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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 JUNE 30, 2001
[_] 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
August 3, 2001 was 41,784,269
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ASIAINFO HOLDINGS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2001
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited) 3
a) Condensed Consolidated Statements of Operations for the
three months and six months ended June 30, 2000 and 2001 3
b) Condensed Consolidated Balance Sheets as of December 31, 2000
and June 30, 2001 5
c) Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2000 and 2001 6
d) Notes to Condensed Consolidated Financial Statements for the
six months ended June 30, 2000 and 2001 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 26
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 27
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURE 29
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US dollars)
Three Months Ended June 30,
2000 2001
----------- -----------
(Unaudited)
Revenues:
Network solutions............................................... $46,445,556 $13,772,579
Software license................................................ 4,442,288 6,705,990
Software service................................................ 202,948 1,072,940
----------- -----------
Total Software............................................... 4,645,236 7,778,930
----------- -----------
Total revenues.................................................. 51,090,792 21,551,509
----------- -----------
Cost of revenues:
Network solutions............................................... 42,370,006 7,335,840
Software........................................................ 729,796 866,268
----------- -----------
Total cost of revenues.......................................... 43,099,802 8,202,108
----------- -----------
Gross profit...................................................... 7,990,990 13,349,401
----------- -----------
Operating expenses:
Sales and marketing (excluding
stock-based compensation:
2000: $176,469; 2001: $103,159)................................ 4,137,879 5,820,410
General and administrative (excluding
stock-based compensation:
2000: $318,705; 2001: $138,502)................................ 3,402,614 3,539,359
Research and development (excluding
stock-based compensation:
2000: $90,341; 2001: $41,511).................................. 1,594,039 1,944,784
Amortization of deferred stock
compensation................................................... 585,515 283,172
----------- -----------
Total operating expenses........................................ 9,720,047 11,587,725
----------- -----------
(Loss) income from operations................................... (1,729,057) 1,761,676
----------- -----------
Other income (expense):
Interest income................................................. 2,686,818 2,194,753
Interest expense................................................ (340,636) (340,343)
Other expenses, net............................................. (288,457) (26,758)
----------- -----------
Total other income, net......................................... 2,057,725 1,827,652
----------- -----------
Income before income taxes, minority
interests and equity in loss
of affiliate.................................................... 328,668 3,589,328
Income tax (benefit) expense...................................... (105,039) 804,866
----------- -----------
Income before minority interests and
equity in loss of affiliate.................................... 433,707 2,784,462
Minority interests in profit of
consolidated subsidiaries...................................... -- 47,555
Equity in loss of affiliate....................................... -- (256,335)
----------- -----------
Net income........................................................ $ 433,707 $ 2,575,682
=========== ===========
Net income per share:
Basic.......................................................... $ 0.01 $ 0.06
=========== ===========
Diluted........................................................ $ 0.01 $ 0.06
=========== ===========
Shares used in computation:
Basic.......................................................... 39,738,567 41,305,291
=========== ===========
Diluted........................................................ 47,020,308 46,761,204
=========== ===========
See notes to condensed consolidated financial statements.
-3-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US dollars)
Six Months Ended June 30,
-------------------------
2000 2001
----------- -----------
(Unaudited)
Revenues:
Network solutions...................... 67,544,835 43,681,350
Software license....................... 6,235,314 12,177,760
Software service....................... 202,948 1,470,916
----------- -----------
Total Software........................ 6,438,262 13,648,676
----------- -----------
Total revenues......................... 73,983,097 57,330,026
----------- -----------
Cost of revenues:
Network solutions...................... 62,584,731 30,979,212
Software............................... 731,594 1,722,863
----------- -----------
Total cost of revenues................. 63,316,325 32,702,075
----------- -----------
Gross profit............................ 10,666,772 24,627,951
----------- -----------
Operating expenses:
Sales and marketing (excluding
stock-based compensation:
2000: $396,080; 2001: $227,335)....... 7,588,551 11,447,219
General and administrative (excluding
stock-based compensation:
2000: $672,450; 2001: $383,427)....... 5,774,058 7,145,656
Research and development (excluding
stock-based compensation:
2000: $216,076; 2001: $109,545)....... 2,689,793 3,576,675
Amortization of deferred stock
compensation.......................... 1,284,606 720,307
----------- -----------
Total operating expenses............... 17,337,008 22,889,857
----------- -----------
(Loss) income from operations.......... (6,670,236) 1,738,094
----------- -----------
Other income (expense):
Interest income........................ 3,220,559 4,580,550
Interest expense....................... (609,565) (666,870)
Other expenses, net.................... (206,875) (33,652)
----------- -----------
Total other income, net................ 2,404,119 3,880,028
----------- -----------
(Loss) income before income taxes,
minority interests and equity in loss
of affiliate.......................... (4,266,117) 5,618,122
Income tax (benefit) expense........... (61,329) 1,276,031
----------- -----------
(Loss) income before minority interests
and equity in loss of affiliate....... (4,204,788) 4,342,091
Minority interests in loss of
consolidated subsidiaries............. -- (130,692)
Equity in loss of affiliate............ -- (256,335)
----------- -----------
Net (loss) income...................... (4,204,788) 3,955,064
=========== ===========
Net (loss) income per share:
Basic................................. $(0.12) $0.10
=========== ===========
Diluted............................... $(0.12) $0.09
=========== ===========
Shares used in computation:
Basic................................. 34,279,990 41,136,459
=========== ===========
Diluted............................... 34,279,990 45,955,050
=========== ===========
See notes to condensed consolidated financial statements.
