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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
[_] 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 001-15713
ASIAINFO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 752506390
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4TH FLOOR, ZHONGDIAN INFORMATION TOWER
6 ZHONGGUANCUN SOUTH STREET, HAIDIAN DISTRICT
BEIJING 100086, CHINA
(Address of principal executive office, including zip code)
+8610 6250 1658
(Registrant's telephone number, including area code)
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such
reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the Registrant's common stock as of
November 8, 2002 was 44,186,985
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ASIAINFO HOLDINGS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 3
a) Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2001 and 2002 3
b) Condensed Consolidated Balance Sheets as of December 31, 2001 and September 30, 2002 5
c) Condensed Consolidated Statements of Cash Flows for the three and nine months ended September
30, 2001 and 2002 6
d) Notes to Condensed Consolidated Financial Statements for the three and nine months ended
September 30, 2001 and 2002 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 42
Item 4. Controls and Procedures 42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 43
Item 2. Changes in Securities and Use of Proceeds 43
Item 6. Exhibits and Reports on Form 8-K 44
SIGNATURE 46
CERTIFICATIONS 47
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US Dollars thousands, except per share amounts)
Three Months Ended
September 30,
----------------------------
2001 2002
------------ ------------
(unaudited)
Revenues:
Network solutions ................................................................. $ 86,323 $ 23,498
Software solutions ................................................................ 7,708 9,073
------------ ------------
Total revenues .................................................................... 94,031 32,571
------------ ------------
Cost of revenues:
Network solutions ................................................................. 77,649 20,019
Software solutions ................................................................ 842 4,052
------------ ------------
Total cost of revenues ............................................................ 78,491 24,071
------------ ------------
Gross profit ........................................................................ 15,540 8,500
------------ ------------
Operating expenses:
Sales and marketing (excluding stock-based compensation: 2001: $78;
2002: $31 and amortization of acquired intangible assets: 2001: nil;
2002: $238) ..................................................................... 6,322 3,082
General and administrative (excluding stock-based compensation: 2001:
$104; 2002: $41 and amortization of acquired intangible assets: 2001:
nil; 2002: $147) ................................................................ 3,550 2,719
Research and development (excluding stock-based compensation: 2001: $34;
2002: $10 and amortization of acquired intangible assets: 2001: nil;
2002: $92) ...................................................................... 1,945 2,097
Amortization of deferred stock compensation ....................................... 216 82
Amortization of acquired intangible assets ........................................ - 477
------------ ------------
Total operating expenses .......................................................... 12,033 8,457
------------ ------------
Income from operations .............................................................. 3,507 43
------------ ------------
Other income (expense):
Interest income ................................................................... 1,644 523
Interest expense .................................................................. (216) (1)
Other (expenses) income, net ...................................................... (5) 6
------------ ------------
Total other income (expense), net ................................................. 1,423 528
------------ ------------
Income before income taxes, minority interests and equity in loss of
affiliate ....................................................................... 4,930 571
Income tax expense .................................................................. 986 74
------------ ------------
Income before minority interests .................................................... 3,944 497
Minority interests in (income) loss of consolidated subsidiaries .................... (105) 73
Equity in loss of affiliate ......................................................... (320) (102)
------------ ------------
Net income .......................................................................... $ 3,519 $ 468
============ ============
Net income per share:
Basic ............................................................................. $ 0.08 $ 0.01
============ ============
Diluted ........................................................................... $ 0.08 $ 0.01
============ ============
Shares used in computing per share amounts:
Basic ............................................................................. 41,757,250 44,081,170
============ ============
Diluted ........................................................................... 45,159,256 44,835,907
============ ============
See notes to condensed consolidated financial statements.
-3-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US Dollars thousands, except per share amounts)
Nine Months Ended
September 30,
-----------------------------------
2001 2002
------------- -------------
(unaudited)
Revenues:
Network solutions ............................................................ $ 130,004 $ 73,006
Software solutions ........................................................... 21,357 24,661
------------- -------------
Total revenues ............................................................... 151,361 97,667
------------- -------------
Cost of revenues:
Network solutions ............................................................ 108,628 55,835
Software solutions ........................................................... 2,565 9,006
------------- -------------
Total cost of revenues ....................................................... 111,193 64,841
------------- -------------
Gross profit ................................................................... 40,168 32,826
------------- -------------
Operating expenses:
Sales and marketing (excluding stock-based compensation: 2001: $305;
2002: $66 and amortization of acquired intangible assets: 2001:
nil; 2002: $513) ........................................................... 17,769 11,460
General and administrative (excluding stock-based compensation:
2001: $488; 2002: $206 and amortization of acquired intangible
assets: 2001: nil; 2002: $515) ............................................. 10,696 7,736
Research and development (excluding stock-based compensation: 2001:
$144; 2002: $60 and amortization of acquired intangible assets:
2001: nil; 2002: $244) ..................................................... 5,522 6,706
Amortization of deferred stock compensation .................................. 937 332
In-process research and development .......................................... - 350
Amortization of acquired intangible assets ................................... - 1,272
------------- -------------
Total operating expenses ..................................................... 34,924 27,856
------------- -------------
Income from operations ......................................................... 5,244 4,970
------------- -------------
Other income (expense):
Interest income .............................................................. 6,225 1,757
Interest expense ............................................................. (883) (75)
Other (expenses) income, net ................................................. (39) 43
------------- -------------
Total other income (expense), net ............................................ 5,303 1,725
------------- -------------
Income before income taxes, minority interests and equity in loss of
affiliate .................................................................... 10,547 6,695
Income tax expense ............................................................. 2,262 870
------------- -------------
Income before minority interests ............................................... 8,285 5,825
Minority interests in (income) loss of consolidated subsidiaries ............... (235) 63
Equity in loss of affiliate .................................................... (576) (383)
------------- -------------
Net income ..................................................................... $ 7,474 $ 5,505
============= =============
Net income per share:
Basic ........................................................................ $ 0.18 $ 0.13
============= =============
Diluted ...................................................................... $ 0.16 $ 0.12
============= =============
Shares used in computing per share amounts:
Basic ........................................................................ 41,343,389 43,387,643
============= =============
Diluted ...................................................................... 45,689,785 45,765,340
============= =============
See notes to condensed consolidated financial statements.
-4-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In US Dollars thousands, except per share amounts)
December 31, September 30,
------------ -------------
2001 2002
------------ -------------
(1) (Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents .................................................... $ 110,635 $ 118,265
Restricted cash .............................................................. 13,475 14,458
Short-term investments ....................................................... 27,184 4,010
Accounts receivable, trade (net of allowance for doubtful accounts of
$1,094 and $1,961 at December 31, 2001 and September 30, 2002,
respectively) .............................................................. 66,723 62,633
Inventories - hardware and parts ............................................. 1,180 4,357
Other receivables ............................................................ 10,533 6,128
Deferred income taxes - current .............................................. 1,689 1,893
Prepaid expenses and other current assets .................................... 1,417 4,644
----------- -------------
Total current assets ....................................................... 232,836 216,388
Property and equipment - net ................................................... 5,376 4,799
Goodwill ....................................................................... 2,188 37,255
Other acquired intangibles - net ............................................... - 4,508
Investment in affiliate ........................................................ 5,272 4,889
Deferred income taxes .......................................................... 188 -
----------- -------------
Total Assets ............................................................... $ 245,860 $ 267,839
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term bank loans ........................................................ $ 2,924 $ 72
Accounts payable ............................................................. 23,789 22,017
Other payables ............................................................... 1,682 1,837
Deferred revenue ............................................................. 4,279 5,731
Accrued employee benefits .................................................... 9,088 7,096
Accrued expenses ............................................................. 11,431 13,252
Income taxes payable ......................................................... 4,743 3,354
Other taxes payable .......................................................... 2,524 1,845
----------- -------------
Total current liabilities .................................................. 60,460 55,204
Deferred income taxes .......................................................... - 205
----------- -------------
Total Liabilities .......................................................... 60,460 55,409
----------- -------------
Minority interest .............................................................. 610 329
----------- -------------
Stockholders' Equity:
Common stock, 100,000,000 shares authorized, $0.01 par value, shares
issued and outstanding: 2001: 42,132,818; 2002: 44,152,307 ................. 421 442
Additional paid-in capital ................................................... 178,649 200,059
Deferred stock compensation .................................................. (512) (180)
Retained earnings ............................................................ 6,204 11,709
Accumulated other comprehensive income ....................................... 28 71
----------- -------------
Total stockholders' equity ................................................. 184,790 212,101
----------- -------------
Total Liabilities and Stockholders' Equity ................................. $ 245,860 267,839
=========== =============
See notes to condensed consolidated financial statements.
(1) Derived from the audited balance sheet included in the annual report on Form
10-K of AsiaInfo Holdings, Inc., for the year ended December 31. 2001.
-5-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In US Dollars thousands, except per share amounts)
Nine Months Ended
September 30,
----------------------------------
2001 2002
---------- ---------
(unaudited)
Cash flows from operating activities:
Net income ............................................................. $ 7,474 $ 5,505
Adjustments to reconcile net income to net
cash (used in) provided by operating
activities:
Depreciation ........................................................... 1,630 2,219
Amortization of goodwill ............................................... 818 -
Amortization of other acquired intangible
assets ............................................................... - 1,272
In-process research and development .................................... - 350
Amortization of deferred stock compensation ............................ 937 332
Deferred income taxes .................................................. (35) (275)
Minority interest in income (loss) of consolidated subsidiaries ........ 235 (63)
Equity in loss of an affiliate ......................................... 576 383
Loss on disposal of property and equipment ............................. 159 56
Bad debt expense ....................................................... 643 553
Changes in operating assets and liabilities,
net of effects of business acquired:
Restricted cash ...................................................... 969 3,544
Accounts receivable .................................................. (26,005) 14,792
Inventories .......................................................... 7,626 (1,946)
Other receivables .................................................... (788) (1,571)
Prepaid expenses and other current assets ............................ (775) (381)
Accounts payable ..................................................... (12,201) (4,106)
Other payables ....................................................... (751) 6
Deferred revenue ..................................................... (8,916) (121)
Accrued employee benefits ............................................ (826) (2,544)
Accrued expenses ..................................................... 4,276 1,559
Income taxes payable ................................................. 1,717 (589)
Other taxes payable .................................................. (285) (1,764)
---------- ---------
Net cash (used in) provided by operating
activities ............................................................. (23,522) 17,211
---------- ---------
Cash flows from investing activities:
Decrease in short-term investments ..................................... 87,990 23,174
Purchases of property and equipment .................................... (1,278) (885)
Proceeds from disposal of fixed assets ................................. 11 29
Increase in loan receivable ............................................ - (3,572)
Investment in affiliate ................................................ (6,157) -
Purchase of a subsidiary, net of cash
acquired ............................................................. - (26,063)
---------- ---------
Net cash provided by (used in) investing
activities ............................................................. 80,566 (7,317)
---------- ---------
-6-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(In US Dollars thousands, except per share amounts)
Nine Months Ended
September 30,
-----------------------------------
2001 2002
------------ ----------
(unaudited)
Cash flows from financing activities:
Increase in short-term bank loans ................................ $ 40,535 $ 2,924
Repayment of short-term bank loans ............................... (44,446) (7,636)
Proceeds on exercise of stock options ............................ 2,621 2,628
Earning distribution of consolidated subsidiaries ................ - (218)
------------ ----------
Net cash used in financing activities ............................ (1,290) (2,302)
------------ ----------
Net increase in cash and cash equivalents: ......................... 55,754 7,592
Cash and cash equivalents at beginning of period ................... 48,834 110,635
Effect of exchange rate changes on cash and cash equivalents ....... 10 38
------------ ----------
Cash and cash equivalents at end of period ......................... $ 104,598 $ 118,265
============ ==========
Supplemental cash flow information:
Cash paid during the period:
Interest ......................................................... $ 888 $ 55
Income taxes ..................................................... $ 580 $ 1,102
============ ==========
Deferred stock compensation ...................................... $ 937 $ 332
============ ==========
Non-cash investing activity:
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson for cash of $33,387, of which $624 represented acquisition costs, and the
issuance of 1,031,686 shares of common stock with a fair market value at the
time the acquisition was announced of approximately $18,003. Of the cash amount,
$20,433 was paid on April 4, 2002. In connection with the acquisition, the
Company acquired tangible assets with a fair value of $28,364 and assumed
liabilities of $17,737.
See notes to condensed consolidated financial statements.
-7-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION
Interim Financial Information - The accompanying condensed consolidated
financial statements of AsiaInfo Holdings, Inc. (the "Company"), and its
wholly-owned subsidiaries as of September 30, 2002 and for the three- and
nine-months ended September 30, 2001 and 2002 are unaudited. In the opinion of
management, the condensed consolidated financial statements include all
adjustments (consisting only of normal recurring accruals) that management
considers necessary for a fair presentation of its financial position. Operating
results and cash flows for interim periods are not necessarily indicative of
results for the entire year.
