issue costs from operating
                  activities
                  to financing activities.




2.
              Reclassification
                  of certain reconciling items that have no cash or net earnings
                  effect from
                  operating activities to a separate line labeled “Effect of exchange rate
                  on cash and cash equivalents.”




3.
              Reclassification
                  of loan receivables from financing activities to investing activities.




The
        restatement had no effect on previously reported net increase in cash and
        cash
        equivalents or cash balances.




The
        restatement for the six months ended June 30, 2006, can be summarized as
        follows:




SIX
                        MONTHS
                      ENDED
                        JUNE 30(Originally Reported)
                  
                  SIX
                        MONTHS
                      ENDED
                        JUNE 30(RESTATED)**2006**
                  
                  **2006****Cash
                      Flows from operating activities**Net
                      earnings
                  
                  
                  1,873
                  
                  
                  1,719*Adjustment
                      to reconcile net earnings to net cash used in operating
                      activities:*Equity
                      loss of associated company
                  
                  
                  (49
                  )
                  
                  (49
                  )Provision
                      for income taxes
                  
                  
                  33
                  
                  
                  33Provision
                      for allowance for doubtful accounts
                  
                  
                  28
                  
                  
                  28Minority
                      Interest
                  
                  
                  1,934
                  
                  
                  1,934Depreciation
                      and amortization
                  
                  
                  768
                  
                  
                  768Stock-based
                      compensation
                  
                  
                  120
                  
                  
                  120Change
                      in fair value of derivatives
                  
                  
                  (208
                  )
                  
                  (208
                  )Amortization
                      of interest discount
                  
                  
                  
                  
                  
                  154*Changes
                      in current assets and liabilities net of effects from purchase
                      of
                      subsidiaries:*Accounts
                      receivable and other current assets **
                  
                  
                  (10,370
                  )
                  
                  (9,870
                  )Inventories
                  
                  
                  (415
                  )
                  
                  (415
                  )Accounts
                      payable and other accrued expenses
                  
                  
                  (1,745
                  )
                  
                  (1,745
                  )***Net
                      cash used in operating activities***
                  
                  
                  **(8,031**
                  **)**
                  
                  **(7,531**
                  **)****Cash
                      flows from investing activities**Decrease
                      in restricted cash
                  
                  
                  1,422
                  
                  
                  1,422Increase
                      in purchase of marketable securities
                  
                  
                  -Acquisition
                      of property and equipment
                  
                  
                  (3,124
                  )
                  
                  (3,124
                  )Acquisition
                      of subsidiaries and affiliated companies
                  
                  
                  (836
                  )
                  
                  (836
                  )Loans
                      receivable from third parties
                  
                  
                  562
                  
                  
                  562Loans
                      receivable from related party
                  
                  
                  (2,233
                  )
                  
                  (2,233
                  )***Net
                      cash used in investing activities***
                  
                  
                  **(4,209**
                  **)**
                  
                  **(4,209**
                  **)****CASH
                      FLOWS FROM FINANCING ACTIVITIES:**Increase
                      in loan payable to related party
                  
                  
                  201
                  
                  
                  201Advances
                      (repayments) under bank line of credit
                  
                  
                  (171
                  )
                  
                  (171
                  )Advances
                      under bank loan
                  
                  
                  623
                  
                  
                  623Increase
                      (repayments) of amount borrowed under capital lease obligations
                  
                  
                  (73
                  )
                  
                  (73
                  )Repurchase
                      of treasury shares
                  
                  
                  (124
                  )
                  
                  (124
                  )Proceeds
                      from exercise of stock options and warrants
                  
                  
                  86
                  
                  
                  86Proceeds
                      from issuance of convertible debenture
                  
                  
                  8,000
                  
                  
                  8,000Payment
                      of convertible debenture issue costs
                  
                  
                  -
                  
                  
                  (500
                  )***Net
                      cash provided by financing activities***
                  