-4-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In US dollars)
December 31, June 30,
------------- ------------
2000 2001
------------- ------------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents...................................... $ 48,833,956 $ 58,427,006
Restricted cash................................................ 26,733,179 21,613,447
Short-term investments......................................... 110,400,000 82,938,144
Accounts receivable, trade (net of allowance for
doubtful accounts of $545,013 and $1,026,278 at
December 31, 2000 and June 30, 2001, respectively) 55,597,496 42,142,563
Inventories - hardware and parts............................... 8,876,010 36,039,757
Other receivables.............................................. 3,078,851 4,297,206
Deferred income taxes.......................................... 78,203 83,398
Prepaid expenses and other current assets...................... 592,201 1,738,000
------------ ------------
Total current assets........................................... 254,189,896 247,279,521
Property and equipment--net..................................... 6,339,751 6,308,423
Goodwill, at cost less accumulated amortization................. 3,245,310 2,716,648
Investment in affiliate......................................... -- 5,901,041
Deferred income taxes........................................... 228,107 258,390
------------ ------------
Total Assets................................................... $264,003,064 $262,464,023
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term bank loans.......................................... $ 20,644,834 $ 14,256,373
Accounts payable............................................... 42,037,151 49,128,297
Deferred revenue............................................... 12,501,524 5,352,079
Other payables................................................. 1,590,850 1,246,045
Accrued employee benefits...................................... 10,019,624 8,141,719
Accrued expenses............................................... 6,194,844 6,775,646
Income taxes payable........................................... 307,373 1,277,303
Other taxes payable............................................ 1,909,450 1,664,022
------------ ------------
Total current liabilities...................................... 95,205,650 87,841,484
------------ ------------
Minority interest............................................... 188,044 318,736
------------ ------------
Stockholders' Equity:
Common stock, 100,000,000 shares authorized, $0.01
par value, shares issued and outstanding: 2000:
40,822,940; 2001: 41,434,981.................................. 408,229 414,350
Additional paid-in capital..................................... 175,370,544 176,375,570
Deferred stock compensation.................................... (1,655,821) (935,514)
Accumulated deficit............................................ (5,530,601) (1,575,537)
Accumulated other comprehensive income......................... 17,019 24,934
------------ ------------
Total stockholders' equity..................................... 168,609,370 174,303,803
------------ ------------
Total Liabilities and Stockholders' Equity..................... $264,003,064 $262,464,023
============ ============
See notes to condensed consolidated financial statements.
-5-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In US dollars)
Six Months Ended June 30,
--------------------------------
2000 2001
---------- ----------
(unaudited)
Cash flows from operating activities:
Net (loss) income................................................ $(4,204,788) $3,955,064
Adjustments to reconcile net (loss)
income to net cash used in
operating activities:
Depreciation..................................................... 500,506 1,075,265
Amortization of goodwill......................................... 528,662 528,662
Amortization of deferred stock
compensation.................................................... 1,284,606 720,307
Deferred income taxes............................................ (61,329) (35,478)
Minority interest in loss of
consolidated subsidiaries....................................... -- 130,692
Equity in loss of affiliate...................................... -- 256,335
Loss on disposal of property
and equipment................................................... 54,037 32,341
Bad debt provision............................................... 13,546 481,265
Changes in operating assets and
liabilities:
Restricted cash................................................. (13,950,000) 5,119,732
Accounts receivable............................................. (38,427,998) 12,973,668
Advance to suppliers............................................ (110,373) (75,221)
Inventories..................................................... (11,584,205) (27,163,747)
Other receivables............................................... (1,214,310) (1,218,355)
Prepaid expenses and other current
assets......................................................... (113,938) (1,070,578)
Accounts payable................................................ 31,550,932 7,091,146
Deferred revenue................................................ 2,566,185 (7,149,445)
Other payables.................................................. (459,390) (344,805)
Accrued employee benefits....................................... 3,264,568 (1,877,905)
Accrued expenses................................................ 328,124 580,802
Other taxes payable............................................. (433,376) (245,428)
Income taxes payable............................................ (180,475) 969,930
------------ ----------
Net cash used in operating
activities....................................................... (30,649,016) (5,265,753)
Cash flows from investing activities:
(Increase) decrease of short-term
investments.................................................... (98,691,500) 27,461,856
Purchases of property and
equipment....................................................... (2,400,429) (1,080,335)
Investment in affiliate.......................................... -- (6,157,376)
------------ ----------
Net cash (used in) provided from
investing activities............................................. (101,091,929) 20,224,145
------------ ----------
-6-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(In US dollars)
Six Months Ended June 30,
---------------------------------
2000 2001
----------- -----------
(unaudited)
Cash flows from financing activities:
Net proceeds on issuance of common
stock in initial public offering................. 127,851,874 --
Increase in short-term bank loans.................. 23,705,449 36,849,100
Repayment of short-term bank loans................. (15,781,198) (43,240,303)
Proceeds on exercise of stock options.............. 892,182 1,011,147
Warrants exercised................................. 200 --
------------ ------------
Net cash provided by (used in)
financing activities............................... 136,668,507 (5,380,056)
------------ ------------
Net increase in cash and cash
equivalents........................................ 4,927,562 9,578,336
Cash and cash equivalents at beginning
of period.......................................... 25,403,884 48,833,956
Effect of exchange rate changes on cash
and cash equivalents............................... (7,867) 14,714
------------ ------------
Cash and cash equivalents at end of
period............................................. $ 30,323,579 $ 58,427,006
------------ ------------
Supplemental cash flow information:
Cash paid during the period:
Interest........................................... $ 446,302 $ 664,094
Income taxes....................................... $ 188,475 $ 270,623
============ ============
See notes to condensed consolidated financial statements.
-7-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars except shares)
1. GENERAL AND BASIS OF PREPARATION
AsiaInfo Holdings, Inc. (the "Company") was incorporated in the State of Texas,
in the United States, on June 17, 1993 and was subsequently reincorporated in
the State of Delaware in June 1998. The Company currently operates through the
following subsidiaries: AsiaInfo Technologies (China), Inc. ("AI Technology")
(100% owned), Zhejiang AsiaInfo Telecommunication Technology Co., Ltd. ("AI
Zhejiang") (100% owned) and Guangdong Wangying Information Technology Co., Ltd.
("Wangying") (40% owned, but controlled by the Company), all incorporated in the
People's Republic of China ("China" or the "PRC") and MarSec Holdings, Inc.
("MarSec") (75% owned), 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 $126.6 million. The
Company's common stock is traded on The Nasdaq National Market in the United
States.
The Company acts as a holding company and sources computer related equipment in
the U.S. for sale to customers in the PRC.
AI Technology 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 Internet-related information technology professional services
and software products.
AI Zhejiang has an initial operating term of 20 years commencing April 5, 1995
(date of establishment). Its activities are performed in the PRC and comprise
the development and sale of communication hardware and software, as well as
providing related technology services. In connection with its acquisition in
April 1999, the Company recorded goodwill of approximately $4.7 million, which
is being amortized over 5 years. AI Zhejiang's results of operations are
included in the Company's financial statements from the date of acquisition. In
March 2001, the Company commenced the process of merging AI Zhejiang into AI
Technology.
Wangying was established on September 6, 2000 with an initial operating term of
4 years for a particular customer project in the PRC.
MarSec, through its wholly owned subsidiary, provides Internet security
consulting and services in the PRC.
On April 27, 2001, the Company invested approximately $6 million acquiring
14.25% of equity interest of Intrinsic Technology (Holdings), Ltd., a company
registered in Cayman Islands and engaged in wireless Internet application and
development through its two wholly owned subsidiaries in the PRC.
The consolidated financial statements of the Company include the accounts of the
Company and its subsidiaries. Investments in 50% or less owned affiliates over
which the Company exercises significant influence, but not control, are
accounted for using the equity method. Intercompany transactions and balances
have been eliminated.