This financial data should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2001. This financial data should
also be read in conjunction with the Company's critical accounting policies
included in "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001.
AsiaInfo Holdings, Inc. is incorporated in the State of Delaware, in the United
States (the "US"). The Company principally operates through the following
directly owned subsidiaries, or their respective subsidiaries: AsiaInfo
Technologies (China), Inc. ("AsiaInfo Technologies") (100% owned), Guangdong
Wangying Information Technology Co., Ltd. ("Wangying") (40% owned, but
controlled by the Company), both incorporated in the People's Republic of China
("China" or the "PRC"), Marsec Holdings, Inc. ("Marsec") (79% owned), and Bonson
Information Technology Holdings Limited, ("Bonson") (100% owned), both
incorporated in the Cayman Islands.
On March 2, 2000, the Company completed an initial public offering of 5,750,000
shares of its common stock, raising net proceeds of $126,610. The Company's
common stock is traded on The Nasdaq National Market in the United States.
The Company acts as a holding company and, through certain subsidiaries, sources
network-related equipment in the United States for sale to customers in the PRC.
AsiaInfo Technologies was established as a wholly foreign owned enterprise with
an initial operating term of 15 years commencing May 2, 1995 (date of
establishment). Its principal activities are conducted in the PRC and comprise
the provision of telecommunications-related information technology professional
services and software products. In November 2001, the Company merged its wholly
owned subsidiary, Zhejiang AsiaInfo Telecommunication Technology Co., Ltd. ("AI
Zhejiang"), into AsiaInfo Technologies. AI Zhejiang's activities were performed
in the PRC and comprised the development and sale of communication hardware and
software as well as providing related technology services. AI Zhejiang was
acquired in April 1999, and its results of operations are included in the
Company's financial statements from the date of acquisition.
-8-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
On December 31, 2001, AsiaInfo Technologies formed a wholly owned subsidiary,
AsiaInfo Technologies (Chengdu), Inc., with an initial operating term of 15
years to provide hardware procurement support for network solution projects.
Wangying was established on September 6, 2000 with an initial operating term of
4 years for a particular customer project in the PRC. As of September 30, 2002,
Wangying is being liquidated.
Marsec, through its wholly owned subsidiary, provides internet security
consulting and services in the PRC. In September 2001, the Company exercised
warrants to purchase 200,000 additional voting preferred shares of Marsec at
$3.50 a share, increasing its investment in Marsec from 75% to 79%.
On April 27, 2001, the Company invested $6,157 to acquire a 14.25% interest (in
the form of voting preferred shares) in Intrinsic Technology (Holdings), Ltd.
("Intrinsic"), a Cayman Islands company engaged in wireless infrastructure
solutions development through two wholly-owned subsidiaries in the PRC.
In 2000, the Company dissolved its subsidiary AsiaInfo-CTC Network Systems Inc.
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson, a leading developer of wireless telecommunications software and
solutions, operating through its subsidiary Guangzhou Bonson Technology Limited,
based in Guangzhou, China, for $32,763 in cash and the issuance of 1,031,686
shares of the Company's common stock. (See Note 10).
The consolidated financial statements of the Company include the accounts of the
Company and its subsidiaries. Intercompany transactions and balances have been
eliminated. Investments in 50% or less owned affiliates over which the Company
exercises significant influence, but not control, are accounted for using the
equity method.
Revenue from network solutions contracts, which includes the procurement of
hardware on behalf of customers, systems design, planning, consulting and system
integration is recognized based on the percentage of completion method. Labor
costs and direct project expenses are used to determine the stage of completion
except for revenues associated with the procurement of hardware. Such
hardware-related revenues are recognized upon delivery. Estimates of hardware
warranty costs are included in determining project costs.
Software solutions revenues represent license fees and related services that
allow customers to use the Company's software products in perpetuity up to a
maximum number of users. Contract revenue from software license fees and
software implementation services represent customer orders requiring significant
production, modifications, or customization of the software. Contract revenue
for software is recognized in conjunction with the revenues of the related
solutions project over the installation and customization period based on the
percentage of completion of the project as measured by labor costs and direct
project expenses. The Company may also sell packaged software occasionally, and
license fees from such software sales are recognized as revenue upon the
-9-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
occurrence of the following events: an agreement is close to being entered into,
the fee is determined, collection of the fee is reasonably assured, and the
delivery to or acceptance by the customer of the software product has occurred.
Costs related to insignificant obligations for a period up to one year, which
include telephone support, are accrued at the time the revenue is recorded.
Software revenues include the benefit of the rebate of value added taxes on
sales of software received from the tax authorities as part of the PRC
government's policy of encouragement of software development in the PRC. The
rebate was approximately $759 and $550 for the three months ended September 30,
2001 and 2002, respectively, and $2,454 and $1,813 for the nine months ended
September 30, 2001 and 2002, respectively.
Revisions in estimated contract profits are made in the period in which the
circumstances requiring the revision become known. Provisions, if any, are made
currently for anticipated losses on uncompleted contracts. Revenue in excess of
billings is recorded as unbilled receivables and included in trade accounts
receivable, and amounted to $45,910 at December 31, 2001 and $36,354 at
September 30, 2002. Billings in excess of revenues recognized are recorded as
deferred income. Billings are rendered based on agreed milestones included in
the contracts with customers. At December 31, 2001 and September 30, 2002, the
balance of trade accounts receivable of $20,813 and $26,279, respectively,
represented amounts billed but not yet collected. All billed and unbilled
amounts are expected to be collected within 1 year. The Company revisits its
estimate on collectibility on a periodic basis. As a result, bad debt expenses
were $162 and $568 for the three months ended September 30, 2001 and 2002,
respectively. Bad debt expenses were $643 and $553 for the nine months ended
September 30, 2001 and 2002, respectively.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at December 31, 2001 and September 30, 2002
and the reported amounts of revenues and expenses during the three and nine
months ended September 30, 2001 and 2002. Actual results could differ from those
estimates.
The financial records of the Company's PRC subsidiaries are maintained in
Renminbi ("RMB"), their functional currency and the currency of the PRC. Their
balance sheets are translated into United States dollars based on the rates of
exchange ruling at the balance sheet date. Their statements of operations are
translated using a weighted average rate for the period. Translation adjustments
are reflected as cumulative translation adjustments in the statement of
stockholders' equity.
The Renminbi is not fully convertible into United States dollars or other
foreign currencies. The rate of exchange quoted by the People's Bank of China on
September 30, 2002 was US$1.00=RMB8.2771. No representation is made that the
Renminbi amounts could have been, or could be, converted into United States
dollars at that rate or at any other rate.
-10-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires, among other things, the discontinuance of goodwill amortization.
Effective January 1, 2002, the Company discontinued amortization of its existing
goodwill, which arose from the acquisition of AI Zhejiang and the Company's
investment in Intrinsic, and was being amortized over 5 years.
In addition, the standard includes provisions for the reclassification of
certain existing recognized intangibles such as goodwill, reassessment of the
useful lives of existing recognized intangibles, reclassification of certain
intangibles out of previously reported goodwill and the identification of
reporting units for purposes of assessing potential future impairment of certain
intangible assets, including goodwill. The effects of adopting the
non-amortization provisions of SFAS No. 142, assuming these provisions were
adopted as of January 1, 2001, are summarized at Note 4. SFAS No. 142 also
requires the Company to complete a transitional goodwill impairment test six
months from the date of adoption. The Company has completed the transitional
goodwill impairment test and concluded that no impairment of recorded goodwill
was necessary as of January 1, 2002.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations," which addresses the accounting
for the recognition of obligations associated with the retirement of tangible
long-lived assets. SFAS No. 143 is effective for financial statements issued for
years beginning after June 15, 2002. Management does not believe that the
adoption of SFAS No. 143 will have a significant impact on its financial
position or results of operations.
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses the financial accounting and reporting requirements for the impairment
or disposal of long-lived assets and discontinued operations. SFAS No. 144
applies to all recorded long-lived assets that are held for use or that will be
disposed of, but excludes goodwill and other intangible assets that are not
amortized. SFAS No. 144 was adopted by the Company on January 1, 2002. Adoption
of SFAS No. 144 did not have a significant effect on the Company's financial
position or results of operations.
In July 2002, the Financials Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities" which
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Such costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. SFAS No. 146 replaces the previous accounting guidance
provided by the Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
-11-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
is to be applied prospectively to exit or disposal activities initiated after
December 31, 2002 and the Company does not anticipate that the statement will
have a material impact on the Company's financial statements or results of
operations.
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, demand deposits and highly
liquid investments, which are unrestricted as to withdrawal or use, and which
have maturities of three months or less when purchased.
3. SHORT-TERM INVESTMENTS
Short-term investments are classified as available for sale and consist
principally of certificates of deposit issued by major financial institutions,
and have maturities of between 6 and 12 months. As there are no significant
market price movements for such investments, they are held at cost and accrued
interest. There were no realized or unrealized gains or losses as of September
30, 2002.
4. GOODWILL - ADOPTION OF STATEMENT 142
The following table summarizes the effect of adopting the non-amortization
provisions of SFAS No. 142, assuming these provisions were adopted as of January
1, 2001.
Three Months Ended September 30,
--------------------------------------
2001 2002
----------------- ------------------
Reported net income $3,519 $468
Add back: Goodwill amortization 290 -
----------------- ------------------
Adjusted net income $3,809 $468
================= ==================
Basic earnings per share:
Reported net income $ 0.08 $0.01
Goodwill amortization 0.01 -
----------------- ------------------
Adjusted net income $ 0.09 $0.01
================= ==================
Diluted earnings per share:
Reported net income $ 0.08 $0.01
Goodwill amortization $ 0.01 -
----------------- ------------------
Adjusted net income $ 0.09 $0.01
================= ==================
-12-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
4. GOODWILL - ADOPTION OF STATEMENT 142 - CONTINUED
Nine Months Ended September 30,
--------------------------------------------------
2001 2002
---------------------- ------------------------
Reported net income $7,474 $5,505
Add back: Goodwill amortization 818 -
---------------------- ------------------------
Adjusted net income $8,292 $5,505
====================== ========================
Basic earnings per share:
Reported net income $ 0.18 $ 0.13
Goodwill amortization 0.02 -
---------------------- ------------------------
Adjusted net income $ 0.20 $ 0.13
====================== ========================
Diluted earnings per share:
Reported net income $ 0.16 $ 0.12
Goodwill amortization 0.02 -
---------------------- ------------------------
Adjusted net income $ 0.18 $ 0.12
====================== ========================
5. COMPREHENSIVE INCOME
The components of comprehensive income for the periods presented are as follows:
Three Months Ended September 30,
--------------------------------
2001 2002
---------------- --------------
Net income ............................................................. $3,519 $ 468
Change in cumulative translation adjustment ............................ 2 6
---------------- --------------
Comprehensive income ................................................... $3,521 $ 474
================ ==============
Nine Months Ended September 30,
--------------------------------
2001 2002
---------------- --------------
Net income ............................................................. $7,474 $5,505
Change in cumulative translation adjustment ............................ 10 43
---------------- --------------
Comprehensive income ................................................... $7,484 $5,548
================ ==============
6. SHORT-TERM BANK LOANS
As of September 30, 2002, the Company had total short-term credit facilities for
working capital purposes totaling $23,000 ($3,000 expiring in October 2002 and
$20,000 expiring in October 2003). The facilities were secured by bank deposits
of $10,900 as of December 31, 2001 and $10,000 as of September 30, 2002. At
September 30, 2002, unused short-term credit facilities were $21,701 and used
facilities totaled $1,299. The used facilities are pledged for issuing letters
of credit to hardware suppliers and customers. In addition, as of September 30,
2002, the Company had short-term borrowings of $72 in RMB, the currency of the
PRC, secured by Bonson's assets.
-13-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
6. SHORT-TERM BANK LOANS - CONTINUED
The RMB loan bears interest at a rate of 4.8% per annum and are repayable upon
demand by the lending bank. Additional bank deposits of $4,458 were used for
issuing standby letters of credit and guarantees as of September 30, 2002. Bank
deposits pledged as security for these credit facilities totaled $13,475 and
$14,458 as of December 31, 2001 and September 30, 2002, respectively, and are
presented as restricted cash in the condensed consolidated balance sheets.
7. INCOME TAXES
The Company is subject to US federal and state income taxes. The Company's
subsidiaries incorporated in the PRC are subject to PRC income taxes.
