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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 MARCH 31, 2002
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
---- ----
Commission File Number 001-15713
ASIAINFO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 752506390
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4TH FLOOR, ZHONGDIAN INFORMATION TOWER
6 ZHONGGUANCUN SOUTH STREET, HAIDIAN DISTRICT
BEIJING 100086, CHINA
(Address of principal executive office, including zip code)
+8610 6250 1658
(Registrant's telephone number, including area code)
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the Registrant's common stock as of
May 10, 2002 was 43,421,854
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ASIAINFO HOLDINGS, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2002
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited) 3
a) Condensed Consolidated Statements of Operations for the three
months ended March 31, 2001 and 2002 3
b) Condensed Consolidated Balance Sheets as of December 31, 2001
and March 31, 2002 4
c) Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2001 and 2002 5
d) Notes to Condensed Consolidated Financial Statements for the
three months ended March 31, 2001 and 2002 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 37
Item 5. Other Information 37
Item 6. Exhibits and Reports on Form 8-K 38
SIGNATURE 40
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US Dollars thousands, except per share amounts)
Three Months Ended March 31,
------------------------------
2001 2002
----------- -----------
(unaudited)
Revenues:
Network solutions......................... $ 29,909 $ 21,731
Software solutions........................ 5,870 6,806
----------- -----------
Total revenues............................ 35,779 28,537
----------- -----------
Cost of revenues:
Network solutions......................... 23,643 15,253
Software solutions........................ 857 1,996
----------- -----------
Total cost of revenues.................... 24,500 17,249
----------- -----------
Gross profit............................... 11,279 11,288
----------- -----------
Operating expenses:
Sales and marketing (excluding
stock-based compensation:
2001: $211; 2002: $27 and amortization
of acquired intangible assets: 2001:
nil; 2002: $225)......................... 5,627 3,569
General and administrative (excluding
stock-based compensation:
2001: $158; 2002: $92 and amortization
of acquired intangible assets: 2001;
nil; 2002: $32).......................... 3,606 3,545
Research and development (excluding
stock-based compensation:
2001: $68; 2002: $33 and amortization
of acquired intangible assets: 2001:
nil; 2002: $61).......................... 1,632 2,264
Amortization of deferred stock
compensation............................. 437 152
In-process research and development....... - 350
Amortization of acquired intangible
assets................................... - 318
----------- -----------
Total operating expenses.................. 11,302 10,198
----------- -----------
(Loss) income from operations............. (23) 1,090
----------- -----------
Other income (expense):
Interest income........................... 2,386 734
Interest expense.......................... (327) (44)
Other (expenses) income, net.............. (7) 1
----------- -----------
Total other income, net................... 2,052 691
----------- -----------
Income before income taxes,
minority interests and
equity in loss of affiliate............... 2,029 1,781
Income tax expense......................... 471 267
----------- -----------
Income before minority interests........... 1,558 1,514
Minority interests in (income) loss
of consolidated subsidiaries.............. (179) 35
Equity in loss of affiliate................ - (127)
----------- -----------
Net income................................. $ 1,379 $ 1,422
=========== ===========
Net income per share:
Basic..................................... $ 0.03 $ 0.03
=========== ===========
Diluted................................... $ 0.03 $ 0.03
=========== ===========
Shares used in computation:
Basic..................................... 40,967,627 42,430,509
=========== ===========
Diluted................................... 45,148,897 45,884,452
=========== ===========
See notes to condensed consolidated financial statements.