In the Company's opinion, all adjustments necessary for a fair presentation of
the unaudited results of operations for the three and six months ended June 30,
2000 and 2001 are included. All such adjustments are accruals of a normal and
recurring nature. The results of operations for the periods are not necessarily
indicative of the results of operations for the full year. The financial
statements are unaudited.
-8-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars)
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 hours 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.
Software revenues consist of software license revenues and software
implementation services revenues. Software license revenues represent license
fees which allow customers to use the Company's software products in perpetuity
up to a maximum number of users. Software implementation services revenue
includes revenue from software installation, customization, training and other
services. Substantially all of the Company's revenues from both software
license fees and software implementation services are contract-related, meaning
that these revenues are derived from customer orders requiring significant
production, modifications, or customization of the Company's software. The
Company recognizes all software revenue that is contract-related in conjunction
with the revenues of the related network solutions project over the installation
and customization period based on the percentage of completion of the project as
measured by labor hours. 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 $404,000 and $1,023,000 for the three months
ended June 30, 2000 and 2001, respectively, and $541,000 and $1,695,000 for the
six months ended June 30, 2000 and 2001, 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, 2000 and June 30, 2001 and the
reported amounts of revenues and expenses during the three and six months ended
June 30, 2000 and 2001. Actual results could differ from those estimates.
Revenue in excess of billings on service contracts is recorded as unbilled
receivables and included in trade accounts receivable, and amounted to
$33,241,532 at December 31, 2000 and $22,348,441 at June 30, 2001. Billings in
excess of revenues recognized on service contracts are recorded as deferred
income until revenue recognition criteria are met. At December 31, 2000 and
June 30, 2001, the balance of trade account receivables of $22,355,964 and
$19,794,122, respectively, represented amounts billed but not yet collected.
All billed and unbilled amounts are expected to be collected within 1 year.
With the expansion of its client base that includes smaller service providers,
the Company revisits its estimate on collectibility on a periodic basis. As a
result, accrued bad debt expenses were ($325,108) and $1,242,356 for the six
months ended June 30, 2000 and 2001, respectively.
The financial records of the Company's PRC subsidiaries are maintained in
Renminbi. 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 June 30, 2001 was US$1.00=RMB8.2770. 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.
In June 1998, the Financial Accounting Standards Board issued SFAS No.133,
"Accounting for Derivative Instruments and Hedging Activities", which was
amended by SFAS137 and SFAS138. This statement requires companies to record all
derivatives on the balance sheet as assets or liabilities measured at fair
value. Gains and losses resulting from changes in fair market values of those
derivative instruments are accounted for depending on the use of the instrument
and whether it qualifies for hedge accounting. SFAS No.133 was adopted by the
Company on January 1, 2001. Adoption of SFAS No.133 did not have a significant
effect on the Company's financial position, results of operations or cash flows.
-9-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars)
In July 2001, the Financial Accounting Standards Board issued SFAS No.141,
"Business Combinations". SFAS No.141 requires the purchase method of accounting
for business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The Company does not believe that the adoption of
SFAS No.141 will have a significant impact on its financial statements.
In July 2001, the Financial Accounting Standards Board issued SFAS No.142,
"Goodwill and Other Intangible Assets", which is effective January 1, 2002.
SFAS No.142 requires, among other things, the discontinuance of goodwill
amortization. In addition, the standard includes provisions for the
reclassification of certain existing recognized intangibles 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
impairments of goodwill. SFAS No.142 also requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
Company is currently assessing but has not yet determined the impact of SFAS
No.142 on its financial position and results of operations.
Information concerning the organization and business of the Company, accounting
policies followed by the Company and other information is contained in the notes
to the Company's financial statements for the year ended December 31, 2000
prepared as part of the Company's Form 10-K filed with the Securities and
Exchange Commission on March 16, 2001. This report should be read in
conjunction with such financial statements.
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, demand deposits, money market
funds 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
which have maturities of between 3 and 12 months. As there are no significant
market price movements, such investments are held at cost and accrued interest.
There were no realized or unrealized gains or losses.
4. COMPREHENSIVE (LOSS) INCOME
The components of comprehensive (loss) income for the periods presented are as
follows:
Three Months Ended June 30,
---------------------------
2000 2001
----------- -----------
(unaudited)
Net (loss) income............................ $ 433,707 $ 2,575,682
Change in cumulative translation adjustment.. (6,087) 10,357
----------- ------------
Comprehensive (loss) income.................. $ 427,620 $ 2,586,039
=========== ============
Six Months Ended June 30,
---------------------------
2000 2001
----------- -----------
(unaudited)
Net (loss) income............................ $(4,204,788) $3,955,064
Change in cumulative translation adjustment.. 21,393 7,915
----------- ----------
Comprehensive (loss) income.................. $(4,183,395) $3,962,979
=========== ==========
5. SHORT-TERM BANK LOANS
As of June 30, 2001, the Company had total short-term credit facilities of $24.2
million expiring in November, 2001 and June, 2002, respectively. All of these
facilities were for working capital purposes. At June 30, 2001, unused short-
term credit facilities were $17.6 million and used facilities were $6.6 million,
of which $3.1 million were used for issuing a standby letter of credit and $3.5
million were borrowings.
-10-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars except shares)
Additional borrowings of approximately $10.8 million were secured by bank
deposits of $11.3 million. All the borrowings were in RMB, the currency of the
PRC. The loans carry interest of 5.58% per annum and are repayable within one
year. Bank deposits pledged as security for the bank loans and short-term
credit facilities totaled $26.7 million and $21.6 million as of December 31,
2000 and June 30, 2001, respectively, and are presented as restricted cash in
the condensed consolidated balance sheets.
6. INVESTMENT IN AFFILIATE
In April 2001, the Company invested $6,157,376 in Intrinsic Technology
(Holdings), Ltd. ("Intrinsic") for a 14.25% equity interest. The excess of the
purchase price over the Company's percentage interest in the recorded amount of
the net assets of Intrinsic as of the acquisition date is $5,631,124. The
period of amortization for the goodwill is five years based on the estimated
useful life. The Company's share of loss of the affiliate of $256,335 includes
amortization of goodwill in the amount of $187,704. In connection with the
investment, the Company also received warrants from Intrinsic that will entitle
the Company and its co-investors to acquire a controlling interest in Intrinsic.
The investment in Intrinsic is recorded using the equity method because the
Company is able to exercise significant influence over the operating and
financial policies of Intrinsic through its representation on the Board.
Intrinsic and its wholly owned subsidiaries are engaged in wireless Internet
application and development. The Company's total investment in affiliate at
June 30, 2001 was $5.9 million.
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.