                  
                  **8,542**
                  
                  
                  **8,042****Effect
                      of exchange rate change on cash and cash
                      equivalents**
                  
                  
                  **54**
                  
                  
                  **54****NET
                      DECREASE IN CASH AND CASH EQUIVALENTS**
                  
                  
                  **(3,644**
                  **)**
                  
                  **(3,644**
                  **)****CASH
                      AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD**
                  
                  
                  **9,579**
                  
                  
                  **9,579****CASH
                      AND CASH EQUIVALENTS, END OF THE PERIOD**
                  
                  
                  **5,935**
                  
                  
                  **5,935****CASH
                      PAID FOR:**Interest
                  
                  $
                  292
                  
                  $
                  292Income
                      taxes
                  
                  $
                  463
                  
                  $
                  463**NON-CASH
                      INVESTING AND FINANCING ACTIVITIES:**Issuance
                      of option shares through increase in subscription
                      receivable
                  
                  
                  522
                  
                  
                  522Investments
                      in subsidiaries acquired through the issuance of common stock
                  
                  
                  2,275
                  
                  
                  2,275
  19


**16.
        SUBSEQUENT EVENTS**


**Stock
        Option Exercise**
  On
        July
        1, 2006, PacificNet issued 100,000 shares of common stock as a result of
        stock
        option exercise in accordance to PacificNet’s stock option plan.
   **Business
        Acquisitions**
  **Able
        Entertainment Technology Ltd by PacificNet Games Limited**
  On
        August
        3, 2006, PacificNet’s wholly owned subsidiary PacificNet Games Limited
        (“PacGames”, Chinese Company Name 太平洋网络游戏有榰公司 )
        completed the acquisition of 100% of Able Entertainment Technology Ltd.,
        a
        leading gaming technology provider based in the Macau Special Administrative
        Region of China, by exchanging 65% of the share ownership of PacificNet Games
        Limited and the issuance of 200,000 restricted shares of PacificNet Inc. 
Upon completion of this transaction, PacificNet Inc. owns 35% of PacificNet
        Games Limited (Chinese Company Name 太平洋网络游戏有榰公司 ).
        Under
        the purchase agreement, Able Entertainment Technology Ltd has committed to
        generate an annual profit of USD$1,600,000 and will provide for an adjustment
        to
        the purchase price if the PacGames does not achieve an annual net profit
        of
        USD$1,600,000 during the first 12-month period and USD$3,000,000 during the
        second 12-month period.
  The
        consideration was paid as follows:
  The
        purchase consideration for the entire Issued Shares of 100,000 shares
        (representing 100%) of the equity interest of Able Entertainment Technology
        Ltd.
        is 650 shares (representing 65%) of the ownership interest in PacificNet
        Games
        Limited, a Special Purpose Vehicle (SPV) company registered in the BVI, plus
        200,000 restricted PACT shares.  Able Entertainment Technology Ltd. has
        represented it expects to generate USD$1,600,000, and will provide for an
        adjustment to the purchase price if the Company does not achieve an annual
        net
        profit of USD$1,600,000 during the first 12-month period and USD$3,000,000
        during the second 12-month period. The purchase consideration is payable
        100% in
        restricted shares of PACT, equivalent to 200,000 restricted PACT
        shares.


**Allink
        Hong Kong Limited**
  On
        August
        11, 2006, PacificNet’s wholly owned subsidiary PacificNet Communications Limited
        (“PacCom”) completed the acquisition of 80% of Allink Hong Kong Limited (Allink,
        Chinese name “ 瘺瑑濦晧港有榰公司 ”),
        a
        leading provider of security and surveillance technology and services based
        in
        the Hong Kong Special Administrative Region of China, through the issuance
        of
        200,000 restricted shares of PacificNet Inc.  Upon completion of this
        transaction, PacificNet Inc. owns 80% of Allink. Under the purchase agreement,
        Allink has committed to generate an annual profit of HKD$3,000,000 (approx
        USD$385,000) and will provide for an adjustment to the purchase price if
        the
        Allink does not achieve an annual net profit of HKD$3,000,000.  Allink
        operates one of the leading CCTV communication and security surveillance
        technology and services provider utilizing extra low voltage technology for
        property management companies in Hong Kong and Macau, China.
  The
        consideration was paid as follows:
  (1)
                The
                    purchase consideration for 80% of the equity interest of the
                    Company is
                    payable entirely (100%) in restricted shares of PACT, equivalent
                    to
                    200,000 restricted PACT
                    shares.
  (2)
                The
                    purchase price is payable upon achievement of certain quarterly
                    earn-out
                    targets based on net
                    profits.