-3-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In US Dollars thousands, except per share amounts)
December 31, March 31,
-------------- -------------
2001 2002
-------------- -------------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents............................ $ 110,635 $ 107,620
Restricted cash...................................... 13,475 16,109
Short-term investments............................... 27,184 18,642
Accounts receivable, trade (net of allowance for
doubtful accounts of $1,094 and $2,407 at
December 31, 2001 and March 31, 2002, respectively) 66,723 82,066
Inventories - hardware and parts..................... 1,180 3,368
Other receivables.................................... 10,533 4,933
Deferred income taxes - current...................... 1,689 1,713
Prepaid expenses and other current assets............ 1,417 5,219
-------------- -------------
Total current assets............................... 232,836 239,670
Property and equipment - net........................... 5,376 5,935
Goodwill............................................... 2,188 37,255
Other acquired intangibles - net....................... - 5,462
Investment in affiliate................................ 5,272 5,145
Deferred income taxes.................................. 188 -
-------------- -------------
Total Assets....................................... $ 245,860 $ 293,467
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term bank loans................................ $ 2,924 $ 2,730
Accounts payable..................................... 23,789 22,174
Other payables....................................... 1,682 23,560
Deferred revenue..................................... 4,279 7,260
Accrued employee benefits............................ 9,088 9,896
Accrued expenses..................................... 11,431 13,215
Income taxes payable................................. 4,743 5,034
Other taxes payable.................................. 2,524 3,627
-------------- -------------
Total current liabilities.......................... 60,460 87,496
Deferred income taxes.................................. - 277
-------------- -------------
Total Liabilities.................................. 60,460 87,773
-------------- -------------
Minority interest...................................... 610 575
-------------- -------------
Stockholders' Equity:
Common stock, 100,000,000 shares authorized, $0.01
par value, shares issued and outstanding: 2001:
42,132,818; 2002: 42,663,941........................ 421 427
Additional paid-in capital........................... 178,649 197,383
Deferred stock compensation.......................... (512) (360)
Retained earnings.................................... 6,204 7,626
Accumulated other comprehensive income............... 28 43
-------------- -------------
Total stockholders' equity......................... 184,790 205,119
-------------- -------------
Total Liabilities and Stockholders' Equity......... $ 245,860 $ 293,467
============== =============
See notes to condensed consolidated financial statements.
-4-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In US Dollars thousands, except per share amounts)
Three Months Ended March 31,
----------------------------
2001 2002
-------- --------
(unaudited)
Cash flows from operating activities:
Net income............................. $ 1,379 1,422
Adjustments to reconcile net
income to net cash used in
operating activities:
Depreciation........................... 556 668
Amortization of goodwill............... 264 -
Amortization of other acquired
intangible assets..................... - 318
In-process research and development.... - 350
Amortization of deferred stock
compensation.......................... 437 152
Deferred income taxes.................. (35) (24)
Minority interest in income (loss) of
consolidated subsidiaries............. 179 (35)
Equity in loss of an affiliate......... - 127
Loss on disposal of property
and equipment......................... 6 12
Bad debt expense....................... (99) 998
Changes in operating assets and
liabilities, net of effects of
business acquired:
Restricted cash....................... (1,745) 1,893
Accounts receivable................... 10,257 (5,089)
Inventories........................... 8,615 (957)
Other receivables..................... (1,116) 1,086
Prepaid expenses and other current
assets............................... (514) (956)
Accounts payable...................... (10,298) (3,952)
Other payables........................ (646) (1,158)
Deferred revenue...................... (8,363) 1,408
Accrued employee benefits............. (2,126) 257
Accrued expenses...................... (1,067) 1,521
Income taxes payable.................. 469 291
Other taxes payable................... (7) 18
-------- ------
Net cash (used in) operating
activities............................. (3,854) (1,650)
-------- ------
Cash flows from investing activities:
(Increase) decrease in short-term
investments........................... (19,501) 8,542
Purchases of property and
equipment............................. (875) (397)
Proceeds on disposal of property
and equipment......................... 1 -
Increase in loan receivable............ - (3,572)
Purchase of a subsidiary, net of
cash acquired......................... - (4,637)
-------- ------
Net cash (used in) provided by
investing activities................... (20,375) (64)
-------- ------
-5-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(In US Dollars thousands, except per share amounts)
Three Months Ended March 31,
----------------------------
2001 2002
-------- --------
(unaudited)
Cash flows from financing activities:
Increase in short-term bank loans.......... $ 15,705 701
Repayment of short-term bank loans......... (12,914) (2,754)
Proceeds on exercise of stock options...... 566 736
-------- -------
Net cash provided by (used in)
financing activities....................... 3,357 (1,317)
-------- -------
Net (decrease) in cash and cash
equivalents: (20,872) (3,031)
Cash and cash equivalents at beginning
of period.................................. 48,834 110,635
Effect of exchange rate changes on cash
and cash equivalents....................... 3 16
-------- -------
Cash and cash equivalents at end of
period..................................... $ 27,965 107,620
======== =======
Supplemental cash flow information:
Cash paid during the period:
Interest................................... $ 324 42
Income taxes............................... $ 38 -
======== =======
Non-cash investing activity:
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson for cash of $33,387, $624 of which represented acquisition costs, and the
issuance of 1,031,686 shares of common stock with a fair market value at the
time the acquisition was announced of approximately $18,003. Of the cash amount,
$23,004 was payable as of March 31, 2002. In connection with the acquisition,
the Company acquired tangible assets with a fair value of $28,364 and assumed
liabilities of $17,737 (see Note 10).