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
------------------ ---------------------------
(unaudited)
Outstanding, January 1, 2001: 8,781,865 $ 9.43
Granted........................ 2,022,560 9.34
Cancelled...................... (644,320) 15.51
Exercised...................... (236,137) 2.40
-------------------- ---------------------
Outstanding, March 31, 2001: 9,923,968 $ 9.18
Granted........................ 411,780 9.63
Cancelled...................... (297,590) 13.93
Exercised...................... (375,904) 1.18
-------------------- ---------------------
Outstanding, June 30, 2001..... 9,662,254 $ 9.37
==================== =====================
-11-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars except shares)
9. NET INCOME (LOSS) PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income (loss) per share computations:
Three Months Ended June 30, Six Months Ended June 30,
2000 2001 2000 2001
----------- ------------ ------------ ------------
(unaudited) (unaudited)
Net (loss) income (numerator):
Net (loss) income
Basic and diluted....................... $ 433,707 $ 2,575,682 $ (4,204,788) $ 3,955,064
=========== ============ ============ ============
Shares (denominator):
Basic - Weighted average
Common Stock Outstanding........ 39,738,567 41,305,291 34,279,990 41,136,459
Options................................. 7,261,746 5,455,913 -- 4,818,591
Warrants................................ 19,995 -- -- --
----------- ------------ ------------ ------------
Diluted................................... 47,020,308 46,761,204 34,279,990 45,955,050
=========== ============ ============ ============
Net (loss) income per share:
Basic................................... $ 0.01 $ 0.06 $ (0.12) $ 0.10
Diluted................................. $ 0.01 $ 0.06 $ (0.12) $ 0.09
For the six months ended June 30, 2000, the Company had securities outstanding
which could potentially dilute basic earning per share ("EPS") in the future,
but were excluded in the computation of diluted EPS in the period, as their
effect would have been antidilutive due to the net loss reported in the period.
Such outstanding securities consist of the following:
Six Months Ended June 30
------------------------
2000
(unaudited)
Outstanding Options..................... 9,085,385
Warrants................................ 20,000
-----------
9,105,385
===========
-12-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars)
10. SEGMENT AND GEOGRAPHIC OPERATING INFORMATION
Information on the Company's operating segments is as follows:
Three Months Ended June 30,
--------------------------
2000 2001
--------------------------
(unaudited)
Revenues net of hardware cost:
Network solutions net of
hardware cost.......................................... $ 7,090,587 $ 9,246,957
Software licence......................................... 4,442,288 6,705,990
Software service......................................... 202,948 1,072,940
----------- -----------
Total Software.................................... 4,645,236 7,778,930
----------- -----------
Consolidated revenues
net of hardware cost................................... 11,735,823 17,025,887
Consolidated cost of revenues
net of hardware cost................................... 3,744,833 3,676,486
----------- -----------
Consolidated gross profit................................ $ 7,990,990 $13,349,401
=========== ===========
Gross profit:
Network Solutions...................................... $ 4,075,550 $ 6,436,739
Software............................................... 3,915,440 6,912,662
----------- -----------
Consolidated gross profit................................ $ 7,990,990 $13,349,401
=========== ===========
Depreciation and amortization:
Network Solutions...................................... $ 296,438 $ 425,579
Software............................................... 224,476 358,015
----------- -----------
$ 520,914 $ 783,594
=========== ===========
(Loss) income from operations:
Network Solutions...................................... $ (791,232) $ 1,199,546
Software............................................... (937,825) 562,130
----------- -----------
Consolidated (loss) income from
operations............................................. $(1,729,057) $ 1,761,676
=========== ===========
Six Months Ended June 30,
--------------------------
2000 2001
--------------------------
(unaudited)
Revenues net of hardware cost:
Network solutions net of
hardware cost........................................ $10,768,770 $17,583,258
Software license....................................... 6,235,314 12,177,760
Software service....................................... 202,948 1,470,916
----------- -----------
Total Software.................................... 6,438,262 13,648,676
----------- -----------
Consolidated revenues
net of hardware cost................................... 17,207,032 31,231,934
Consolidated cost of revenues
net of hardware cost................................... 6,540,260 6,603,983
----------- -----------
Consolidated gross profit................................ $10,666,772 $24,627,951
=========== ===========
Gross profit:
Network Solutions...................................... $ 4,960,104 $12,702,138
Software............................................... 5,706,668 11,925,813
----------- -----------
Consolidated gross profit................................ $10,666,772 $24,627,951
=========== ===========
Depreciation and amortization:
Network Solutions...................................... $ 643,390 $ 902,994
Software............................................... 385,778 700,933
----------- -----------
$ 1,029,168 $ 1,603,927
=========== ===========
(Loss) income from operations:
Network Solutions...................................... $(4,209,922) $ 1,829,015
Software............................................... (2,460,314) (90,921)
----------- -----------
Consolidated (loss) income from
operations............................................. $(6,670,236) $ 1,738,094
=========== ===========
-13-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Six Months Ended June 30, 2000 and 2001
(In US dollars)
For the three and six months ended June 30, 2000, all of the Company's revenues
were derived from sales to customers in the People's Republic of China. For the
three and six months ended June 30, 2001, more than 90% of the Company's
revenues were derived from sales to customers in the People's Republic of China.
Revenues are attributed to the country based on the installation of hardware,
software and performance of system integration work and software related
service. Also, as of December 31, 2000 and June 30, 2001, 99% of the Company's
long-lived assets were located in the People's Republic of China.
-14-
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 China-based company providing world class software products and
network solutions. Our software products and network solutions enable our
customers to build, maintain, operate and continuously improve their Internet
and communications 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 license revenues in 1998. While we source
hardware for our customers through our U.S. parent company, AsiaInfo Holdings,
Inc., we conduct the bulk of our business through our wholly-owned operating
subsidiary, AsiaInfo Technologies (China) Inc., which is a Chinese company.
Sales to China Telecom and its provincial subsidiaries accounted for
approximately 98%, 84% and 34% of our gross revenues in 1998, 1999 and 2000,
respectively. Our customer base is continuing to diversify and, at June 30,
2001, approximately 33% of our backlog net of hardware costs was attributable to
China Telecom, while 47% was attributable to China Unicom, 3% was attributable
to China Netcom and 9% was attributable to China Mobile.
We expect our business to continue to evolve as the Internet and
telecommunications markets in China change and expand. Over the past several
years, sales of software products have been an increasingly significant
contributor to our business, accounting for 46% of revenues net of hardware
costs in the three-month period ended June 30, 2001. We expect this trend to
continue and have begun to establish arrangements with foreign companies to
distribute our software products outside of China.