A reconciliation between the provision for income taxes computed by applying the
US federal tax rate to income before income taxes, minority interest and equity
in loss of affiliate and the actual provision for income taxes is as follows:
Three Months Ended
September 30,
---------------------------------
2001 2002
---------- --------
US federal rate ........................................... 35% 35%
Difference between statutory rate and
foreign effective tax rate ............................... (21) (23)
Expenses not deductible for tax purpose --
deferred stock compensation expense ...................... 6 4
Other ..................................................... - (3)
---------- --------
20% 13%
========== ========
Nine Months Ended
September 30,
---------------------------------
2001 2002
---------- --------
US federal rate ........................................... 35% 35%
Difference between statutory rate and
foreign effective tax rate ............................... (20) (23)
Expenses not deductible for tax purpose --
deferred stock compensation expense ...................... 6 4
Other ..................................................... - (3)
---------- --------
21% 13%
========== ========
Change in valuation allowance represented a reduction of valuation allowance of
approximately $180 that was recorded to reduce the deferred tax assets arising
from the tax loss carry forward which was approved by the PRC taxing authority
during the second quarter of 2002.
-14-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
8. CAPITAL STOCK
Option activity in the Company's stock option plans is summarized as follows:
Outstanding options
weighted average
Number of shares exercise price per share
---------------- ------------------------
Outstanding, January 1, 2002: ....... 8,309,168 $ 9.40
Granted ............................. 24,600 14.56
Cancelled ........................... (255,740) 11.58
Exercised ........................... (172,563) 4.26
----------- -------
Outstanding, March 31, 2002 ......... 7,905,465 $ 9.46
=========== =======
Granted ............................. 51,000 11.89
Cancelled ........................... (230,790) 14.21
Exercised ........................... (666,340) 2.56
----------- -------
Outstanding, June 30, 2002 .......... 7,059,335 $ 9.97
=========== =======
Granted ............................. 3,171,317 4.03
Cancelled ........................... (164,690) 12.56
Exercised ........................... (148,900) 1.25
----------- -------
Outstanding, September 30, 2002 ..... 9,917,062 $ 8.16
=========== =======
The exercise price of all options granted during the three months and the nine
months ended September 30, 2002 was equal to the fair market value of the
Company's common stock on the dates of grant.
9. NET INCOME PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share computations:
Three Months Ended
September 30,
-------------------------------
2001 2002
------------- ------------
Net income (numerator):
Net income used in computing basic and diluted net
income per share ............................................... $ 3,519 $ 468
============= ============
Shares (denominator):
Weighted average
Common Stock Outstanding .................................... 41,757,250 44,081,170
------------- ------------
Shares used in computing basic net income per share ............ 41,757,250 44,081,170
Dilutive effect of stock options outstanding using the
treasury stock method .......................................... 3,402,006 754,737
------------- ------------
Shares used in computing net income per share .................. 45,159,256 44,835,907
Net income per share:
Basic .......................................................... $ 0.08 $ 0.01
============= ============
Diluted ........................................................ $ 0.08 $ 0.01
============= ============
-15-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
9. NET INCOME PER SHARE - CONTINUED
Nine Months Ended
September 30,
-----------------------------
2001 2002
------------ ------------
Net income (numerator):
Net income used in computing basic and diluted net
income per share ............................................ $ 7,474 $ 5,505
============ ============
Shares (denominator):
Weighted average
Common Stock Outstanding ................................. 41,343,389 43,387,643
------------ ------------
Shares used in computing basic net income per share ......... 41,343,389 43,387,643
Dilutive effect of stock options outstanding using the
treasury stock method ....................................... 4,346,396 2,377,697
------------ ------------
Shares used in computing net income per share ............... 45,689,785 45,765,340
============ ============
Net income per share:
Basic ....................................................... $ 0.18 $ 0.13
============ ============
Diluted ..................................................... $ 0.16 $ 0.12
============ ============
As of September 30, 2001 and 2002, the Company had 2,434,520 and 8,100,297
options outstanding, respectively, which could have potentially diluted earnings
per share ("EPS") in the future, but which were excluded in the computation of
diluted EPS in these periods, as their exercise prices were above the average
market values in such periods.
10. ACQUISITION
On February 6, 2002, the Company completed the acquisition of Bonson. The
acquisition was accounted for as a purchase in accordance with SFAS No. 141,
"Business Combinations." Under the terms of the share purchase agreement, the
Company acquired all outstanding capital stock of Bonson for $32,763 in cash and
1,031,686 shares of the Company's common stock. The total purchase price as of
February 6, 2002 had been allocated to the assets acquired and liabilities
assumed based on their respective fair values as follows, (in thousands):
Total purchase price:
Cash consideration $32,763
Common stock 18,003
Acquisition expenses 624
-------
$51,390
=======
-16-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
10. ACQUISITION - CONTINUED
Purchase Price Allocation:
Fair market value of net tangible assets $10,627
acquired at February 6, 2002
Intangible assets acquired: Economic Life
---------------
Core technology 1,280 3.5 years
Trade name 700 Indefinite
Contract backlog 2,700 2 years
Favorable lease 400 2.1 years
License 700 Indefinite
In-process technology 350
Goodwill 35,067 Indefinite
Deferred tax liabilities (434)
-------
$51,390
=======
The Company recorded a one-time charge of $350 in the first quarter of 2002 for
purchased in-process technology related to a development project that had not
reached technological feasibility, had no alternative future use, and for which
successful development was uncertain. The conclusion that the in-process
development effort, or any material sub-component, had no alternative future use
was reached in consultation with the Company's and Bonson's management.
The following selected unaudited pro forma combined results of operations for
the three months and nine months ended September 30, 2001 and 2002 of the
Company and Bonson have been prepared assuming that the acquisitions occurred at
the beginning of the periods presented. The following pro forma financial
information is not necessarily indicative of the results that would have
occurred had the acquisition been completed at the beginning of the periods
indicated nor is it indicative of future operating results:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2001 2002 2001 2002
------------ ------------ ------------- -----------
Total revenue $ 98,615 $ 32,571 $ 168,939 $ 98,198
Net income 3,766 468 7,549 5,184
Net income per share
- Basic $ 0.09 $ 0.01 $ 0.18 $ 0.12
- Diluted $ 0.08 $ 0.01 $ 0.16 $ 0.11
Shares used in calculation of
net income per share
- Basic 42,788,936 44,081,170 42,375,075 43,669,661
- Diluted 46,190,942 44,835,907 46,721,471 46,047,359
The pro forma results of operations give effect to certain adjustments,
including amortization of purchased intangibles with definite lives, associated
with the acquisition. The charge for purchased in-process research and
development of $350 has been excluded from the pro forma results, as it is a
material non-recurring charge.
-17-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
11. SEGMENT INFORMATION
Information on the Company's operating segments is as follows:
Three Months Ended September 30,
(unaudited)
-----------------------------------------------------------------
2001/1/ 2002
---------- -----------------------------------------------------
Strategic Business Units and Product Offerings
-----------------------------------------------------
Operation Network
Support Security
Communications System Solutions
Solutions Solutions (Marsec) Total
---------------- ----------- ------------ -------
Revenues net of hardware cost:
Network solutions net of hardware cost .......... $12,437 $ 4,299 $ 1,007 $ 308 $ 5,614
Software ........................................ 7,708 1,651 7,422 - 9,073
------- ----------- --------- --------- -------
Consolidated revenues net of hardware cost ...... 20,145 5,950 8,429 308 14,687
Consolidated cost of sales net of
hardware cost ................................. 4,605 2,076 3,896 215 6,187
------- ----------- --------- --------- -------
Consolidated gross profit ....................... $15,540 $ 3,874 $ 4,533 $ 93 $ 8,500
======= =========== ========= ========= =======
Gross profit:
Network solutions ............................... $ 8,674 $ 2,581 $ 804 $ 93 $ 3,478
Software ........................................ 6,866 1,293 3,729 - 5,022
------- ----------- --------- --------- -------
Consolidated gross profit ....................... $15,540 $ 3,874 $ 4,533 $ 93 $ 8,500
======= =========== ========= ========= =======
Depreciation and amortization:
Network solutions ............................... $ 506 $ 225 $ 53 $ 34 $ 312
Software ........................................ 313 87 389 - 476
------- ----------- --------- --------- -------
$ 819 $ 312 $ 442 $ 34 $ 788
======= =========== ========= ========= =======
Amortization of deferred stock compensation:
Network solutions ............................... $ 106 $ 29 $ 5 $ - $ 34
Software ........................................ 110 11 37 - 48
------- ----------- --------- --------- -------
$ 216 $ 40 $ 42 $ - $ 82
======= =========== ========= ========= =======
Amortization of acquired intangible assets:
Network solutions ............................... $ - $ - $ 57 $ - $ 57
Software ........................................ - - 420 - 420
------- ----------- --------- --------- -------
$ - $ - $ 477 $ - $ 477
======= =========== ========= ========= =======
Income from operations:
Network solutions ............................... $ 2,446 $ (98) $ 278 $ (248) $ (68)
Software ........................................ 1,061 264 (153) - 111
------- ----------- --------- --------- -------
Consolidated income from operations ............. $ 3,507 $ 166 $ 125 $ (248) $ 43
======= =========== ========= ========= =======
-18-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
11. SEGMENT INFORMATION - CONTINUED
Nine Months Ended September 30,
(unaudited)
---------------------------------------------------------------------
2001/1/ 2002
---------- ---------------------------------------------------------
Strategic Business Units and Product Offerings
---------------------------------------------------------
Operation Network
Support Security
Communications System Solutions
Solutions Solutions (Marsec) Total
----------------- ----------- ------------ ---------
Revenues net of hardware cost:
Network solutions net of hardware cost ........... $30,021 $ 20,145 $ 5,354 $ 1,214 $26,713
Software ......................................... 21,357 3,676 20,985 - 24,661
------- --------- --------- -------- -------
Consolidated revenues net of hardware cost ....... 51,378 23,821 26,339 1,214 51,374
Consolidated cost of sales net of
hardware cost .................................. 11,210 9,161 8,727 660 18,548
------- --------- --------- -------- -------
Consolidated gross profit ........................ $40,168 $ 14,660 $ 17,612 $ 554 $32,826
======= ========= ========= ======== =======
Gross profit:
Network solutions ................................ $21,376 $ 12,377 $ 4,240 $ 554 $17,171
Software ......................................... 18,792 2,283 13,372 - 15,655
------- --------- --------- -------- -------
Consolidated gross profit ........................ $40,168 $ 14,660 $ 17,612 $ 554 $32,826
======= ========= ========= ======== =======
Depreciation and amortization:
Network solutions ................................ $ 1,431 $ 858 $ 228 $ 84 $ 1,170
Software ......................................... 1,017 156 893 - 1,049
------- --------- --------- -------- -------
$ 2,448 $ 1,014 $ 1,121 $ 84 $ 2,219
======= ========= ========= ======== =======
Amortization of deferred stock compensation:
Network solutions ................................ $ 464 $ 151 $ 31 $ - $ 182
Software ......................................... 473 28 122 - 150
------- --------- --------- -------- -------
$ 937 $ 179 $ 153 $ - $ 332
======= ========= ========= ======== =======
Amortization of acquired intangible assets:
Network solutions ................................ $ - $ - $ 259 $ - $ 259
Software ......................................... - - 1,013 - 1,013
------- --------- --------- -------- -------
$ - $ - $ 1,272 $ - $ 1,272
======= ========= ========= ======== =======
Income from operations:
Network solutions ................................ $ 4,196 $ 2,029 $ 1,265 $ (432) $ 2,862
Software ......................................... 1,048 394 1,714 - 2,108
------- --------- --------- -------- -------
Consolidated income from operations .............. $ 5,244 $ 2,423 $ 2,979 $ (432) $ 4,970
======= ========= ========= ======== =======
/1/ No strategic business unit and product offering information available for
2001.
-19-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
12. COMMITMENTS AND CONTINGENCIES
On December 4, 2001, a securities class action suit was filed in the United
States against the Company, certain of the Company's directors and the co-lead
underwriters involved in the Company's Initial Public Offering (the "IPO") on
behalf of all persons and entities who purchased, converted, exchanged or
otherwise acquired the common stock of the Company between March 2, 2000 and
December 6, 2000, inclusive. The complaint alleges that the Company and certain
of its officers and directors at the time of the IPO violated the federal
securities laws by issuing and selling the Company's common stock pursuant to
the IPO without disclosing to investors that several of the underwriters of the
IPO had solicited and received excessive and undisclosed commissions from
certain investors. The plaintiffs seek class action certification and claim for
an unspecified amount of damages. While the outcome of this litigation is
uncertain, management believes that the Company has meritorious defenses to the
suit and intends to vigorously defend the action. In addition, management
believes that the co-lead underwriters may have an obligation to indemnify the
Company for the legal fees and other costs of defending this suit and that the
Company's directors' and officers' liability insurance policies may also cover
the defense and exposure or settlement of the suit. On October 9, 2002, the
United States District Court for the Southern District of New York dismissed
without prejudice all claims against the individual defendants in the litigation
(Louis Lau, Chairman of the Board, James Ding, President and Chief Executive
Officer and Ying Han, Chief Financial Officer). The dismissals were based on
stipulations signed by those defendants and the plaintiffs' representatives. The
case remains pending against the Company.