See notes to consolidated financial statements.
-6-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US Dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION
AsiaInfo Holdings, Inc. (the "Company") is incorporated in the State of
Delaware, in the United States ("US"). The Company principally operates through
the following directly owned subsidiaries, or their respective subsidiaries:
AsiaInfo Technologies (China), Inc. ("AI Technology") (100% owned), Guangdong
Wangying Information Technology Co., Ltd. ("Wangying") (40% owned, but
controlled by the Company), both incorporated in the People's Republic of China
("China" or the "PRC"), Marsec Holdings, Inc. ("Marsec") (79% owned), and Bonson
Information Technology Holdings Limited, ("Bonson") (100% owned), both
incorporated in the Cayman Islands.
On March 2, 2000, the Company completed an initial public offering of 5,750,000
shares of its common stock, raising net proceeds of $126,610. The Company's
common stock is traded on The Nasdaq National Market in the United States.
The Company acts as a holding company and sources network-related equipment in
the United States 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. In November 2001, the Company merged its wholly owned
subsidiary, Zhejiang AsiaInfo Telecommunication Technology Co., Ltd. ("AI
Zhejiang"), into AI Technology. AI Zhejiang's activities were performed in the
PRC and comprised the development and sale of communication hardware and
software as well as providing related technology services. AI Zhejiang was
acquired in April 1999, and its results of operations are included in the
Company's financial statements from the date of acquisition.
On December 31, 2001, AI Technology formed a wholly owned subsidiary, AsiaInfo
Technologies (Chengdu), Inc., with an initial operating term of 15 years to
provide hardware procurement support for network solution projects.
Wangying was established on September 6, 2000 with an initial operating term of
4 years for a particular customer project in the PRC.
Marsec, through its wholly owned subsidiary, provides internet security
consulting and services in the PRC. In September 2001, the Company exercised
warrants to purchase 200,000 additional voting preferred shares of Marsec at
$3.50 a share increasing its investment in Marsec from 75% to 79%.
On April 27, 2001, the Company invested $6,157 to acquire a 14.25% interest
(voting preferred shares) in Intrinsic Technology (Holdings), Ltd.
("Intrinsic"), a Cayman Islands company engaged in wireless infrastructure
solutions development through two wholly-owned subsidiaries in the PRC.
In 2000, the Company dissolved its subsidiary AsiaInfo-CTC Network Systems Inc.
-7-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US Dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson, a leading developer of wireless telecommunications software and
solutions, operating through its subsidiary Guangzhou Bonson Technology Limited
based in Guangzhou, China, for cash of $32,763 and the issuance of 1,031,686
shares of common stock. (See Note 10).
The consolidated financial statements of the Company include the accounts of the
Company and its subsidiaries. Intercompany transactions and balances have been
eliminated. Investments in 50% or less owned affiliates over which the Company
exercises significant influence, but not control, are accounted for using the
equity method.
In the Company's opinion, all adjustments necessary for a fair presentation of
the unaudited results of operations for the three months ended March 31, 2001
and 2002 are included in the accompanying condensed financial statements. 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.
Revenue from network solutions contracts, which includes the procurement of
hardware on behalf of customers, systems design, planning, consulting and system
integration is recognized based on the percentage of completion method. Labor
costs and direct project expenses are used to determine the stage of completion
except for revenues associated with the procurement of hardware. Such hardware-
related revenues are recognized upon delivery. Estimates of hardware warranty
costs are included in determining project costs.
Software solutions revenues represent license fees and related services that
allow customers to use the Company's software products in perpetuity up to a
maximum number of users. Contract revenue from software license fees and
software implementation services, which generally represent customer orders
requiring significant production, modifications, or customization of the
software, is recognized in conjunction with the revenues of the related
solutions project over the installation and customization period based on the
percentage of completion of the project as measured by labor costs and direct
project expenses.