We also believe that there are opportunities for us to expand into new business
areas. For example, as of June 30, 2001, we had invested a total of $2 million
in our majority-owned network security business, MarSec Holdings, Inc., which
focuses on high-end security services for our customers. MarSec generated sales
orders net of hardware costs of approximately $1.3 million in the six months
ended June 30, 2001, and we anticipate that it will generate total sales orders
net of hardware costs of approximately $3 million in 2001. MarSec's operating
results are consolidated with our operating results for financial reporting
purposes.
On April 27 2001, we invested approximately $6 million to acquire a 14.25%
equity interest in Intrinsic Technology (Holdings), Ltd., a company organized in
the Cayman Islands and engaged in wireless Internet application and development
through its two wholly owned subsidiaries in China. For the three months ended
June 30, 2001, we have accounted for our interest in Intrinsic using the equity
method, but we are currently in the process of reviewing our use of the equity
method, and may determine to use the cost method in the future.
REVENUES
Our total revenues have grown from $44.2 million in 1998 to $60.3 million in
1999 and $176.1 million in 2000. We generate our revenues from our two principal
business lines: network solutions and software products. 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 to focus increasingly on 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 by business line on this basis:
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------------ ------------------------------------------------------
BUSINESS LINE 2001 2000 2000 1999 1998 1997 1996
------------- ---- ---- ---- ---- ---- ---- ----
Network solutions net of
hardware costs 56% 63% 61% 74% 88% 93% 89%
Software 44% 37% 39% 26% 12% 7% 11%
---- ---- ---- ---- ---- ---- ----
Total revenues net of
hardware costs 100% 100% 100% 100% 100% 100% 100%
==== ==== ==== ==== ==== ==== ====
-15-
As demonstrated by the foregoing table, software revenues have accounted for an
increasing portion of our total revenues net of hardware costs over the past
several years, increasing from 11% in 1996 to 44% in the first half of 2001.
BACKLOG. Most of our revenues are derived from customers' orders under separate
binding contracts for hardware, network solutions and software products. These
contracts constitute our backlog at any given time. Revenues for hardware,
network solutions and software products are recognized during the course of the
relevant project, as described in more detail below. At June 30, 2001, our
revenue backlog net of hardware costs was $56 million, 64% of which related to
network solutions and 36% of which related to software, providing clear revenue
visibility into the next two quarters.
NETWORK SOLUTIONS REVENUES. Network solutions revenues consist 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 Internet-related market in China develops,
our customers will increasingly purchase hardware directly from hardware vendors
and pay us separately for the full value of our professional services.
We generally charge a fixed price for our network solutions projects and
recognize revenue based on the percentage of completion of the project. Labor
hours and direct project expenses are used to determine the stage of completion,
except for revenues associated with the procurement of hardware on behalf of the
customer. Such hardware-related revenues are recognized 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 revenues to
fluctuate significantly. However, these fluctuations do not significantly
affect our gross profit because hardware-related revenues generally approximate
the costs of the hardware.
There are three key milestones in the life of a network solutions project. 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
five months after hardware delivery. The third milestone is project acceptance,
which occurs when the customer agrees that we have satisfactorily completed all
our work for the project.
SOFTWARE REVENUES. In order to reflect more accurately the revenues generated
by our two strategic business units - network solutions and software - in the
second quarter of 2001 we began classifying software revenues to include two
types of software revenues: software license revenue and software services
revenue. Software license revenues consist of fees received from customers for
licenses to use our software products in perpetuity, up to a specified maximum
number of users. Our customers must purchase additional user licenses from us
when the number of users exceeds the specified maximum. Our software license
revenues also include 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 revenues from software
installation, customization, training and other services. To date, substantially
all of our revenue from both software licenses and software services has been
contract-related, meaning that it has been derived from customer orders
requiring significant production, modifications, or customization of our
software. We recognize all software revenue that is contract-related over the
installation and customization periods, based on the percentage of completion of
the project as measured by labor hours. Substantially all of our software
revenues are derived from our customer management and billing, network
management and messaging software products.
The foregoing network solutions and software revenue recognition policies result
in our recognizing certain revenues even though we are not due to receive the
corresponding cash payment under the contract. In the case of hardware sales,
the customer typically holds back around 10 to 15% of the hardware contract
amount at the time of delivery. In the case of services, while there may be
some down payment, most of the revenues becomes billable at the time of primary
acceptance. The unpaid amounts for hardware and services become payable at the
time of final project acceptance, when payment of all unpaid contract amounts is
due. When we recognize revenues for which payments are not yet due, we book
unbilled accounts receivable until the corresponding amounts become payable.
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 certain recent large projects, we
obtained 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 recognize compensation and travel costs for project
professionals as incurred. 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
-16-
customers. We currently accrue 0.8% 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. See
"Factors Affecting our Operating Results and our Common Stock -- We extend
warranties to our network solutions customers that expose us to potential
liabilities."
SOFTWARE COSTS. Software license costs consist primarily of packaging and
written manual expenses. The costs associated with creating and enhancing
software are classified as research and development expenses as incurred.
Software implementation services costs consist primarily of compensation and
travel expenses for the professionals involved in modifying, customizing or
installing our software products and in providing consultation, training and
support services.
OPERATING EXPENSES
Operating expenses are comprised of sales and marketing expenses, research and
development expenses, general and administrative expenses, and amortization
expenses for goodwill and deferred stock compensation.
Operating expenses consist for the most part of compensation expenses, which
have risen as we have expanded and hired new personnel. In 1998, we undertook a
comprehensive review of human resource policies, including salaries paid by
leading multinational IT companies operating in China. This review resulted in
a special increase in salaries for most of our employees to bring their
compensation to market levels. Although we review salaries on an annual basis
in order to ensure that we remain competitive with the market, we do not foresee
the need to make material increases in the near term. However, we may be
required to do so from time to time in the future.
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. As we expand our software business, we expect
these expenses to continue to increase.
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, most of which 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. See note 13 to our consolidated financial statements for the year
ended December 31, 2000, included in our annual report on Form 10-K, filed with
the Securities and Exchange Commission on March 16, 2001.
We make bad debt provisions for accounts receivable balances based on
management's assessment of the recoverability of revenues in accordance with the
aging of the accounts receivables. Because our client base is continually
expanding to include smaller telecommunications and Internet service providers,
we revisit our estimates on collectibility on a periodic basis. Our days sales
outstanding as of June 30, 2001, was 132 days, having increased from 115 days as
of December 31, 2001. This increase was the result of the outstanding nature of
several large backbone projects signed last year, which included substantial
hardware pass through payments. At the request of our customers, we have agreed
to allow them to withhold 15 to 20% of the payments due under the applicable
contracts until final acceptance of the projects. The aging of these
outstanding receivables will continue to increase until final acceptance, and we
increased our bad debt provisions in this quarter by including a 100% provision
for all accounts receivable that have aged over 365 days. These bad debt
provisions are reported on our income statement as operating expenses under
general and administrative expenses. See "Factors Affecting our Operating
Results and our Common Stock -- Our working capital requirements may increase
significantly."