13. RELATED PARTY TRANSACTION
On May 16, 2002, China Merchants Bank, Beijing Branch ("Merchants Bank") entered
into an agreement to provide a revolving credit facility to China Netcom
Corporation Ltd. ("China Netcom") of up to approximately $9,061 in connection
with China Netcom's past and future purchases of telecommunications network
infrastructure software and solutions from AsiaInfo Technologies. China Netcom
may draw on the facility to fund amounts that will become payable to AsiaInfo
Technologies under bankers' acceptances. AsiaInfo Technologies has guaranteed
China Netcom's obligations to Merchants Bank under the facility. The facility
will expire on May 16, 2003. Edward Tian, a director and major shareholder of
the Company, is the Chief Executive Officer of China Netcom, as well as a Vice
President of China Netcom's parent company, China Netcom Communication Group
Corporation.
-20-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for historical information, the statements contained in this Quarterly
Report on Form 10-Q are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. The Private Securities Litigation Reform Act of 1995 (the "Reform Act")
contains certain safe harbors regarding forward-looking statements. Certain of
the forward-looking statements include management's expectations, intentions and
beliefs with respect to our growth, our operating results, the nature of the
industry in which we are engaged, our business strategies and plans for future
operations, our needs for capital expenditures, capital resources and liquidity;
and similar expressions concerning matters that are not historical facts. Such
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those expressed in the
statements. All forward-looking statements included in this document are based
on information available to us on the date hereof, and we assume no obligation
to update any such forward-looking statements. These cautionary statements are
being made pursuant to the provisions of the Reform Act with the intention of
obtaining the benefits of the safe harbor provisions of the Reform Act. Among
the factors that could cause actual results to differ materially are the factors
discussed below under the heading "Factors Affecting our Operating Results and
our Common Stock."
OVERVIEW
We are a leading provider of telecommunications software solutions in China. Our
software products and network services enable our customers to build, maintain,
operate, manage and continuously improve their Internet and telecommunications
infrastructure.
We commenced our operations in Texas in 1993 and moved our operations from Texas
to China in 1995. We began generating significant network solutions revenues in
1996 and significant software solutions revenues in 1998. We conduct the bulk of
our business through our wholly-owned operating subsidiaries, AsiaInfo
Technologies (China) Inc., or AsiaInfo Technologies, and Guangzhou Bonson
Technology Limited, or Guangzhou Bonson, which are both Chinese companies.
We believe that there are opportunities for us to expand into new business areas
and to grow our business both organically and through acquisitions. On February
6, 2002, we completed our acquisition of Bonson Information Technology Holdings
Limited, or Bonson, a leading provider of operation support system solutions to
wireless telecommunications carriers in China through its operating subsidiary,
Guangzhou Bonson. The consideration paid to the former shareholders of Bonson
consisted of $32.76 million in cash and 1,031,686 shares of our common stock
which were valued at approximately $18 million at the time the acquisition was
announced. The cash we paid in connection with the acquisition was paid out of
our existing cash reserves. Bonson's operating results have been consolidated
with our operating results from February 6, 2002. In view of the Bonson
acquisition and potential future acquisitions we may engage in, our historical
operating results may not be an adequate basis on which to evaluate our
prospects.
We had invested a total of $2.7 million in our majority-owned network security
business, Marsec System Inc., or Marsec, which focuses on high-end security
-21-
services for our customers. Marsec's operating results are consolidated with our
operating results, with a provision for minority interest.
On April 27, 2001, we invested approximately $6.2 million to acquire a 14.25%
equity interest in Intrinsic Technology (Holdings), Ltd., or Intrinsic, a
company organized in the Cayman Islands and engaged in wireless Internet
application and development through its two wholly-owned subsidiaries in China.
We account for our interest in Intrinsic using the equity method.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period. On an
on-going basis, we evaluate our estimates and judgments, including those related
to revenues and cost of revenues under customer contracts, warranty obligations,
bad debts, income taxes, investment in affiliate, goodwill and other intangible
assets, and litigation. We base our estimates and judgments on historical
experience and on various other factors that we believe are reasonable. Actual
results may differ from these estimates under different assumptions or
conditions.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
REVENUES AND COST OF REVENUES. We derive a significant portion of our revenue
from fixed-price contracts using the percentage of completion method, which
relies on estimates of total expected contract revenue and costs. We follow this
method since reasonably dependable estimates of the revenue and costs applicable
to various stages of a contract can be made. Recognized revenues and profit are
subject to revisions as the contract progresses to completion. Accordingly,
changes in our estimates would impact our future operating results.
WARRANTY OBLIGATIONS. We record our estimate of warranty costs at the time of
final project acceptance, when all hardware pass-through revenue has been
recognized. Revisions for estimated warranties may be required in the period in
which actual warranties are known, thereby impacting our future operating
results.
BAD DEBTS. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the
financial condition of our customers were to change, changes to these allowances
may be required, which would impact our future operating results.
INCOME TAXES. We record a valuation allowance to reduce our deferred tax assets
to the amount that we believe is more likely than not to be realized. In the
event we were to determine that we would be able to realize our deferred tax
assets in the future in excess of their recorded amount, an adjustment to the
deferred tax asset would increase income in the period such determination was
made. Likewise, should we determine that we would not be able to realize all or
part of our net deferred tax asset in the future, an adjustment to the deferred
tax asset would be charged to income in the period such determination is made.
-22-
INVESTMENT IN AFFILIATE. We account for our 14.25% interest in Intrinsic using
the equity method. Intrinsic has incurred operating losses since our investment
in April 2001. Sustained operating losses of this affiliate or other adverse
events could result in our inability to recover the carrying value of the
investment, which may require us to record an impairment charge in the future.
Through September 30, 2002, we have not recorded an impairment charge for this
investment. In accordance with applicable accounting principles, we will conduct
an asset impairment test in the fourth quarter of 2002 in connection with our
private equity investments. This will include our 14% interest in Intrinsic
which is recorded on our balance sheet as an "investment in affiliate" of $4.9
million as of the end of the third quarter. We will report our findings at the
fourth quarter earnings announcement.
GOODWILL AND OTHER INTANGIBLE ASSETS. We make assumptions regarding estimated
future cash flows and other factors to determine the fair value of goodwill and
other intangible assets. If these estimates or their related assumptions change
in the future, we may be required to record an impairment charge if the
estimated fair value of goodwill and other intangible assets is less than its
recorded amount. As required under Statement of Financial Accounting Standards
No. 142, we have completed a transitional goodwill impairment test and have
concluded that no impairment of recorded goodwill was necessary as of January 1,
2002.
LITIGATION. We record contingent liabilities relating to litigation or other
loss contingencies when we believe that the likelihood of loss is probable and
the amount of the loss can reasonably be estimated. Changes in judgments of
outcome and estimated losses are recorded, as necessary, in the period such
changes are determined or become known. Any changes in estimates would impact
our future operating results. Significant contingent liabilities, which we
believe are at least possible, are disclosed in the notes to our consolidated
financial statements.
REVENUES
Currently, our operations are organized into two strategic business units:
communications solutions and operation support system solutions. Communications
solutions and operation support system solutions comprise two of our core
solutions offerings. We also offer our customers service application solutions
(through our communications solutions business unit) and network security
solutions (through our majority-owned subsidiary, Marsec). In deciding how to
allocate our company's resources and assess performance, we frequently evaluate
the separate operating results of our two strategic business units and Marsec.
However, we also rely extensively in this process on our evaluation of the two
primary types of revenue derived from our business: network solutions revenue
and software solutions revenue (each described in greater detail below).
Although both of our strategic business units generate network solutions revenue
and software solutions revenue, the communications solutions business unit
generates a majority of our total network solutions revenues, while the
operation support system solutions business unit generates a majority of our
total software solutions revenue. The following table illustrates our revenue
breakdown both in terms of our strategic business units (communications
solutions, operation support system solutions and network security solutions),
and in terms of our two principal types of revenue (network solutions and
software solutions):
-23-
THREE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------------------
STRATEGIC BUSINESS UNITS AND PRODUCT OFFERINGS
---------------------------------------------------------
Operation Network
Support Security
Communications System Solutions
BUSINESS LINE Solutions Solutions (Marsec) Total
- ------------- -------------- ------------ ------------- -------------
Network solutions net of
hardware costs ........................... $4,299,234 $1,006,812 $308,050 $ 5,614,096
Software solutions ....................... 1,650,662 7,422,659 - 9,073,321
---------- ---------- -------- -----------
Total revenues net of hardware costs ..... $5,949,896 $8,429,471 $308,050 $14,687,417
========== ========== ======== ===========
Although we account for our network solutions revenues on a gross basis,
inclusive of hardware acquisition costs that are passed through to our
customers, we manage our business internally based on revenues net of hardware
costs, which is consistent with our strategy of providing our customers with
high value IT professional services while gradually outsourcing lower-end
services such as hardware acquisition and installation. This strategy may result
in lower growth rates for total revenues as against prior periods, but will not
adversely impact revenues net of hardware costs. The following table shows our
revenue breakdown on this basis:
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
------------------------- ------------------------------------------------
2002 2001 2001 2000 1999 1998 1997
--------- ----------- -------- ------- -------- -------- ---------
Network solutions net of hardware
costs .................................. 52% 58% 61% 61% 74% 88% 93%
Software solutions ....................... 48% 42% 39% 39% 26% 12% 7%
--------- --------- -------- ------- -------- -------- ---------
Total revenues net of hardware costs ..... 100% 100% 100% 100% 100% 100% 100%
========= ========= ======== ======= ======== ======== =========
As demonstrated by the foregoing table, software solutions revenue has accounted
for an increasing portion of our total revenue net of hardware costs over the
past several years, increasing from 7% in 1997 to 39% in 2001 and 48% for the
first three quarters of 2002. We anticipate that software solutions revenue will
account for approximately 40% to 42% of our total net revenues for 2002.
REVENUE BACKLOG. Most of our revenues are derived from customers' orders under
separate binding contracts for hardware, network services, and software products
and services. These contracts constitute our backlog at any given time. Revenues
for hardware, network solutions and software solutions are recognized during the
course of the relevant project, as described in more detail below. At September
30, 2002, our revenue backlog net of hardware
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costs was $41.3 million, a 12% decrease compared to backlog one year ago. The
decrease in total net revenue backlog was primarily due to the prolonged delays
in the restructuring of certain state-controlled telecommunications companies in
China, including China Telecommunications Corporation, or China Telecom, causing
the carriers to delay their orders longer than previously expected. Software
solutions backlog was $19.0 million, or 46% of net revenue backlog, a 13%
increase over the period a year ago. Orders under contracts generated by Bonson
accounted for 23% of the total backlog net of hardware costs and 34% of software
solutions backlog. The software services component of net revenue backlog
increased by 61% year-over-year while the hardware margin (derived from our
hardware sales to customers as part of our services) component decreased 37%
over the same period. We believe that these changes illustrate our successful
transition from a pure systems integration company to a provider of total
software solutions to China's telecommunications service providers.
NETWORK SOLUTIONS REVENUE. Network solutions revenue consists of hardware sales
for equipment procured by us on behalf of our customers from hardware vendors,
as well as services for planning, design, systems integration and training. We
procure for and sell hardware to our customers as part of our total solutions
strategy. We minimize our exposure to hardware risks by sourcing equipment from
hardware vendors against letters of credit from our customers. We believe that
as the telecommunications-related market in China develops our customers will
increasingly purchase hardware directly from hardware vendors and hire us for
our professional services.
We generally charge a fixed price for network solutions projects and recognize
revenue based on the percentage of completion of the project. We use labor costs
and direct project expenses to determine the stage of completion, except for
revenue associated with the procurement of hardware on behalf of the customer.
We recognize such hardware-related revenues upon delivery. Since a large part of
the cost of a network solutions project often relates to hardware, the timing of
hardware delivery can cause our quarterly gross revenue to fluctuate
significantly. However, these fluctuations do not significantly affect our gross
profit because hardware-related revenues generally approximate the costs of the
hardware.
Network solutions projects generally have a life of nine to twelve months,
during which there are three key milestones. The first milestone occurs when the
hardware is delivered, which is usually between three and four months after
signing the contract. The second milestone in a network solutions project is at
primary acceptance, which usually occurs around three to four months after
hardware delivery. At primary acceptance, all services and products are
delivered. The third milestone is final acceptance, which occurs when the
customer agrees that we have satisfactorily completed all of our work on the
project.