Revenue from packaged software license fees through resellers is recognized upon
the delivery and installation of the software. Costs related to insignificant
obligations for a period up to one year, which include telephone support, are
accrued at the time the revenue is recorded. Software revenues include the
benefit of the rebate of value added taxes on sales of software received from
the tax authorities as part of the PRC government's policy of encouragement of
software development in the PRC. The rebate was approximately $672 and $650 for
the three months ended March 31, 2001 and 2002, respectively.
Revisions in estimated contract profits are made in the period in which the
circumstances requiring the revision become known. Provisions, if any, are made
currently for anticipated losses on uncompleted contracts. Revenue in excess of
billings is recorded as unbilled receivables and included in trade accounts
receivable, and amounted to $45,910 at December 31, 2001 and $55,716 at March
31, 2002. Billings in excess of revenues recognized are recorded as deferred
income. Billings are rendered based on agreed milestones included in the
contracts with customers. At December 31, 2001 and March 31, 2002, the balance
of trade accounts receivable of $20,813 and $26,350 respectively, represented
amounts billed but not
-8-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US Dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
yet collected. All billed and unbilled amounts are expected to be collected
within 1 year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at December 31, 2001 and March 31, 2002 and
the reported amounts of revenues and expenses during the three months ended
March 31, 2001 and 2002. Actual results could differ from those estimates.
The financial records of the Company's PRC subsidiaries are maintained in
Renminbi ("RMB"), their functional currency and the currency of the PRC. Their
balance sheets are translated into United States dollars based on the rates of
exchange ruling at the balance sheet date. Their statements of operations are
translated using a weighted average rate for the period. Translation
adjustments are reflected as accumulative translation adjustments in
stockholders' equity.
The Renminbi is not fully convertible into United States dollars or other
foreign currencies. The rate of exchange quoted by the People's Bank of China
on March 31, 2002 was US$1.00=RMB8.2774. 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.
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires, among other things, the discontinuance of goodwill amortization.
Effective January 1, 2002, the Company discontinued amortization of its existing
goodwill of $7,068, which arose from the acquisition of AI Zhejiang and the
investment in Intrinsic, and was being amortized over 5 years. This resulted in
the elimination of amortization expenses of $546 in the three months ended March
31, 2002. In addition, the standard includes provisions for the reclassification
of certain existing recognized intangibles such as goodwill, reassessment of the
useful lives of existing recognized intangibles, reclassification of certain
intangibles out of previously reported goodwill and the identification of
reporting units for purposes of assessing potential future impairment of certain
intangible assets, including goodwill. The effects of adopting the non-
amortization provisions of SFAS No. 142, assuming these provisions were adopted
as of January 1, 2001, are summarized at Note 4. SFAS No. 142 also requires the
Company to complete a transitional goodwill impairment test six months from the
date of adoption. The Company is currently performing, but has not yet
completed, the transitional goodwill impairment test which is expected to be
completed by June 30, 2002.
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses the financial accounting and reporting requirements for the impairment
or disposal of long-lived assets and discontinued operations. SFAS No. 144
applies to all recorded long-lived assets that are held for use or that will be
disposed of, but excludes goodwill and other intangible assets that are not
amortized. SFAS No. 144 was adopted by the Company on January 1, 2002. Adoption
of SFAS No. 144 did not have a significant effect on the Company's financial
position, results of operations or cash flows.
-9-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US Dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations," which addresses the accounting
for the recognition of obligations associated with the retirement of tangible
long-lived assets. SFAS No. 143 is effective for financial statements issued
for years beginning after June 15, 2002. Management does not believe that the
adoption of SFAS No. 143 will have a significant impact on its financial
position or results of operations.
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, demand deposits and highly
liquid investments, which are unrestricted as to withdrawal or use, and which
have maturities of three months or less when purchased.
3. SHORT-TERM INVESTMENTS
Short-term investments are classified as available for sale and consist
principally of certificates of deposit issued by major financial institutions
which have maturities of between 6 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 as of March 31, 2002.
4. GOODWILL-ADOPTION OF SFAS No. 142
The following table summarizes the effect of adopting the non-amortization
provisions of SFAS No. 142, assuming these provisions were adopted as of January
1, 2001.