20




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




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







**PRELIMINARY
      NOTE REGARDING FORWARD-LOOKING STATEMENTS**




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







**FACTORS
      THAT COULD AFFECT FUTURE RESULTS**




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


·
            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.




**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.




21
 
  On
        an
        on-going basis, we evaluate our estimates, including those related to accounts
        receivable reserves, provisions for impairment losses of affiliated companies
        and other intangible assets, income taxes and contingencies. We base our
        estimates on historical experience and on various other assumptions that
        are
        believed to be reasonable under the circumstances, the results of which form
        the
        basis for making judgments about the carrying values of assets and liabilities
        that are not readily apparent from other sources. Actual results may differ
        from
        these estimates under different assumptions or conditions.




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






*Allowance
      For Doubtful Accounts*




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






*Income
      Taxes*




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







*Contingencies*




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







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




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




22




*Convertible
      Debt*


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




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







**NATURE
      OF THE OPERATIONS OF THE COMPANY**




**NATURE
      OF BUSINESS.**




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




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




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




23




PacificNet's
      operations include the following four groups:




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


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


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


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




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




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


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


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







**RESULTS
      OF OPERATIONS**




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




THREE
                  MONTHS ENDED JUNE 30,
              SIX
                  MONTHS ENDED JUNE 30,2006
                  (%)
              2005
                  (%)
              2006
                  (%)
              2005
                  (%)Revenues
              100
              100
              100
              100Cost
                  of Revenues
              (74.53)
              (78.28)
              (66.81)
              (79.69)Gross
                  Margin
              25.47
              21.72
              33.19
              20.31Selling,
                  general and administrative expense
              (19.17)
              (12.01)
              (23.79)
              (11.16)Earnings
                  from operations
              6.30
              9.71
              9.40
              9.15Earnings
                  before income taxes, minority interest and discontinued
                  operations
              8.46
              12.26
              11.07
              11.03NET
                  EARNINGS
              4.13
              4.83
              5.00
              4.69