SOFTWARE SOLUTIONS REVENUE. Software solutions revenues include two types of
revenues: software license revenue and software services revenue. Software
license revenue consists of fees received from customers for licenses to use our
software products in perpetuity, typically up to a specified maximum number of
users. In most cases, our customers must purchase additional user licenses from
us when the number of users exceeds the specified maximum. Our software license
revenue also includes the benefit of value added tax rebates on software license
sales, which are part of the Chinese government's policy of encouraging China's
software industry. Software services revenue consists of revenue from software
installation, customization, training and other services. To date, substantially
all of our revenue from both software
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licenses and software services has been derived from customer orders for
projects requiring some modifications or customization of our software. We
recognize substantially all software revenue over the installation and
customization periods, based on the percentage of completion of the related
project as measured by labor costs and direct project expenses.
UNBILLED REVENUE. The foregoing network solutions and software solutions revenue
recognition policies result in our recognizing certain revenues even though we
are not due to receive the corresponding cash payment under the relevant
contract. In the case of hardware sales, the customer typically holds back
around 10 to 20% of the hardware contract payments at the time of delivery until
final project acceptance. Although we record all hardware revenue at the time of
delivery, the 10 to 20% held back by the customer is recorded as unbilled
receivables and does not become billable until final project acceptance.
In the case of services, most of the revenue becomes billable at the time of
primary acceptance, but the customer typically holds back around 10 to 20% of
the services and software contract payments until final acceptance. Unpaid
amounts for services, as well as for hardware, become payable at the time of
final project acceptance. When we recognize revenue for which payments are not
yet due, we book unbilled accounts receivable until the corresponding amounts
become billable.
COST OF REVENUES
NETWORK SOLUTIONS COSTS. Network solutions costs consist primarily of third
party hardware costs, compensation and travel expenses for the professionals
involved in designing and implementing projects, and hardware warranty costs. We
recognize hardware costs in full upon delivery of the hardware to our customers.
In order to minimize our working capital requirements, we generally obtain from
our hardware vendors payment terms that are timed to permit us to receive
payment from our customers for the hardware before our payments to hardware
vendors are due. However, in large projects we sometimes obtain less favorable
payment terms from our customers, thereby increasing our working capital
requirements. We accrue hardware warranty costs when hardware revenue is fully
recognized upon final acceptance. We obtain manufacturers' warranties for
hardware we sell, which cover a portion of the warranties that we give to our
customers. We currently accrue 0.5% of hardware sales to cover potential
warranty expenses. This estimate of warranty cost is based on our current
experience with contracts for which the warranty period has expired.
SOFTWARE SOLUTIONS COSTS. Software solutions costs consist primarily of three
components:
.. packaging and written manual expenses for our proprietary software
products;
.. compensation and travel expenses for the professionals involved in
modifying, customizing or installing our software products and in providing
consultation, training and support services; and
.. software license fees paid to third-party software providers for the right
to sublicense their products to our customers as part of our solutions
offerings.
The costs associated with creating and enhancing our proprietary software are
classified as research and development expenses as incurred.
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OPERATING EXPENSES
Operating expenses are comprised of sales and marketing expenses, research and
development expenses, general and administrative expenses, and amortization
expenses for intangible assets and deferred stock compensation.
Operating expenses consist primarily of compensation expenses. Recently, in an
effort to scale our business to accommodate lower market demand, we have reduced
these costs through a 10% headcount reduction and a 10% salary cut for employees
at the manager level and above.
Research and development expenses relate almost entirely to the development of
new software and the enhancement and upgrading of existing software. We expense
these costs as they are incurred.
We provide most of our officers, employees and directors, with stock options. In
the past, we granted a number of options with exercise prices below the fair
market value of the related shares at the time of grant, resulting in our
incurring deferred compensation expenses. Most of the options granted with
exercise prices below fair market value on the date of grant were issued prior
to 1997. We do not, however, intend to issue options below fair market value in
the future. Therefore, our deferred compensation expenses have been
significantly higher historically than we expect them to be in future years. The
difference between the exercise price and the fair market value of the related
shares is amortized over the vesting period of the options and reflected on our
income statement as amortization of deferred stock compensation. For further
information, please see note 15 to our consolidated financial statements for the
year ended December 31, 2001, included in our annual report on Form 10-K, filed
with the Securities and Exchange Commission on March 22, 2002.
We make bad debt provisions for accounts receivable balances based on
management's assessment of their recoverability. In any event, we make bad debt
provisions for all accounts receivable balances that are aged over one year. We
include those bad debt provisions in general and administrative expenses.
TAXES
Except for certain of our hardware procurement and resale transactions, we
conduct substantially all of our business through our Chinese operating
subsidiaries. Our Chinese subsidiaries are generally subject to a 30% state
corporate income tax and a 3% local income tax. AsiaInfo Technologies, our
principal operating subsidiary, is classified as a "foreign invested enterprise"
and as a "high technology" company for purposes of Chinese tax law and, as such,
is entitled to preferential tax treatment in China. AsiaInfo Technologies
operated free of Chinese state corporate income tax for three years, beginning
with its first year of operation, and was entitled to a 50% tax reduction for
the subsequent three years. The tax holiday for AsiaInfo Technologies expired on
December 31, 1997 and the 50% tax reduction expired on December 31, 2000.
However, AsiaInfo Technologies received a continuation of its preferential tax
treatment from the local tax authorities in China for an additional three years,
expiring at the end of 2003, which reduces our effective income tax rate to not
less than 10%. In 2002, we anticipate that the effective corporate income tax
rate applicable to AsiaInfo Technologies will be 10%.
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AsiaInfo Technologies (Chengdu), Inc., or AsiaInfo Chengdu, our subsidiary which
sources hardware in China for our customers, is classified as a "foreign
invested enterprise" in China. AsiaInfo Chengdu operates free of Chinese state
and local corporate income tax for two years beginning from its first year of
operation, and is entitled to a 50% tax reduction for the subsequent three
years. As such, the tax holiday for AsiaInfo Chengdu will expire on December 31,
2003 and the 50% tax reduction will expire on December 31, 2006.
Guangzhou Bonson is classified as a "foreign invested enterprise" and as a "high
technology" company for purposes of Chinese tax laws. Guangzhou Bonson operated
free of Chinese state and local corporate income tax for two years, beginning
with its first year of operation, and is entitled to a 50% tax reduction for the
subsequent three years. The tax holiday for Guangzhou Bonson expired on December
31, 2001 and the 50% tax reduction will expire on December 31, 2004. In 2002,
the current corporate income tax rate for Guangzhou Bonson is 7.5%.
Sales of hardware procured in China are primarily made through AsiaInfo Chengdu
and are subject to a 17% value added tax. Most of our sales of hardware procured
outside China are made through our Hong Kong subsidiary, AsiaInfo H.K. Limited,
or AsiaInfo H.K., and thus are not subject to the value added tax. We
effectively pass value-added taxes on hardware sales through to our customers
and do not include them in revenues reported in our financial statements. Sales
of software in China are subject to a 17% value added tax. However, for
companies that develop their own proprietary software, a value added tax refund
is available. If the net amount of the value added tax payable exceeds 3% of
software sales, the excess portion of the value added tax is refundable
immediately. This policy is effective until 2010. Changes in Chinese tax laws
may adversely affect our future operations.
We are also subject to U.S. income taxes on revenues generated in the U.S.,
including revenues from our limited hardware procurement activities through our
U.S. parent company and interest income earned in the U.S.
FOREIGN EXCHANGE
A majority of our revenues and expenses relating to hardware sales are
denominated in U.S. dollars, and substantially all of our revenues and expenses
relating to the service component of our network solutions business and software
business are denominated in Renminbi. Although, in general, our exposure to
foreign exchange risks should be limited, the value of our shares will be
affected by the foreign exchange rate between U.S. dollars and Renminbi because
the value of our business is effectively denominated in Renminbi, while our
shares are traded in U.S. dollars. Furthermore, a decline in the value of
Renminbi could reduce the U.S. dollar equivalent of the value of the earnings
from, and our investment in, our subsidiaries in China.
CONSOLIDATED RESULTS OF OPERATIONS
REVENUES. Gross revenues were $32.6 million and $97.7 million, respectively, in
the three- and nine-month periods ended September 30, 2002, representing
decreases of 65% and 35%, respectively, against the comparable periods in 2001.
These decreases are primarily attributable to a shift in our customer's focus
from increasing network capacity to increasing network productivity through the
provision of more advanced applications.
Revenues net of hardware costs were $14.7 million and $51.4 million,
respectively, in the three- and nine-month periods ended September 30, 2002,
representing a decrease of 27% compared to the three-month period ended
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September 30, 2001 and remaining relatively unchanged as compared to the
nine-month period ended September 30, 2001. Total software revenues were $9.1
million and $24.7 million, respectively, in the three- and nine-month periods
ended September 30, 2002, representing increases of 18% and 15%, respectively,
over the comparable periods in 2001. Bonson contributed 34% to this quarter's
total revenue net of hardware costs and 40% of software solutions revenue. As
compared to the preceding quarter, software solutions revenues were up 3% and
total net revenues were down approximately 25%. The year-over-year and
sequential decrease in total net revenues was primarily attributable to the
prolonged telecommunications industry restructuring in China. We expect further
delays in order decisions from our major customers, affecting both our network
solutions revenues and our software solutions revenues. We expect our net
revenue to be approximately $12 million to $13 million for the fourth quarter of
2002 and in the range of $63.4 million to $64.4 million for the full year 2002,
in line with our earnings guidance of July 23, 2002.
COST OF REVENUES. Our cost of revenues decreased 69% to $24.1 million and 42% to
$64.8 million, respectively, in the three- and nine-month periods ended
September 30, 2002, as compared to the same periods in 2001. These decreases in
costs of revenues are attributable to lower hardware pass through costs in the
third quarter of 2002 as compared to the third quarter of 2001 when we made a
major hardware delivery in connection with a backbone project for China Unicom.
GROSS PROFIT. Gross profit was $8.5 million and $32.8 million, respectively, in
the three- and nine-month periods ended September 30, 2002, representing
decreases of 45% and 18%, respectively, against the comparable periods in 2001.
Gross profit as a percentage of gross revenues, or gross margin, increased to
26% and 34%, respectively, in the three- and nine-month periods ended September
30, 2002, as compared to 17% and 27%, respectively, in the comparable periods of
2001. These increases in gross margin are primarily attributable to the smaller
amount of low margin hardware pass through revenue recognized in the relevant
periods of 2002. Gross profit as a percentage of net revenues decreased to 58%
and 64%, respectively, in the three- and nine-month periods ended September 30,
2002, as compared to 77% and 78%, respectively, in the comparable periods of
2001.
OPERATING EXPENSES. Total operating expenses decreased 30% and 20%,
respectively, to $8.5 million and $27.9 million, respectively, in the three- and
nine-month periods ended September 30, 2002, from $12.0 million and $34.9
million, respectively, in the comparable periods in 2001. These decreases
resulted from cost cutting measures implemented during the third quarter,
including a 10% headcount decrease and a 10% salary cut for employees at the
manager level and above. We expect to continue to maintain tight cost controls
in the coming quarters.
Sales and marketing expenses decreased 51% and 36%, respectively, to $3.1
million and $11.5 million, respectively, in the three- and nine-month periods
ended September 30, 2002 against the comparable periods in 2001. This decrease
was attributable to reductions in staff, reduced efforts in international and
channel sales, and tighter control of our marketing expenses.
General and administrative expenses decreased 23% and 28%, respectively, to $2.7
million and $7.7 million, respectively, in the three- and nine-month periods
ended September 30, 2002, against the comparable periods in 2001. We plan to
continue to reduce general and administrative expenses as part of our
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cost cutting efforts.
Research and development expenses increased 8% and 21%, respectively, to $2.1
million and $6.7 million, respectively, in the three- and nine-month periods
ended September 30, 2002, against the comparable periods in 2001, due to our
increased focus on developing new products and solutions for China's telecom
carriers, such as advanced operation support systems solutions.
We recognized a charge of $0.48 million for amortization of intangible assets in
the third quarter of 2002 related to our acquisition of Bonson. As a result of
that acquisition, we will amortize a total of $4.4 million in intangible assets
over a period of two to three and a half years, $1.7 million of which will be
amortized in 2002.
INCOME FROM OPERATIONS. Our operating income for the quarter decreased 99% to
$43,000 and 5% to $5.0 million, respectively, in the three- and nine-month
periods ended September 30, 2002, against the comparable periods in 2001. As
compared to the preceding quarter, operating income decreased 99%. This decrease
in profitability was attributable to our decrease in revenue and the partially
fixed nature of our cost structure. The Bonson acquisition contributed 54% of
our operating profit for the quarter. We expect operating profit for the year
2002 to be in the range of $4 million to $6 million.
OTHER INCOME (EXPENSE). Other income (expenses), consisting primarily of net
interest income and expense, decreased from income (expense) of approximately
$1.4 million and $5.3 million, respectively, in the three- and nine-month
periods ended September 30, 2001 to income of $0.53 million and $1.7 million,
respectively, in the three- and nine-month periods ended September 30, 2002,
primarily due to a decrease in interest rates and our having less cash invested
in interest bearing investments.