TAXES
Except for hardware procurement and resale, 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 "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 recently received a continuation of its
preferential tax treatment from the local government for an additional three
years, which will reduce its effective income tax rate to not less than 10%. In
2001, we anticipate that the effective corporate income tax rate applicable to
AsiaInfo Technologies will be 10%. Changes in Chinese tax laws may adversely
affect our future operations.
Sales of hardware in China are subject to a 17% value added tax. Most of our
hardware sales are made through our U.S. parent company and thus are not subject
to the value added tax. We effectively pass these taxes through to our
customers and do not include them in revenues reported in our financial
statements. In respect of revenue on software license, if the net amount of
value added tax payable exceeds 3% of software sales, the excess portion of
value added tax can be
-17-
refunded immediately. The Company therefore enjoys an effective net value added
tax burden of 3% on software license revenues. This policy is effective until
2010.
We are also subject to U.S. income taxes on revenues generated in the U.S.,
including revenues from our hardware procurement activities in the U.S. 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 to our
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 the 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 $21.6 million and $57.3 million, respectively, in
the three- and six-month periods ended June 30, 2001, representing decreases of
58% and 23%, respectively, over the comparable periods in fiscal 2000. This
decrease resulted from our recording a lower than normal amount of hardware
pass-through revenues and costs in the three months ended June 30, 2001. As
discussed above under "Revenues--Network Solutions Revenues," the timing of
hardware delivery in our network solutions projects can cause gross revenues to
fluctuate significantly, but these fluctuations do not significantly affect our
gross profit because hardware-related revenues generally approximate the costs
of the hardware.
Revenues net of hardware costs were $17.0 million and $31.2 million,
respectively, in the three- and six-month periods ended June 30, 2001,
representing increases of 45% and 82%, respectively, over the comparable periods
in fiscal 2000. Our strong growth in net revenue was driven by our high-end
software and services. Total software revenues were $7.8 million
and $13.6 million, respectively, in the three- and six-month periods ended June
30, 2001, representing increases of 67% and 112%, respectively, over the
comparable periods in fiscal 2000. Of total software revenues for the three
month period ended June 30, 2001, $6.7 million was software license revenues,
representing a 51% increase over $4.4 million of software license revenues for
the comparable period of 2000, 23% sequential growth and 39% of total net
revenues.
COST OF REVENUES. Our cost of revenue was $8.2 million and $32.7 million,
respectively, in the three- and six-month periods ended June 30, 2001,
representing decreases of 81% and 48% over the comparable periods in fiscal
2000. The decreases were primarily due to a lower than normal amount of
hardware pass-through revenues and costs in the three months ended June 30,
2001, as discussed above under "- Revenues".
GROSS PROFIT. Gross profit was $13.3 million and $24.6 million, respectively,
in the three- and six-month periods ended June 30, 2001, representing increases
of 67% and 131%, respectively, over the comparable periods in fiscal 2000.
Gross profit as a percentage of gross revenues, or gross margin, was 62% and
43%, respectively, in the three- and six-month periods ended June 30, 2001, as
compared to 16% and 14% in the comparable periods of 2000. The increases in
gross profit and gross margin are attributable to the continued growth in our
higher-margin software revenues, the increased contribution of high-end services
to our network solutions projects, and the less than normal amount of hardware
pass-through revenues and costs associated with our network solutions projects
during the three months ended June 30, 2001. See the discussion above under
"-- Revenues."
OPERATING EXPENSES. Total operating expenses were $11.6 million and $22.9
million, respectively, in the three- and six-month periods ended June 30, 2001,
representing increases of 19% and 32%, respectively, over the comparable periods
in fiscal 2000.
Sales and marketing expenses were $5.8 million and $11.4 million, respectively,
in the three- and six-month periods ended June 30, 2001, representing increases
of 41% and 51%, respectively, over the comparable periods in fiscal 2000. Our
sales and marketing expenses in the second quarter of 2001 were higher than our
previous expectations as a result of a number of sales and marketing events and
exhibitions that took place during the quarter. However, we expect our sales
and marketing expenses for the full year of 2001 to be very close to our
previous estimates.
Research and development expenses were $1.9 million and $3.6 million,
respectively, in the three- and six-month periods ended June 30, 2001,
representing increases of 22% and 33%, respectively, over the comparable periods
in fiscal 2000. Although our research and development expenses for the second
quarter of 2001 were lower than our previous expectations, we expect our full-
year research and development expenses to be consistent with our previous
estimates.
General and administrative expenses were $3.5 million and $7.1 million,
respectively, in the three- and six-month periods ended June 30, 2001,
representing increases of 4% and 24%, respectively, over the comparable periods
in fiscal 2000. We continue to manage our general and administrative
-18-
expenses tightly, and have employed conservative risk management methods by
increasing our provision for bad debt in the second quarter to accommodate an
increase in days sales outstanding for our accounts receivable. See the
discussion above under "Operating Expenses."
INCOME (LOSS) FROM OPERATIONS. As a result of our strong top line growth and
cost control, we posted a higher than expected operating profit for the quarter.
For the three-month period ended June 30, 2001, we had an operating profit of
$1.8 million, compared to an operating loss of $1.7 million for the second
quarter of 2000. For the six-month period ended June 30, 2001, we had an
operating profit of $1.7 million, compared to an operating loss of $6.7 million
for the six-month period ended June 30, 2000.
OTHER INCOME (EXPENSE). Other income (expense), consisting primarily of net
interest income, totaled $1.8 million and $3.9 million for the three- and six-
month periods ended June 30, 2001, as compared to other net income of $2.1
million and $2.4 million, respectively, for the corresponding periods in 2000.
Interest income decreased to $2.2 million for the three-month period ended June
30, 2001 compared to $2.7 million for the comparable period in 2000 as a result
of lower interest rates and as a result of our having less cash in interest
bearing investments.
EQUITY IN LOSS OF AFFILIATE. In the three- and six-month periods ended June 30,
2001, equity in loss of affiliate of $256,335 represented our share of the net
loss of Intrinsic Technology (Holdings), Ltd., including goodwill amortization
of $191,815. We acquired a 14.25% interest in Intrinsic Technology (Holdings),
Ltd. on April 27, 2001.
NET INCOME. We recorded net income of $2.6 million, or $0.06 basic earnings per
share, for the quarter ended June 30, 2001 and net income of $4.0 million, or
$0.10 basic earnings per share for the six-month period ended June 30, 2001.
This is in comparison to net income of $0.4 million in the quarter ended June
30, 2000 and a net loss of $4.2 million for the six-month period ended June 30,
2000.