24


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


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




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


(1)
              Outsourcing
                  services: The year-over-yeargrowth
                  in outsourcing services in the second quarter and first half of
                  2006 was
                  primarily due to the higher revenue from Call Centre business in
                  Hong
                  Kong. For the second quarter of 2006, Epro’s revenues increased $643,000,
                  or 26.8%, year-over-year, which was largely due to a 148% increased
                  in
                  revenues from facilities management services, and a 54% increased
                  in
                  revenue from outbound services. Its revenues accounted for 86%
                  and 85% of
                  total outsourcing services revenues in the second quarter and first
                  half
                  of 2006, respectively. Due to rising labor costs, management believes
                  that
                  Business Process Outsourcing (BPO) has become a firmly-entrenched
                  trend in
                  Hong Kong and the PRC. Demand for outsourcing services has been
                  steadily
                  increasing, especially in sectors such as banking, insurance and
                  telecom,
                  and such demand has lead to continued growth in the first half
                  of 2006.
                  The Company’s combined Hong Kong-China operations expanded total contract
                  center capacity to host 1000 working positions and to occupy a
                  total of
                  53,000 square feet. During the first half of 2006, the outsourcing
                  contract center in Hong Kong was at nearly full utilization. With
                  increasing information technology expenditures by Hong Kong companies,
                  both the Contact Center (or Customer Services Center) System and
                  IT
                  Solutions departments enjoyed revenue growth. Additionally, EPRO
                  is the
                  Value-added Reseller (VAR) of EPICOR’s Customer Relationship Management
                  Solution (CRM) and Enterprise Resource Planning Solution (ERP)
                  which led
                  to additional marketing activities and promotional programs in
                  the first
                  half of 2006. Management retains its positive outlook on its software
                  operations as companies search for tools to streamline or automate
                  their
                  business processes. With an experienced technical support team,
                  EPRO is
                  able to provide end-to-end solutions to meet the increasing IT
                  needs of
                  clients.  (2)
              Value-added
                  Telecom Services: In the aggregate, revenues received through VAS
                  business
                  and its subsidiaries accounted for 28.5% and 36.5% of the Company’s total
                  revenues for the three and six months ended June 30, 2006,
                  respectively, and 38.6% and 28.6 % of the Company’s total revenues for the
                  three and six months ended June 30, 2005, respectively. Guangzhou 3G,
                  Linkhead, Lion Zone contributed 12.8%, 8.9%, and 6.5%, respectively,
                  of
                  the total revenues for the three month ended June 30, 2006 and
                  13.1 %,
                  9.7% and 13.4%, respectively, for the six month ended June 30,
                  2006,
                  respectively. During the second quarter and first half of 2006,
                  China
                  accounted for 37.5% and 45.8% of the total revenues, respectively,
                  compared to 46.8 % and 37.4% in the same periods of 2005, respectively.
                  The significant increase in revenues during the second quarter
                  of 2006 and
                  a small increase during the first half of 2006 in Guangzhou 3G
                  was mostly
                  attributed to providing new 3G services and through the merger
                  of
                  Guangzhou Wanrong, which added approximately $308,000 and $574,000
                  to
                  three and six months ended June 30, 2006, respectively.On
                  a year-over-year basis,the
                  Company’s VAS revenue only increased a small percentage, approximately
                  16%
                  in the second quarter, which is primarily attributed to the approximate
                  20% decline in the sales of voice cards from Linkhead. During 2006,
                  there
                  was a general market decline for voice cards in Asia, and a 25%
                  decline in
                  SMS revenues from Clickcom in whichSMS
                  advertising has been restricted by China Information Industry Department.However,
                  voice cards revenues had a slight increase of 5% ($81,000)
                  quarter-to-quarter. Additionally,the development of WAP and color ring back tone services had growth
                  during
                  the period to partially offset the decline in SMS business.




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




25






(3)
              Communication
                  Products Distribution: iMobile added approximately $1,230,000
                  and $2,231,000, or accounted for 13.8% and 18.8% in Communication
                  Products
                  Distribution revenues for the three and six months ended June 30,
                  2006,
                  respectively, in which its major business included internet sales
                  of
                  mobile phone and accessories. The revenues from the sales of Motorola
                  and
                  Nokia contributed 95% of iMobile’s total revenues during the second
                  quarter and first half of 2006. Additionally, the completion of
                  a charging
                  platform for new services and content information is in process
                  and is
                  expected to be rolled out in August of this year.PacCom
                  revenues accounted for 54 % and 8 % of total revenues in the Communication
                  Products Distribution business in the first half of 2006 and 2005,
                  respectively.Revenues
                  from PacCom increased by 2535% and 811% year-over-year in the second
                  quarter and first half of 2006, respectively, primarily due to
                  approximately $1.9million (HK$15million) revenues from providing
                  LED
                  lighting technology and solution for Galaxy Starworld Hotel of
                  Macau and
                  approximately $0.23million (HK$1.78million) revenues from Dell
                  computer,
                  Fiber Converter, Mirror Finish Steel, Cabling, DCM player, and
                  others
                  during the second quarter of 2006.  (4)
              The
                  remaining incremental revenues for the three and six months ended
                  June 30,
                  2006 as compared to respective period was derived from organic
                  growth from
                  existing subsidiaries, such as PacPower ($894,000 and $2,474,000)
                  and
                  PacificNet Limited ($407,000 and $825,000). The Light Eco installation
                  system project awarded in the second quarter of 2006 posted positive
                  revenue increases during the second quarter and first half of 2006.
                  Additionally, projects involving $0.13million (HK$1.04million)
                  of the
                  installation of Central Air-Conditioning Chilled-Water Pump Intelligence
                  Control System at the incorporate owner of Goodrich Garden and
                  $0.96million (HK$7.50million) of Nan Fung Centre chiller replacement
                  project strongly help pushed drive revenues. The Company also received
                  two
                  services agreements during the second quarter of 2006 including
                  providing
                  consulting services in the areas of legal, accounting, finance,
                  management
                  and web site design and construction (HK$1million), and providing
                  Internet
                  e-commerce software application and e-commerce web site development
                  service (HK$1.5million).