EQUITY IN LOSS OF AFFILIATE. In the three- and nine-month periods ended
September 30, 2002, equity in loss of affiliate of approximately $0.1 million
and $0.38 million, respectively, represented our proportionate share of the loss
incurred by Intrinsic. In accordance with applicable accounting standards, we
will conduct an asset impairment test of this investment in the fourth quarter.
NET INCOME. We recorded net income of $0.47 million, or $0.01 basic earnings per
share, for the quarter ended September 30, 2002 and net income of $5.5 million,
or $0.13 basic earnings per share, for the nine-month period ended September 30,
2002. This represents decreases of 87% as compared to the quarter ended
September 30, 2001, 26% as compared to the nine-month period ended September 30,
2001 and 87% as compared to the second quarter of 2002. Bonson contributed 10%
of total net income this quarter. We expect net income to be between $0 and $0.5
million, or equal $0.0 to $0.01 per basic share, for the fourth quarter of 2002
and approximately $5.5 million to $6 million, or $0.12 to $0.13 per basic share,
for the year 2002.] This is in line with our earnings guidance of July 23, 2002.
LIQUIDITY AND CAPITAL RESOURCES
Our capital requirements are primarily working capital requirements related to
hardware sales and costs associated with the expansion of our business, such as
research and development and sales and marketing expenses. We recognize hardware
costs in full upon delivery of the hardware to our customers. In order to
minimize our working capital requirements, we generally obtain from our hardware
vendors payment terms that are timed to permit us to receive
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payment from our customers for the hardware before our payments to hardware
vendors are due. However, we sometimes obtain less favorable payment terms from
our customers, thereby increasing our working capital requirements. See "Factors
Affecting our Operating Results and our Common Stock - Our working capital
requirements may increase significantly." We have historically financed our
working capital and other financing requirements through careful management of
our billing cycle, private placements of equity securities, our initial public
offering in March of 2000 and, to a limited extent, bank loans.
Our accounts receivable balance at September 30, 2002 was $62.6 million,
consisting of $26.3 million in billed receivables and $36.3 million in unbilled
receivables. Our billed receivables are based on revenue we have booked and
billed. Our unbilled receivables are based on revenue we have booked through the
percentage completion method, but for which we have not yet billed the customer.
For example, we recognize revenues for hardware pass-through at the time the
hardware is accepted by the customer, based on the cost of the underlying
hardware. However, our contracts with our customers will often allow the
customers to withhold 10-20% of the total contract payments until final project
acceptance, which on average is eight to nine months after hardware delivery. As
a result, revenues from hardware pass-through generally represent a significant
portion of our unbilled receivables and can cause the aging of these receivables
to be relatively long.
At the end of the third quarter of 2002, our days sales outstanding were 173
days, as compared to 205 days as of the end of the second quarter. Our billed
receivables were 73 days sales outstanding and our unbilled receivables were 100
days sales outstanding. The improvement in our days sales outstanding as
compared to the end of the second quarter is primarily attributable to improved
collection efforts and the increasing contribution of software solutions revenue
to total net revenue.
As of September 30, 2002, we had total short-term credit facilities totaling $23
million, expiring in October, 2002 and October, 2003, for working capital
purposes, of which unused short-term credit facilities were $21.7 million and
$1.3 million had been used to issue letters of credit. In addition to the
short-term credit facilities, we had short-term borrowings in Renminbi of $0.072
million as of September 30, 2002 for Bonson's working capital purposes, secured
by Bonson's assets. The Renminbi loan bears interest at a rate of 4.8% per annum
and is repayable upon demand by the lending bank. Bank deposits pledged as
security for these credit facilities and bank loans, issuing letters of credit,
and short-term credit facilities totaled $14.5 million as of September 30, 2002,
and are presented as restricted cash in our consolidated balance sheets.
We ended the quarter with a cash position of $136.7 million, of which $4.0
million was in short term investments, $14.4 million was in restricted cash and
$118.3 million of which was in cash and cash equivalents. The $14.4 million in
restricted cash consists of $10 million used to secure our $20 million credit
facility, $4.0 million pledged as security for issuing a standby letter of
credit and $0.4 million held by Bonson and pledged as security for a bank
guarantee. Our short-term investments feature fixed income, liquidity and low
risk. The cash equivalents include investments in cash management accounts to
enhance our interest income. We had net cash inflow of $7.6 million for the
third quarter, primarily attributable to our improved collection efforts.
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We anticipate that the net proceeds of our initial public offering in March
2000, together with available funds and cash flows generated from operations,
will be sufficient to meet our anticipated needs for working capital, capital
expenditures and business expansion through 2003. We may need to raise
additional funds in the future, however, in order to fund acquisitions, develop
new or enhanced services or products, respond to competitive pressures to
compete successfully for larger projects involving higher levels of hardware
purchases, or if our business otherwise grows more rapidly than we currently
predict. If we do need to raise additional funds, we expect to raise those funds
through new issuances of shares of our equity securities in one or more public
offerings or private placements, or through credit facilities extended by
lending institutions.
In the event that we decide to pay dividends to our shareholders, our ability to
pay dividends will depend in part on our ability to receive dividends from our
operating subsidiaries in China. Foreign exchange and other regulations in China
may restrict our ability to distribute retained earnings from our operating
subsidiaries in China or convert those payments from Renminbi into foreign
currencies.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires, among other things, the discontinuance of goodwill amortization.
Effective January 1, 2002, we discontinued amortization of existing goodwill of
approximately $7.1 million, which arose from the acquisition of Zhejiang
AsiaInfo Telecommunication Technology Co., Ltd. in April 1999 and our investment
in Intrinsic in April 2001. In addition, the standard includes provisions for
the reclassification of certain existing recognized intangibles, reassessment of
the useful lives of existing recognized intangibles, reclassification of certain
intangibles out of previously reported goodwill and the identification of
reporting units for purposes of assessing potential future impairment of certain
intangible assets, including goodwill. See Note 4 to our Financial Statements
included in this Report for a summary of the effects of adopting the
non-amortization provisions of SFAS No. 142, assuming these provisions were
adopted as of January 1, 2001. SFAS No. 142 also requires us to complete a
transitional goodwill impairment test six months from the date of adoption. We
completed the transitional goodwill impairment test and concluded that no
impairment of recorded goodwill was necessary as of January 1, 2002.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations," which addresses accounting for
the recognition of obligations associated with the retirement of tangible
long-lived assets. SFAS No. 143 is effective for financial statements issued for
years beginning after June 15, 2002. We do not believe that the adoption of SFAS
Nos. 143 will have a significant impact on our financial position or results of
operations.
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses the financial accounting and reporting requirements for the impairment
or disposal of long-lived assets and discontinued operations. SFAS No. 144
applies to all recorded long-lived assets that are held for use or that will be
disposed of, but excludes goodwill and other intangible assets that are not
amortized. We adopted SFAS No. 144 on January 1, 2002. Adoption
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of SFAS No. 144 did not have a significant effect on our financial position or
results of operations.
In July 2002, the Financials Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities," which
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Such costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. SFAS No. 146 replaces the previous accounting guidance
provided by the Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002 and we do not anticipate that the statement will have a
material impact on our financial statements or results of operations.
FACTORS AFFECTING OUR OPERATING RESULTS AND OUR COMMON STOCK
In addition to the other information in this report, the following factors
should be considered in evaluating our business and our future prospects:
THE GROWTH OF OUR BUSINESS IS DEPENDENT ON GOVERNMENT BUDGETARY POLICY,
PARTICULARLY THE ALLOCATION OF FUNDS TO SUSTAIN THE GROWTH OF THE
TELECOMMUNICATIONS INDUSTRY AND THE INTERNET IN CHINA.
Virtually all of our large customers are directly or indirectly owned or
controlled by the government of China. Accordingly, their business strategies,
capital expenditure budgets and spending plans are largely decided in accordance
with government policies, which, in turn, are determined on a centralized basis
at the highest level by the State Development and Planning Commission of China.
As a result, the growth of our business is heavily dependent on government
policies for telecommunications and Internet infrastructure. Insufficient
government allocation of funds to sustain the growth of China's
telecommunications and Internet industries in the future could reduce the demand
for our products and services and have a material adverse effect on our ability
to grow our business.
On December 11, 2001, in an effort to increase the efficiency of
telecommunications service providers through competition, China's State Council
announced that it would split China Telecom geographically into a northern
division (comprising ten provinces) and a southern division (comprising 21
provinces). Under the State Council's plan, the northern division of China
Telecom has merged with China Netcom Corporation Ltd., or China Netcom, and
Jitong Communication, and has been renamed China Netcom Communication Group
Corporation, or CNC, while the southern division operates under the China
Telecom name. As a result of the restructuring, new orders for
telecommunications infrastructure expansion and improvement projects have
decreased over the past several quarters, adversely affecting our backlog and
our rate of net revenue growth on a sequential basis. The restructuring has
caused widespread personnel shifts in both China Telecom and CNC, which have
slowed or prevented a large number of investment decisions in new infrastructure
and network management solutions. Although we expect that the restructuring will
have a positive impact on growth in the telecommunications industry in China in
the long-term, continued delays in capital expenditure projects could negatively
affect our growth in the near-term. In addition,
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similar restructurings of this nature could cause our operating results to vary
unexpectedly from quarter to quarter in the future.
OUR CUSTOMER BASE IS CONCENTRATED AND THE LOSS OF ONE OR MORE OF OUR CUSTOMERS
COULD CAUSE OUR BUSINESS TO SUFFER SIGNIFICANTLY.
We have derived, and believe that we will continue to derive, a significant
portion of our revenues from a limited number of large customers, such as China
Telecom, China Unicom and China Mobile Telecommunications Corporation. China
Telecom accounted for almost all of our revenues in 1997 and 1998. In 1999,
China Telecom, together with China Unicom, accounted for almost all of our
revenues. The loss, cancellation or deferral of any large contract by any of our
large customers would have a material adverse effect on our revenues, and
consequently our profits.
THE LONG AND VARIABLE SALES CYCLES FOR OUR PRODUCTS AND SERVICES CAN CAUSE OUR
REVENUES AND OPERATING RESULTS TO VARY SIGNIFICANTLY FROM PERIOD TO PERIOD AND
MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our revenues and operating results will vary significantly from quarter to
quarter due to a number of factors, many of which are outside of our control and
any of which may cause our stock price to fluctuate. A customer's decision to
purchase our services and products involves a significant commitment of its
resources and an extended evaluation. As a result, our sales cycle tends to be
lengthy. We spend considerable time and expense educating and providing
information to prospective customers about features and applications of our
services and products. Because our major customers operate large and complex
networks, they usually expand their networks in large increments on a sporadic
basis. The combination of these factors can cause our revenues and results of
operations to vary significantly and unexpectedly from quarter to quarter. Other
factors that may affect us include the following:
.. fluctuation in demand for our products and services as a result of the
budgetary cycles of our large customers, particularly state-owned
enterprises;
.. the reduction, delay, interruption or termination of one or more
infrastructure projects; and
.. our ability to introduce, develop and deliver new software products that
meet customer requirements in a timely manner.
A large part of the contract amount of a network solutions project usually
relates to hardware procurement. Since we recognize most of the revenues
relating to hardware plus a portion of contract services revenues at the time of
hardware delivery, the timing of hardware delivery can cause our quarterly gross
revenues to fluctuate significantly. Due to the foregoing factors, we believe
that quarter to quarter comparisons of our operating results are not a good
indication of our future performance and should not be relied upon. It is likely
that our operating results in some periods may be below the expectations of
public market analysts and investors. In this event, the price of our common
stock will probably decline, perhaps significantly more in percentage terms than
any corresponding decline in our operating results.
-34-
OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE SIGNIFICANTLY.
We typically purchase hardware for our customers as part of our turn-key total
solutions services. We generally require our customers to pay 80 to 90% of the
invoice value of the hardware upon delivery. We typically place orders for
hardware against back-to-back orders from customers and seek favorable payment
terms from hardware vendors. This policy has historically minimized our working
capital requirements. However, for certain large and strategically important
projects, we have agreed to payment of less than 80 to 90% of the invoice value
of the hardware upon delivery in order to maintain competitiveness. Wider
adoption of less favorable payment terms or delays in hardware deliveries will
require us to increase our working capital needs significantly.
Our working capital requirements may also increase significantly in order to
fund more rapid expansion and acquisitions, to develop new or enhanced services
or products, to respond to competitive pressure to compete successfully for
larger projects involving higher levels of hardware purchases or otherwise if
our business grows more rapidly than we currently predict. An increase in our
working capital needs may require that we raise additional funds sooner than we
presently expect.
WE HAVE SUSTAINED LOSSES IN PRIOR YEARS AND MAY INCUR SLOWER EARNINGS GROWTH,
EARNINGS DECLINES OR NET LOSSES IN THE FUTURE.