LIQUIDITY AND CAPITAL RESOURCES
In March 2000, we completed an initial public offering of our common stock, from
which we derived net proceeds of approximately $126.6 million. Total contributed
shareholder equity at June 30, 2001 was $174.3 million.
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 payment from our
customers for the hardware before our payments to hardware vendors are due.
However, in certain recent large projects, we obtained 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 network solutions 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 June 30, 2001 was $42.1 million, consisting
of $19.8 million in billed receivables and $22.3 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 10-15% 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 second quarter, our accounts receivable
were 132 days sales outstanding, as compared to 147 days at the end of the same
period last year and 115 days at the end of the first quarter of 2001. The main
reason for the longer period of days sales outstanding as compared to the end of
the first quarter of 2001 is the outstanding nature of several large Internet
backbone projects signed last year. These projects included large hardware pass-
through components for which the customers are entitled to withhold 15-20% of
the total payments until final acceptance of the projects. These items accounted
for about 30% of our total receivables and are reported as un-billed
receivables. The aging of these receivables will continue until final acceptance
of the projects, which we expect will occur in the second half of this year.
Based on our past collection records with the relevant customers, we are
confident that collection will be realized. However, in accordance with our
conservative risk management methodologies, we increased our bad debt provisions
for the three month period ended June 30, 2001 by including a 100% provision for
all receivables aged over 365 days. Our bad debt provisions are reported on our
income statement as operating expenses, under general and administrative
expenses.
Our inventory position at the end of the quarter was approximately $36 million.
Almost all of this inventory related to one project, signed in the first quarter
of this year. The inventory was shipped in the first week of July. As of the
date of this report, the inventory has been accepted by the customer, the
revenue has been booked in the month of July and the letter of credit collection
is in process.
-19-
As of June 30, 2001, we had total short-term credit facilities totaling $24.2
million expiring in November, 2001 and June, 2002, for working capital purposes,
of which unused short-term credit facilities were $17.6 million at that date.
At June 30, 2001, borrowings under these facilities totaled $3.5 million, and
$3.1 million was used to issue a standby letter of credit. Additional
borrowings of approximately $10.8 million were secured by bank deposits of $11.3
million. All the borrowings were in Renminbi, the currency of China. The loans
carry interest of 5.58% per annum and are repayable within one year. Bank
deposits pledged as security for these bank loans and short-term credit
facilities totaled $22 million and $27 million as of June 30, 2001 and December
31, 2000, respectively, and are presented as restricted cash in our consolidated
balance sheets.
We ended the quarter with a strong cash position of $163 million, of which $83
million was in short term investments, $22 million was in restricted cash for
the purpose of securing local currency loans, and $58 million of which was in
cash and cash equivalents. Our short-term investments feature good fixed
income, liquidity and low risk. The cash equivalents include investments in
cash management accounts to enhance our interest incomes. The main reasons for
the changes in our cash position are the $6 million investment we made in
Intrinsic Technology (Holdings), Ltd., the release of $5 million of restricted
cash to repay Renminbi-denominated loans, and a $5 million payment towards our
$36 million in inventory.
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 2001. 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. We plan to raise additional funds, if necessary, 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
In June 1998, the Financial Accounting Standards Boards issued SFAS No.133,
"Accounting for Derivative Instruments and Hedging Activities". This statement
requires companies to record all derivatives on the balance sheet as assets or
liabilities measured at fair value. Gains and losses resulting from changes in
fair market values of those derivative instruments would be accounted for
depending on the use of the instrument and whether it qualifies for hedge
accounting. We adopted SFAS No.133 on January 1, 2001 and it did not have a
material effect on our financial condition, results of operations or cash flows.
In July 2001, the Financial Accounting Standards Board issued SFAS No.141,
"Business Combinations". SFAS No.141 requires the purchase method of accounting
for business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. We do not believe that the adoption of SFAS No.141
will have a significant impact on our financial statements.
In July 2001, the Financial Accounting Standards Board issued SFAS No.142,
"Goodwill and Other Intangible Asses", which is effective January 1, 2002. SFAS
No.142 requires, among other things, the discontinuance of goodwill
amortization. In addition, the standard includes provisions for the
reclassification of certain existing recognized intangibles 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
impairments of goodwill. SFAS No.142 also requires us to complete a transitional
goodwill impairment test six months from the date of adoption. We are currently
assessing but have not yet determined the impact of SFAS No.142 on our financial
position and 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 Planning Commission of the PRC. As a result,
the growth of our business is heavily dependent on government policies for
telecommunications and Internet infrastructure. Despite the high priority
currently accorded by the government to the development of telecommunications
industry and Internet infrastructure, and a high level of funding allocated by
the government to these sectors, insufficient government allocation of
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funds to sustain the growth of the 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.
Furthermore, if demand for Internet and telecommunications service from Chinese
enterprises and households is not as strong as projected, our customers'
investment in Internet and telecommunications infrastructure is likely to
decrease. Although China's Internet population has increased dramatically in
recent years and is expected to continue to grow, the average annual household
income level in China is low relative to other industrialized nations. Low
income levels may dampen the overall commercial impact of the Internet's growth
in China relative to other countries.
LAWS AND REGULATIONS APPLICABLE TO THE INTERNET IN CHINA REMAIN UNSETTLED AND
COULD HAVE A MATERIAL ADVERSE EFFECT ON THE INTERNET'S GROWTH AND THEREBY HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Growth of the Internet in China could be materially adversely affected by
governmental regulation of the industry. Due to the increasing popularity and
use of the Internet and other online services, new regulations have been and may
continue to be adopted with respect to the Internet or other online services.
The Ministry of Information Industry has recently promulgated the Administrative
Measures on Internet Information Services and related implementing regulations.
Among other things, the Administrative Measures on Internet Information
Services:
-- require Internet content providers to obtain approval from the Ministry of
Information Industry before they can list securities overseas or obtain foreign
investment;
-- require Internet content providers to obtain licenses from various
ministries, depending on the nature of the content they provide; and
-- require Internet content providers to police their content in order to
prevent restricted material from appearing on their websites.
Because we are engaged in Internet infrastructure development and Internet-
related software development and licensing, we do not expect these new
regulations to have a direct impact on us. However, we cannot guarantee that
the adoption of these regulations or other regulations will not slow the growth
of the Internet or other online services in China. In particular, the
prohibitions against a broad but vague range of information on the Internet
(such as information that is damaging to national security, national interest,
and social order), the relevant monitoring, record-keeping, reporting and other
administrative burdens imposed on Internet access and content providers, and the
severe penalties for violations of these regulations could have a chilling
effect on Internet content providers and Internet users and could lead to
increased compliance costs for Internet content providers. Any slow-down in the
growth of the Internet in China could in turn lead to reduced Internet traffic,
and a decrease in the demand for our network solutions and Internet-related
software products.