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




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




FOR
      THE
      THREE MONTHS ENDED


Group
                    3Group
                    1
                
                
                
                CommunicationsOutsourcing
                
                Group
                    2.
                
                Distribution
                
                Group
                    4Business
                
                VAS
                    Business
                
                Business
                
                Other
                    Business
                
                TOTALJUNE
                    30, 2006
                
                ($)
                
                ($)
                
                ($)
                
                ($)
                
                ($)Revenues
                
                
                3,552,000
                
                
                5,517,000
                
                
                8,914,000
                
                
                1,347,000
                
                
                19,330,000Earnings
                    / Loss from Operations
                
                
                283,000
                
                
                1,130,000
                
                
                208,000
                
                
                -404,000
                
                
                1,217,000
  FOR
          THE
          SIX MONTHS ENDED
 Group
                    3Group
                    1
                
                
                
                CommunicationsOutsourcing
                
                Group
                    2.
                
                Distribution
                
                Group
                    4Business
                
                VAS
                    Business
                
                Business
                
                Other
                    Business
                
                TOTALJUNE
                    30, 2006
                
                ($)
                
                ($)
                
                ($)
                
                ($)
                
                ($)Revenues
                
                
                6,579,000
                
                
                12,557,000
                
                
                11,851,000
                
                
                3,377,000
                
                
                34,364,000Earnings
                    / Loss from Operations
                
                
                403,000
                
                
                2,844,000
                
                
                265,000
                
                
                -283,000
                
                
                3,229,000




26
  COST
        OF
        REVENUES. Cost of revenues for the three and six months ended June 30, 2006
        was
        $14,407,000 and $22,960,000, an increase of 49.9% and 34.1% from $9,613,000
        and
        $17,127,000 for the three and six months ended June 30, 2005,
        respectively. The cost of revenues in services and product sales in the
        second quarter and first half of 2006 increased by 3.8% and 81.1%, respectively,
        and 17.4% and 43.5%, respectively, compared with the respective period in
        2005.
        The increase is directly associated with the corresponding increase in revenues.
        In comparison to the same period last year, the majority of the costs associated
        with revenues were from PacCom and Epro. For the second quarter and first
        half
        of 2006, PacCom accounted 34.1% and 26.9% of the total cost of revenues,
        respectively and approximately $1.86million (HK$14.5million) cost of revenue
        from PacCom is the IT equipment cost paid for Macau Galaxy Starworld Hotel
        project during the second quarter of 2006. Cost of revenues from Epro accounted
        for 15.7% and 18.7% of the total cost of revenues in the first half of 2006
        and
        2005, respectively, which was mainly related to 27% increase in staff cost
        related to software sales, 277% increase in occupancy costs such as rents
        and
        electricity and 46% increase in other operating activity. Additionally, 4%
        and
        8.2% of total cost of revenues was contributed from PacPower for the second
        quarter and first half of 2006, respectively, which resulted from a Central
        Air-Conditioning chiller replacement project and a Light Eco installation
        system
        project awarded during the first and second quarter of 2006 respectively.
        In
        addition, PacPower received a contract for a frequency inverter energy-saving
        air-conditioning solution project from a client.