Although we have recently achieved operating profitability and had net income in
1998 and 2001, we sustained net losses in 1997, 1999 and 2000. There are no
assurances that we can sustain profitability or avoid net losses in the future.
We continue to expect that certain of our operating expenses will increase as
our business grows. The level of these expenses will be largely based on
anticipated organizational growth and revenue trends and a high percentage will
be fixed. As a result, any delays in expanding sales volume and generating
revenue could result in substantial operating losses. Any such developments
could cause the market price of our common stock to decline.
OUR ACQUISITION OF BONSON HAS BEEN, AND ANY ACQUISITIONS WE UNDERTAKE IN THE
FUTURE MAY BE, COSTLY, AND WE MAY REALIZE LOSSES ON OUR INVESTMENTS.
As a key component of our business and growth strategy, we have recently
acquired Bonson Information Technology Holdings Limited, or Bonson. In the
future, we may acquire other companies or assets that we feel will enhance our
revenue growth, operations and profitability. Such acquisitions could result in
the use of significant amounts of cash, dilutive issuances of our common stock
and amortization expenses related to goodwill and other intangible assets, each
of which could materially and adversely affect our business. Such acquisitions
involve other significant risks, including:
.. the difficulties of integrating, assimilating and managing the operations,
technologies, intellectual property, products and personnel of the acquired
business;
.. the diversion of management attention from other business concerns;
.. the additional expense associated with acquired contingent liabilities;
.. the loss of key employees in acquired businesses; and
-35-
.. the risk of being sued by terminated employees and contractors.
We will need to integrate and manage Bonson and any other businesses we
determine to acquire in the future. Our failure to do so successfully could have
a material adverse effect on our business, results of operations and financial
condition.
MANAGEMENT'S ABILITY TO IMPLEMENT ADEQUATE CONTROL SYSTEMS WILL BE CRITICAL TO
THE SUCCESSFUL MANAGEMENT OF OUR FUTURE GROWTH.
In recent years, we have been expanding our operations rapidly, both in size and
scope. Our growth places a significant strain on our management systems and
resources. Our ability to market our products successfully and implement our
business plan in a rapidly evolving market requires an effective planning and
management process. We will need to continue to improve our financial,
managerial and operational controls and reporting systems, and to expand, train
and manage our work force. Our future growth will be compromised if we cannot
implement adequate control systems in an efficient and timely manner.
WE ARE HIGHLY DEPENDENT ON OUR EXECUTIVE OFFICERS.
Each of our executive officers is responsible for an important segment of our
operations. Although we believe that we have significant depth at all levels of
management, the loss of any of our executive officers' services could be
detrimental to our operations. To ensure continuity of management, we have
entered into employment agreements with all of our executive officers. We do not
have, and do not plan to obtain, "key man" life insurance on any of our
employees.
WE FACE A COMPETITIVE LABOR MARKET IN CHINA FOR SKILLED PERSONNEL AND THEREFORE
ARE HIGHLY DEPENDENT ON THE SKILLS AND SERVICES OF OUR EXISTING KEY SKILLED
PERSONNEL AND OUR ABILITY TO HIRE ADDITIONAL SKILLED EMPLOYEES.
Competition for highly skilled software design, engineering and sales and
marketing personnel is intense in China. Our failure to attract, assimilate or
retain qualified personnel to fulfill our current or future needs could impair
our growth. Competition for skilled personnel comes primarily from a wide range
of foreign companies active in China, many of which have substantially greater
resources than we have. Limitations on our ability to hire and train a
sufficient number of personnel at all levels would limit our ability to
undertake projects in the future and could cause us to lose market share.
WE EXTEND WARRANTIES TO OUR CUSTOMERS THAT EXPOSE US TO POTENTIAL LIABILITIES.
We customarily provide our customers with one to three year warranties, under
which we agree to maintain installed systems at no additional cost to our
customers. The maintenance services cover both hardware and our proprietary and
third party software products. Although we seek to arrange back-to-back
warranties with hardware and software vendors, we have the primary
responsibility to maintain the installed hardware and software. Our contracts do
not have disclaimers or limitations on liability for special, consequential and
incidental damages, nor do we cap the amounts our customers can recover for
damages. In addition, we do not currently maintain any insurance policy with
respect to our exposure to warranty claims. The failure of our installed
projects to operate properly could give rise to substantial liability for
special, consequential or incidental damages, that in turn could materially and
adversely affect us.
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WE SELL OUR LARGE SYSTEMS INTEGRATION PROJECTS ON A FIXED-PRICE, FIXED-TIME
BASIS WHICH EXPOSES US TO RISKS ASSOCIATED WITH COST OVERRUNS AND DELAYS.
We sell substantially all of our systems integration projects on a fixed-price,
fixed-time basis. In contracts with our customers, we typically agree to pay
late completion fines of up to 5% of the total contract value. In large scale
telecommunications infrastructure projects, there are many factors beyond our
control which could cause delays or cost overruns. In this event, we would be
exposed to cost overruns and liable for late completion fines. Our failure to
complete a fixed-price, fixed-time project within budget and the required time
frame would expose us to cost overruns and penalties that could have a material
adverse effect on our business, operating results and financial condition. A
part of our business is installing network hardware. If we are unable to obtain
access to such equipment in a timely manner or on acceptable commercial terms,
our business, particularly our relationships with our customers, may be
materially and adversely affected.
WE MAY BECOME LESS COMPETITIVE IF WE ARE UNABLE TO DEVELOP OR ACQUIRE NEW
PRODUCTS OR ENHANCEMENTS TO OUR SOFTWARE PRODUCTS THAT ARE MARKETABLE ON A
TIMELY AND COST-EFFECTIVE BASIS.
We continually develop new services and proprietary software products.
Unexpected technical, operational, distribution or other problems could delay or
prevent the introduction of one or more of these products or services or any
products or services that we may plan to introduce in the future. Moreover, we
cannot be sure that any of these products and services will achieve widespread
market acceptance or generate incremental revenues.
OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED AND THERE IS A RISK OF POOR
ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS IN CHINA.
Our success and ability to compete depend substantially upon our intellectual
property rights, which we protect through a combination of copyright, trade
secret law and trademark law. We have registered some marks and filed trademark
applications for other marks with the United States Patent and Trademark Office,
the Trademark Bureau of the State Administration of Industry and Commerce in
China and the Trade Marks Registry in Hong Kong. We have also registered
copyrights with the State Copyright Bureau in China with respect to certain of
our telecommunications-related software products, although we have not applied
for copyright protection elsewhere (including the United States). Despite these
precautions, the legal regime protecting intellectual property rights in China
is weak. Moreover, Bonson, which we acquired in February, 2002, has never
registered copyrights for its telecommunications-related software products.
Because the Chinese legal system in general, and the intellectual property
regime in particular, are relatively weak, it is often difficult to enforce
intellectual property rights in China. In addition, there are other countries
where effective copyright, trademark and trade secret protection may be
unavailable or limited, and the global nature of the Internet makes it virtually
impossible to control the ultimate destination of our products.
We do not own any patents and have not filed any patent applications, as we do
not believe that the benefits of patent protection outweigh the costs of filing
and updating patents for our software products. We enter into confidentiality
agreements with our employees and consultants, and control access to, and
distribution of, our documentation and other licensed information. Despite these
precautions, it may be possible for a third party
-37-
to copy or otherwise obtain and use our licensed services or technology without
authorization, or to develop similar technology independently. Policing
unauthorized use of our licensed technology is difficult and there can be no
assurance that the steps we take will prevent misappropriation or infringement
of our proprietary technology. In addition, litigation may be necessary to
enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of the proprietary rights of others, which
could result in substantial costs and diversion of our resources.
WE ARE EXPOSED TO CERTAIN BUSINESS AND LITIGATION RISKS WITH RESPECT TO
TECHNOLOGY RIGHTS HELD BY THIRD PARTIES.
We currently license technology from third parties and intend to do so
increasingly in the future as we introduce services that require new technology.
There can be no assurance that these technology licenses will be available to us
on commercially reasonable terms, if at all. Our inability to obtain any of
these licenses could delay or compromise our ability to introduce new services.
In addition, we may or may allegedly breach the technology rights of others and
incur legal expenses and damages, which could be substantial.
INVESTORS MAY NOT BE ABLE TO ENFORCE JUDGMENTS BY UNITED STATES COURTS AGAINST
US.
We are incorporated in the State of Delaware. However, a majority of our
directors, executive officers and principal shareholders live outside the United
States, principally in Beijing and Hong Kong. As a result, you may not be able
to:
.. effect service of process upon us or these persons within the United
States; or
.. enforce against us or these persons judgments obtained in United States
courts, including judgments relating to the federal securities laws of the
United States.
WE DO NOT INTEND TO PAY AND MAY BE RESTRICTED FROM PAYING DIVIDENDS ON OUR
COMMON STOCK.
We have never declared or paid dividends on our capital stock and we do not
intend to declare any dividends in the foreseeable future. We currently intend
to retain future earnings to fund our growth. Furthermore, if we decide to pay
dividends, foreign exchange and other regulations in China may restrict our
ability to distribute retained earnings from China or convert these payments
from Renminbi, the currency of China, into foreign currencies. In addition, loan
agreements and contractual arrangements we enter into in the future may also
restrict our ability to pay dividends.
THE FACT THAT OUR BUSINESS IS CONDUCTED IN BOTH U.S. DOLLARS AND RENMINBI MAY
SUBJECT US TO CURRENCY EXCHANGE RATE RISK DUE TO FLUCTUATIONS IN THE EXCHANGE
RATE BETWEEN THESE TWO CURRENCIES.
Substantially all of our revenues, expenses and liabilities are denominated in
either U.S. dollars or Renminbi. As a result, we are subject to the effects of
exchange rate fluctuations between these currencies. Because of the unitary
exchange rate system introduced in China on January 1, 1994, the official bank
exchange rate for conversion of Renminbi to U.S. dollars
-38-
experienced a devaluation of approximately 50%. We report our financial results
in U.S. dollars, therefore, any future devaluation of the Renminbi against the
U.S. dollar may have an adverse effect on our reported net income.
Substantially all our revenues and expenses relating to hardware sales are
denominated in U.S. dollars, and substantially all our revenues and expenses
relating to the software and services component of our business are denominated
in Renminbi. Although, in general, our exposure to foreign exchange risks should
be limited, the value in our shares may be affected by the foreign exchange rate
between the U.S. dollar and the Renminbi because the value of our business is
effectively denominated in Renminbi, while our shares are traded in U.S.
dollars. Furthermore, a decline in the value of the Renminbi could reduce the
U.S. dollar value of earnings from, and our investments in, our subsidiaries in
China.
THE MARKETS IN WHICH WE SELL OUR SERVICES AND PRODUCTS ARE COMPETITIVE AND WE
MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The market for telecommunications and Internet infrastructure solutions in China
is new and rapidly changing. Our competitors in the network infrastructure
solutions market mainly include domestic systems integrators such as Zoom
Networks and Openet Information Technology (Shenzhen) Corporation. Although we
are a leading player in this market, there are many large multinational
companies with substantial, existing information technology operations in other
markets in China, that have significantly greater financial, technological,
marketing and human resources. Should they decide to enter the network
infrastructure solutions market, this could hurt our profitability and erode our
market share. In the operation support system solutions market, we compete with
both international and local software and solutions providers.
In the online billing segment, we compete primarily with Portal Software, MIND
C.T.I. Ltd. and Zoom Networks, and in the wireless billing segment, we compete
with more than ten local competitors. Currently, due in part to a stringent
approval system for providers of wireless billing software in China and
competitive pricing offered by domestic companies, some multinational
information technology companies have been deterred from entering this market.
In view of the gradual deregulation of the Chinese telecommunications industry
and China's entry into the WTO, we anticipate the entrance of new competitors
into the operation support system solutions market. The service application
solutions sector is highly competitive. Our principal competitor in this sector
is Openwave Systems Inc. (formerly Software.com and Phone.com).
In the network security solutions market, we mainly compete with Information
Security One Limited, Nsfocus Information Technology Co., Ltd., and 21ViaNet
China Inc. An increasing number of companies are devoting their resources to
this sector in developing network security products. Through mergers and
acquisitions, many information technology companies are entering the network
security solutions market as part of their strategy of providing a full range of
system integration services.
Our competitors, some of whom have greater financial, technical and human
resources than us, may be able to respond more quickly to new and emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of new products or services. It is possible
that competition in the form of new competitors or alliances, joint ventures or
consolidation among existing competitors may decrease our market share.
Increased competition could result in lower personnel utilization
-39-
rates, billing rate reductions, fewer customer engagements, reduced gross
margins and loss of market share, any one of which could materially and
adversely affect our profits and overall financial condition.
POLITICAL AND ECONOMIC POLICIES OF THE CHINESE GOVERNMENT COULD AFFECT OUR
INDUSTRY IN GENERAL AND OUR COMPETITIVE POSITION IN PARTICULAR.