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, China Mobile and China Netcom. 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. At June
30, 2001, China Telecom and China Unicom accounted for approximately 80% of our
backlog net of hardware costs. In the future, we expect to derive an increasing
portion of our revenues from China Unicom, China Mobile and China Netcom. 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. 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
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-- 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
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 the decline in operating results.
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 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 90% of the invoice value of the
hardware upon delivery in order to maintain competitiveness. For example, in
certain large Internet backbone projects we secured last year, we agreed to
allow our customers to withhold 15 to 20% of the total contract payments until
final acceptance of the projects. The outstanding nature of these payments and
the large size of the backbone projects have caused our number of days sales
outstanding to increase. 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 funding 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
1996 and 1998, we have sustained net losses in 1997, 1999, 2000 and prior years.
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.
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. We may not be able to implement adequate control
systems in an efficient and timely manner.
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. 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.
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SINCE OUR BUSINESS HAS BEEN EVOLVING, OUR HISTORICAL FINANCIAL INFORMATION MAY
NOT BE AN APPROPRIATE BASIS ON WHICH TO EVALUATE US OR OUR PROSPECTS.
We moved our operations from Texas to China in 1995 and began generating
significant network solutions revenue in 1996 and significant software license
revenues in 1998. We expect our business to continue to evolve as the Internet
and telecommunications markets in China change and expand. In particular, we
are currently investing substantial personnel and financial resources in
expanding our software business, which we expect to account for a significantly
greater portion of our operating expenses and revenues than in the past. As a
result, our historical financial data may not provide a meaningful basis upon
which investors may evaluate us and our prospects. You should consider the
risks and difficulties encountered by companies like ours in a new and rapidly
evolving market. Our ability to sell products and our level of success depend,
among other things, on the level of demand for Internet-related, professional IT
services and software products in China.
WE EXTEND WARRANTIES TO OUR NETWORK SOLUTIONS CUSTOMERS THAT EXPOSE US TO
POTENTIAL LIABILITIES.
We customarily provide our customers with one to three year warranties, under
which we agree to maintain the 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 recoverable for damages. In
addition, we do not currently maintain any insurance policy with respect to our
exposure to warranty claims. Although to date we have not incurred any
liability for special, consequential or incidental damages, failure of our
installed projects to operate properly could give rise to substantial claims
against us that in turn could materially and adversely affect us.
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. 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. 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 Internet 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. A part of our
network solutions business is installing Internet 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
LAW ENFORCEMENT.
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 filed trademark applications with the
United States 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 Internet-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. 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 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
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addition, litigation may be necessary in the future in order 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, we will probably need to license additional third party technology.
We cannot assure you 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, in the aggregate, 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 shareholders live outside the United States,
principally in Beijing, China and Hong Kong. Also, all or most of our assets
are located outside the United States. 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 any dividends on our capital stock and we do not
intend to declare any dividends. We currently intend to retain future earnings
to fund 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 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. Most contracts we enter
into with our customers provide for price adjustments reflecting foreign
exchange fluctuations; however, we cannot guarantee that future contracts will
contain such provisions. As a result 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 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 upon 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 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 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
investment 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 network solutions market for Internet infrastructure in China is new and
rapidly changing. Our competitors in the market mainly include domestic systems
integrators such as Ztec and Autian. 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 solutions market for Internet
infrastructure, this could hurt our profitability and erode our market share.
In the customer management and billing software market, we compete with both
international and local software providers. In the online billing segment, we
compete primarily with Portal Software, MIND and Ztec, and in the wireless
billing segment, we compete with more than ten local competitors. The messaging
software sector is highly competitive. Our principal competitors in this sector
are Open Wave (formerly known as Software.com) and Netease. Currently, due in
part to a stringent approval
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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 pending
entry into the WTO, we anticipate the entrance of new competitors into the
customer management and billing software market.
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 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 PRC 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 the 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.
THE FAILURE OF CHINA TO GAIN ENTRY INTO THE WTO COULD NEGATIVELY IMPACT THE
CHINESE ECONOMY AND OUR GROWTH.
Failure by China to join the World Trade Organization, as expected, could slow
down China's economic growth and could result in lower than forecasted spending
in the telecommunications sector in China, which in turn could adversely affect
the demand for our products and services from our large customers.
UNCERTAINTIES WITH RESPECT TO THE CHINESE LEGAL SYSTEM COULD ADVERSELY AFFECT
US.
Our principal operating subsidiary, AsiaInfo Technologies, is a wholly foreign
owned enterprise for Chinese legal purposes, which means that it is incorporated
in China and wholly-owned by foreign investors. AsiaInfo Technologies, along
with our indirect majority-owned subsidiary, MarSec Systems Inc., are subject to
laws and regulations applicable to foreign investment in China in general and
laws applicable to wholly foreign owned enterprises in particular. The
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
-- 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.
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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.
Our five largest shareholders, 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, in the
aggregate, control over 60% of our voting stock. As a result, these
shareholders 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 OF ASIAINFO 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 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.
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 seven-
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 2002. This classification of the board of directors
may have the effect of delaying or preventing changes in 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 underlying
liabilities. 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.
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PART II. OTHER INFORMATION
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 $126,608,884. As of June
30, 2001, $6.1 million of the net proceeds had been used for purchases and
installation of machinery and equipment, $8.3 million had been invested in our
subsidiaries, Marsec Holdings, Inc., Guangdong Wanying Information Technology
Co., Ltd., and Intrinsic Technology (Holdings) Ltd., and $14.7 million had been
applied to research and development and sales and marketing expenses. The
remainder of the net proceeds were held in temporary investments.
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.
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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
-------------- --------------------
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 Certificate of Merger of HTC Investments, Inc., a
Delaware Corporation, with and into AsiaInfo
Holdings, Inc., a Delaware corporation, dated
October 13, 1999/*/
10.3 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./**/
10.4 Warrant to purchase Series A Preferred Shares of
MarSec Holdings, Inc., issued to AsiaInfo
Holdings, Inc. as of September 15, 2000/**/
10.5 Lease of AsiaInfo's headquarters at 6 Zhongguancun
South Street, Beijing, China, dated August 31,
1999/*/
10.6 Agreement for the Merger of AsiaInfo Technologies
(China) Inc. and Zhejiang AsiaInfo
Telecommunications Technology Co. Ltd. /***/
10.7 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)
/*/ 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.
/***/ Incorporated by reference to our Annual Report on Form 10-K for the fiscal
year ended December 31, 2000.
(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: August 13, 2001 By: /s/ Ying Han
-------------------------------
Name: Ying Han
Title: Chief Financial Officer
(duly authorized officer
and principal financial officer)
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