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




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




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




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






27
 
  EARNINGS
          FROM OPERATIONS. On
          a
          year-over-year basis, earnings from operations increased 2% and 64% in
          the
          second quarter and first half of 2006, respectively. Operating earnings
          of
          $283,000, $1,130,000, and $208,000 for the three months ended June 30,
          2006 were
          generated from the Company's three business units: (1) CRM Outsourcing
          Services,
          (2) Value Added Services (VAS), and (3) Communications Distribution Services,
          respectively. This compares to operating earnings of $305,000, $1,086,000
          and
          $118,000 for the three months ended June 30, 2005, respectively. Various
          factors
          affected operating earnings during the second quarter of 2006, including
          increased capital expenditures resulting in greater non-cash charges such
          as
          depreciation and amortization expenses. As the Company expanded its call
          centre
          sites in Hong Kong, amortization and depreciation expenses related to the
          new
          leasehold improvement, furniture & fixtures, computer equipment and software
          incurred in the second quarter and first half of 2006 also increased. The
          increase in fixed assets also included a recorder monitor system, DVCAM,
          computer equipment. We continued to shift our business from our traditional
          lower-margin distribution business (B2B services) to higher margin value-added
          telecom services and B2C e-commerce which we believe will help drive superior
          bottom-line results. We believe that the Company has made substantial progress
          in a relatively short period of time which has been demonstrated by our
          increase
          in both gross and operating margins in the second quarter. Furthermore,
          the
          acquisition of the majority interest in both iMobile and Guangzhou Wanrong
          during the first quarter enhanced our position in this rapidly growing
          B2C
          market in China.




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




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




NET
        EARNINGS. Overall net earnings year-over-year increased 34.6% and 70.5% in
        the
        second quarter and first half of 2006, respectively. The Company’s results for
        the six months ended June 30, 2006 included a total of $888,000 in non-cash
        expenses, including depreciation and amortization expense of $768,000 and
        $120,000 non-cash stock-based compensation expense recognized during 2006
        as a
        result of the implementation of SFAS 123(R), which we adopted effective on
        January 1, 2006, The Company’s quarterly results also included a total of
        $530,000 in non-cash expenses, including depreciation and amortization expense
        of $472,000 and non-cash stock-based compensation expense $58,000 recognized
        during the second quarter as a result of the implementation of SFAS 123(R),
        which we adopted effective on January 1, 2006. Each of our subsidiaries and
        investments, including Epro, Smartime, Guangzhou 3G, Clickcom, ChinaGoHi,
        iMobile, PacificNet Communications, PacificNet Limited and PacificNet Power
        were
        profitable.




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




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




28




**LIQUIDITY
      AND CAPITAL RESOURCES**




CASH
      AND
      CASH EQUIVALENTS.




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




WORKING
      CAPITAL.




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




NET
      CASH
      FROM OPERATING ACTIVITIES.




Net
          cash
          used in operating activities was $ 7,531,000
          for the six months ended June 30, 2006 as compared to net cash used in
          operating
          activities of $110,000 for the six months ended June 30, 2005. Net cash
          used in
          operating activities in the six months ended June 30, 2006 was primarily
          due to
          net earnings of $1,719,000 offset by minority interest of $1,934,000, non-cash
          related expenses of $900,000, $208,000 for the change in fair value of
          our
          derivatives as of the balance sheet date, and a net increase in working
          capital
          items of $12,530,000. The increase in working capital was mainly due to
          an
          increase in accounts receivable of $9,870,000 and an increase in inventories
          of
          $415,000 which mainly resulted from higher revenues and a net decrease
          in
          account payables and accrued expenses of $1,745,000 which was primarily
          due to
          the decrease in accrued expenses and income tax
          payable.




NET
      CASH
      FROM INVESTING ACTIVITIES.




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




NET
      CASH
      FROM FINANCING ACTIVITIES.




Net
        cash
        provided by financing activities for the six months ended June 30, 2006 was
        $8,042,000, which was mainly due to the proceeds from issuance of convertible
        debenture of $8,000,000 less debt issuance costs paid of $50,000, the exercise
        of share options and warrants of $86,000, an increase in bank loan of $623,000
        which was due to the purchase of our Beijing office, and an increase in loans
        payable to related party of $201,000 by Epro. The amount was partially offset
        by
        the repayment of banking facilities of $171,000 from Epro and Smartime, the
        repayment of amount borrowed under capital lease of $73,000, and repurchase
        of
        treasury shares of $124,000. Net cash provided by financing activities for
        the
        six months ended June 30, 2005 was $2,302,000, which was primarily a result
        of
        an increase in loans payable to related party of $390,000, an increase in
        advances from banking facilities of $142,000 primarily by EPRO, an increase
        in
        bank loan of $727,000, and an increase from the exercise of share options
        and
        warrants of $981,000.




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




29


CURRENCY
      EXCHANGE FLUCTUATIONS.