Since the establishment of the People's Republic of China in 1949, the Communist
Party has been the governing political party in China. The highest bodies of
leadership are the Politburo of the Communist Party, the Central Committee and
the National People's Congress. The State Council, which is the highest
institution of government administration, reports to the National People's
Congress and has under its supervision various commissions, agencies and
ministries, including The Ministry of Information Industry, the
telecommunications regulatory body of the Chinese government. Since the late
1970s, the Chinese government has been reforming the Chinese economic system.
Although we believe that economic reform and the macroeconomic measures adopted
by the Chinese government have had and will continue to have a positive effect
on economic development in China, there can be no assurance that the economic
reform strategy will not from time to time be modified or revised. Such
modifications or revisions, if any, could have a material adverse effect on the
overall economic growth of China and investment in the Internet and the
telecommunications industry in China. Such developments could reduce, perhaps
significantly, the demand for our products and services. There is no guarantee
that the Chinese government will not impose other economic or regulatory
controls that would have a material adverse effect on our business. Furthermore,
changes in political, economic and social conditions in China, adjustments in
policies of the Chinese government or changes in laws and regulations could
adversely affect our industry in general and our competitive position in
particular.
UNCERTAINTIES WITH RESPECT TO THE CHINESE LEGAL SYSTEM COULD ADVERSELY AFFECT
US.
Our principal operating subsidiaries, AsiaInfo Technologies and Guangzhou
Bonson, are wholly foreign owned enterprises for Chinese legal purposes, which
means that they are incorporated in China and wholly-owned by foreign investors.
Several of our subsidiaries are subject to laws and regulations applicable to
foreign investment in China in general and laws applicable to wholly foreign
owned enterprises in particular. Legislation and regulations over the past 20
years have significantly enhanced the protections afforded to various forms of
foreign investment in China. However, since the Chinese legal system is still
evolving, the interpretations of many laws, regulations and rules are not always
uniform and enforcement of these laws, regulations and rules involve
uncertainties, which may limit remedies available to us.
HIGH TECHNOLOGY AND EMERGING MARKET SHARES HAVE HISTORICALLY EXPERIENCED EXTREME
VOLATILITY AND MAY SUBJECT YOU TO LOSSES.
The trading price of our shares may be subject to significant market volatility
due to:
.. investor perceptions of us and investments relating to China and Asia;
.. developments in the Internet and telecommunications industries;
.. variations in our operating results from period to period due to project
timing; and
-40-
.. announcements of new products or services by us or by our competitors.
In addition, the high technology sector of the stock market frequently
experiences extreme price and volume fluctuations, which have particularly
affected the market prices of many Internet and computer software companies and
which have often been unrelated to the operating performance of these companies.
IF OUR STOCK PRICE IS VOLATILE, WE MAY BECOME SUBJECT TO SECURITIES LITIGATION
WHICH IS EXPENSIVE AND COULD RESULT IN A DIVERSION OF RESOURCES.
In the past, following periods of volatility in the market price of a particular
company's securities, securities class action litigation has often been brought
against that company. Many companies in our industry have been subject to this
type of litigation in the past, and we have recently become the subject of this
type of litigation. For more information on this litigation, see the discussion
under the heading "Item 1. Legal Proceedings" in Part II of this report.
Litigation is often expensive and diverts management's attention and resources,
which could materially and adversely affect our business.
FUTURE SALES OF SHARES BY OUR COMPANY OR EXISTING SHAREHOLDERS COULD CAUSE THE
MARKET PRICE OF OUR COMMON STOCK TO FALL.
If our stockholders sell substantial amounts of our common stock in the public
market, including shares issued upon the exercise of outstanding options, the
market price of our common stock could fall. Such sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate.
A SMALL NUMBER OF SHAREHOLDERS CONTROLS US.
A small number of shareholders, including Warburg-Pincus Ventures, ChinaVest
Group, and their affiliates, as well as Edward Tian, one of our directors, James
Ding, our President and Chief Executive Officer, and Louis Lau, our Chairman,
control over 60% of our voting stock. As a result, these shareholders
collectively are able to control all matters requiring shareholder approval,
including election of directors and approval of significant corporate
transactions, such as a sale of our assets and the terms of future equity
financings. The combined voting power of our large shareholders could have the
effect of delaying or preventing a change in control.
WE ARE SUBJECT TO ANTI-TAKEOVER PROVISIONS THAT COULD PREVENT A CHANGE OF
CONTROL AND PREVENT OUR SHAREHOLDERS FROM REALIZING A PREMIUM ON THEIR COMMON
STOCK.
Our board of directors has the authority to issue up to 10,000,000 shares of our
preferred stock. Without any further vote or action on the part of our
stockholders, the board of directors has the authority to determine the price,
rights, preferences, privileges and restrictions of the preferred stock. This
preferred stock, if it is ever issued, may have preference over and harm the
rights of the holders of our common stock. Although the issuance of this
preferred stock will provide us with flexibility in connection with possible
acquisitions and other corporate purposes, this issuance may make it more
difficult for a third party to acquire a majority of our outstanding voting
stock.
-41-
We currently have authorized the size of our board of directors to be not less
than three nor more than nine directors. The terms of the office of the
eight-member board of directors have been divided into three classes: Class I,
whose term will expire at the annual meeting of the stockholders to be held in
2003; Class II, whose term will expire at the annual meeting of stockholders to
be held in 2004; and Class III, whose term will expire at the annual meeting of
stockholders to be held in 2005. This classification of the board of directors
may have the effect of delaying or preventing changes in our control or
management.
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. In general, the statute prohibits a publicly-held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date when the person became
an interested stockholder unless, subject to exceptions, the business
combination or the transaction in which the person became an interested
stockholder is approved in a prescribed manner. Generally, a "business
combination" includes a merger, asset or stock sale, or other transaction
resulting in a financial benefit to the stockholder.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest-rate risk primarily associated with our cash,
short-term investments and short-term bank loans. To date, we have not entered
into any types of derivatives to hedge against interest-rate changes, nor do we
speculate in foreign currency. However, we do maintain a significant portion of
our cash deposits in U.S. dollars to avoid currency risk related to Renminbi. A
portion of these U.S. dollar deposits are used to collateralize
Renminbi-denominated loans from Chinese banks.
Because substantially all of our revenues and expenses relating to hardware
sales are denominated in U.S. dollars, and substantially all of our revenues and
expenses relating to the service component of our network solutions business and
software business are denominated in Renminbi, we do not have significant
exposure to either the U.S. dollar or Renminbi. Thus, we do not believe that it
is necessary to enter into derivatives contracts to hedge our exposures to
either currency.
There have been no significant changes in our exposure to changes in either
interest rates or foreign currency exchange rates for the quarter ended
September 30, 2002. Our exposure to interest rates is limited as we do not have
variable rate and long-term borrowings. We are subject to variable interest
rates on our bank deposits that are cash and short-term investments. As there
are no significant market price movements, such investments are held at cost. As
of September 30, 2002, a hypothetical 10% immediate increase or decrease in
interest rates would increase or decrease our annual interest expense and income
by approximately $7,518 and $175,713, respectively.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the filing date of this quarterly report, we carried out
an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as
amended. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that these disclosure controls and
-42-
procedures are effective. There were no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of our evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On December 4, 2001, a securities class action case was filed in New York City
against us, certain of our current officers and directors and the underwriters
of our initial public offering, or IPO. The lawsuit alleges violations of the
federal securities laws and has been docketed in the United States District
Court for the Southern District of New York as Hassan v. AsiaInfo Holdings,
Inc., et al. The lawsuit alleges, among other things, that the underwriters of
our IPO improperly required their customers to pay the underwriters excessive
commissions and to agree to buy additional shares of our common stock in the
aftermarket as conditions of receiving shares in our IPO. The lawsuit further
claims that these supposed practices of the underwriters should have been
disclosed in our IPO prospectus and registration statement. The suit seeks
rescission of the plaintiffs' alleged purchases of our common stock as well as
unspecified damages. In addition to the case against us, various other
plaintiffs have filed approximately 1,000 other, substantially similar class
action cases against approximately 300 other publicly traded companies and their
IPO underwriters in New York City, which along with the case against us have all
been transferred to a single federal district judge for purposes of case
management. We intend to seek dismissal of the complaint on various legal
grounds at the appropriate time, but no definitive schedule has been set by the
Court for the filing of such a motion. In addition, we believe that the
underwriters may have an obligation to indemnify us for the legal fees and other
costs of defending this suit and that our directors' and officers' liability
insurance policies will also cover the defense and potential exposure or
settlement of the suit.
On October 9, 2002, the United States District Court for the Southern District
of New York dismissed without prejudice all claims against the individual
defendants in the litigation (Louis Lau, our Chairman, James Ding, our President
and Chief Executive Officer and Ying Han, our Chief Financial Officer). The
dismissals were based on stipulations signed by those defendants and the
plaintiffs' representatives. The case remains pending against the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 2, 2000, our Registration Statement on Form S-1 covering the offering
of 5,000,000 shares of our common stock (No.333-93199) was declared effective.
The underwriters in the offering exercised an over-allotment option to purchase
an additional 750,000 shares of our common stock. The total price to the public
for the shares offered and sold was $138,000,000. The net proceeds of the
offering (after deducting expenses) was approximately $126,610,000. From the
effective date of the Registration Statement through September 30, 2002, the net
proceeds have been used for the following purposes:
Purchase and installation of machinery and equipment ........................ $ 7,000,000
Temporary investments, including cash and cash equivalents .................. 40,350,000
Investments in subsidiaries ................................................. 50,800,000
Research and development and sales and marketing expenses ................... 28,460,000
------------
$126,610,000
============
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The net proceeds will be used for general corporate purposes, including working
capital, and expenses such as research and development and sales and marketing.
A portion of the net proceeds may also be used to acquire or invest in
complementary businesses or products. None of the net proceeds of the offering
have been paid directly or indirectly to our directors, officers or their
associates, to persons owning ten percent or more of our common stock, or to our
affiliates.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as a part of this Report.
Exhibit Number Description Exhibits
- -------------- --------------------
2.1 Share Purchase Agreement for the acquisition of Bonson
Information Technology Holdings Limited/****/
3.1 Certificate of Incorporation of AsiaInfo Holdings, Inc.,
dated June 8, 1998/*/
3.2 Certificate of Amendment to Certificate of Incorporation of
AsiaInfo Holdings, Inc., dated August 27, 1999/*/
3.3 Certificate of Amendment to Certificate of Incorporation of
AsiaInfo Holdings, Inc., dated November 15, 2000/***/
3.4 Certificate of Correction to Certificate of Amendment to
Certificate of Incorporation of AsiaInfo Holdings, Inc.,
dated January 18, 2001/***/
3.5 By-Laws of AsiaInfo Holdings, Inc., dated December 19,
2000/***/
4.1 Specimen Share Certificate representing AsiaInfo Holdings,
Inc. shares of common stock/*/
10.1 2000 Stock Option Plan, approved and adopted as of October
18, 2000/**/
10.2 Shareholders' Agreement of Marsec Holdings, Inc., dated as
of September 15, 2000, by and among AsiaInfo Holdings, Inc.
and the Founders (as defined therein) of Marsec Holdings,
Inc./**/
10.3 Lease of AsiaInfo's headquarters at 6 Zhongguancun South
Street, Beijing, China, dated August 31, 1999/*/
10.4 Agreement for the Establishment of a Limited Liability
Company (Guangdong Wangying Communications Technology
Company Limited) and Capital Contribution/***/
11.1 Statement regarding computation of per share earnings
(included in note 9 to condensed consolidated financial
statements)
99.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
/*/ Incorporated by reference to our Registration Statement on Form S-1
(No.333- 93199).
/**/ Incorporated by reference to our Quarterly Report on Form 10-Q/A for the
quarter ended September 30, 2000.
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/***/ Incorporated by reference to our Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
/****/ Incorporated by reference to our Current Report on Form 8-K filed on
February 21, 2002.
(b) Reports on form 8-K
None.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, AsiaInfo
Holdings, Inc. has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
AsiaInfo Holdings, Inc.
Date: November 14, 2002 By: /s/ Ying Han
-----------------------------------
Name: Ying Han
Title: Chief Financial Officer
(duly authorized officer
and principal financial
officer)
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Certification
I, James Ding, certify that:
1. I have reviewed this quarterly report on Form 10-Q of AsiaInfo Holdings,
Inc.;
2. Based on my knowledge, this quarterly report 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect
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internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 14, 2002
/s/ James Ding
------------------------------
James Ding
Chief Executive Officer
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Certification
I, Ying Han, certify that:
1. I have reviewed this quarterly report on Form 10-Q of AsiaInfo Holdings,
Inc.;
2. Based on my knowledge, this quarterly report 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
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including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 14, 2002
/s/ Ying Han
--------------------------------
Ying Han
Chief Financial Officer
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