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




OFF-BALANCE
      SHEET ARRANGEMENTS.




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






**CONTRACTUAL
      OBLIGATIONS**




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




**Payments
      Due by Period**





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






**CONCENTRATION
      OF CREDIT RISK**




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






**SEASONALITY
      AND QUARTERLY FLUCTUATIONS**




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






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




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




30





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


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





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




***Interest
      Rate Risk.***


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






**ITEM
      4. CONTROLS AND PROCEDURES**





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




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




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




31


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




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





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




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




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





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





***Remediation
      Initiatives***





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





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




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





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





32






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





***Remediation
      Initiatives***





As
        indicated in the Company’s 10-K filed on April 28, 2006, PacificNet has greatly
        expanded its Finance and Accounting staff in China in the last six months.
        In
        January, the Company promoted Mary Ma to the new position of Vice President
        of
        Finance, a position which will be permanently stationed in China. The Company
        has gradually transitioned the roles, responsibilities and job function of
        the
        CFO role to Mary May, the new VP of Finance. In May 2006, the Company announced
        the resignation of Mr. ShaoJian Wang as the CFO effective May 26, 2006.
        Concurrently, Mr. Wang announced that he had accepted a new position at Hurray!
        Holding Co. Ltd. (Nasdaq:HRAY) as their President and Chief Operating Operator.
        In
        September 2006, the Company announced the hiring of its new CFO, Mr.Joseph
        Levinson, a former manager at Deloitte and Touche in New York.




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





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





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


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


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





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




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





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





***Remediation
      Initiatives***




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




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





***Remediation
      Initiatives***





Utilization
      of Computerized Automated Controls:




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





33




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




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





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


******


***Remediation
      Initiatives***




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







34




**PART
      II - OTHER INFORMATION**







**ITEM
      1. LEGAL PROCEEDINGS.**




None.







**ITEM
      1A. RISK FACTORS.**




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




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





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


**


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





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


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


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


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


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


•
            unusual
                contract terms required by customers in developing markets;


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


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


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


•
            reduced
                protection for intellectual property rights in some countries;


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


•
            longer
                accounts receivable collection periods; and


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








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





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





35
 
  We
        have
        identified material weaknesses in our internal control over financial reporting.
        See “Item 8A—Controls and Procedures—Management’s Report on Internal Control
        Over Financial Reporting” in our Annual report on Form 10-KSB for the year
        ended December 31, 2005 for a discussion of these material weaknesses. As
        of the date of the filing of this quarterly report on Form 10-Q, we are
        still in the process of implementing remedial measures related to the material
        weaknesses identified. If our efforts to remedy the weaknesses we identified
        are
        not successful, our business and operating results could be harmed and the
        reliability of our financial statements could be impaired, which could adversely
        affect our stock price. The requirements of Section 404 of the
        Sarbanes-Oxley Act are ongoing and also apply to future years. We expect
        that
        our internal control over financial reporting will continue to evolve as
        we
        continue in our efforts to transform our business. Although we are committed
        to
        continue to improve our internal control processes and we will continue to
        diligently and vigorously review our internal control over financial reporting
        in order to ensure compliance with the Section 404 requirements, any
        control system, regardless of how well designed, operated and evaluated,
        can
        provide only reasonable, not absolute, assurance that its objectives will
        be
        met. Therefore, we cannot be certain that in the future additional material
        weaknesses or significant deficiencies will not exist or otherwise be
        discovered.







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




None.






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




None.







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




None.







**ITEM
      5. OTHER INFORMATION.**




None.





**ITEM
      6. EXHIBITS**




The
      following exhibits are filed as part of this report:




EXHIBIT


NUMBER
            DESCRIPTION




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




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




32.1
            18
                U.S.C. Section 1350 Certifications




36


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: November
                3, 2006
              By:
              /s/ TONY
                TONGTony
                  Tong
                Chief
                  Executive Officer
                (Principal
                  Executive Officer)


Date: November
                3, 2006
              By:
              /s/ JOSEPH
                LEVINSONJoseph
                  Levinson
                Chief
                  Financial Officer
                (Principal
                  Financial Officer)








37