Three Months Ended March 31,
----------------------------
2001 2002
--------- ---------
Reported net income $ 1,379 $ 1,422
Add back: Goodwill amortization 264 -
--------- --------
Adjusted net income $ 1,643 $ 1,422
========= ========
Basic earnings per share:
Reported net income $ 0.03 $ 0.03
Goodwill amortization 0.01 -
--------- --------
Adjusted net income $ 0.04 $ 0.03
========= ========
Diluted earnings per share:
Reported net income $ 0.03 $ 0.03
Goodwill amortization 0.01 -
--------- --------
Adjusted net income $ 0.04 $ 0.03
========= ========
5. COMPREHENSIVE INCOME
The components of comprehensive income for the periods presented are as follows:
Three Months Ended March 31,
-------------------------------
2001 2002
-------------- ------------
Net income................................................................. $1,379 $1,422
Change in cumulative translation adjustment................................ (2) 15
-------------- ------------
Comprehensive income....................................................... $1,377 1,437
============== ============
6. SHORT-TERM BANK LOANS
As of March 31, 2002, the Company had total short-term credit facilities for
working capital purposes totaling $23,870 mainly expiring by June 2002. The
facilities were secured by bank deposits of $15,551 as of March 31, 2002. At
March 31, 2002, unused short-term credit facilities were $20,083 and used
facilities totaled $3,787 of which $1,467 was used for issuing standby letters
of credit provided to hardware suppliers. Additional borrowings of $410 were
secured by bank deposits of $350 and Bonson's net assets which approximated
$10,547 as of March 31, 2002. All the borrowings were in RMB, the currency of
the PRC. The loans carry interest from 4.8% to 5.733% per annum and are
repayable within one year. Additional bank deposits of $208 were used for
issuing a standby letter of credit as of March 31, 2002. Bank deposits pledged
as security for these credit facilities totaled $13,475 and $16,109 as of
December 31, 2001 and March 31, 2002, respectively, and are presented as
restricted cash in the condensed consolidated balance sheets.
-10-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US Dollars thousands, except per share amounts)
7. INCOME TAXES
The Company is subject to US federal and state income taxes. The Company's
subsidiaries incorporated in the PRC are subject to PRC income taxes.
A reconciliation between the provision for income taxes computed by applying the
US federal tax rate to income before income taxes, minority interest and equity
in loss of affiliate and the actual provision for income taxes is as follows:
Three Months Ended March 31,
----------------------------
2001 2002
------ ------
US federal rate.......................................................... 35% 35%
Differences between statutory rate and foreign effective tax rate........ (20) (24)
Expenses not deductible for tax purpose - deferred
stock compensation expense and other................................... 8 4
----- ----
23% 15%
===== ====
8. CAPITAL STOCK
Option activity in the Company's stock option plans is summarized as follows:
Outstanding options
weighted average
Number of shares exercise price per share
---------------- ------------------------
Outstanding, January 1, 2002: 8,309,168 $ 9.40
Granted............................................... 24,600 14.56
Cancelled............................................. (255,740) 11.58
Exercised............................................. (172,563) 4.26
--------------- -----------------------
Outstanding, March 31, 2002........................... 7,905,465 $ 9.46
=============== =======================
The exercise price of all options granted during the three months ended March
31, 2002 was equal to the fair market value of the Company's common stock on the
dates of grant.
-11-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US thousands, except per share amounts)
9. NET INCOME PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share computations:
Three Months Ended March 31,
----------------------------
2001 2002
------------- ------------
Net income (numerator):
Net income
Basic and diluted.......................... $ 1,379 $ 1,422
============= ============
Shares (denominator):
Weighted average
Common Stock Outstanding................... 40,967,627 42,430,509
------------- ------------
Basic........................................ 40,967,627 42,430,509
Options (Treasury Method).................... 4,181,270 3,453,943
------------- ------------
Diluted...................................... 45,148,897 45,884,452
============= ============
Net income per share:
Basic........................................ $ 0.03 $ 0.03
============= ============
Diluted...................................... $ 0.03 $ 0.03
============= ============
During the first quarter of 2001 and 2002, the Company had 2,707,220 and
1,333,140 options outstanding, respectively, which could have potentially
diluted earnings per share ("EPS") in the future, but which were excluded in the
computation of diluted EPS in these periods, as their exercise prices were above
the average market values in such periods.
10. ACQUISITION
On February 6, 2002, the Company completed the acquisition of Bonson. The
acquisition was accounted for as a purchase in accordance with SFAS No. 141,
"Business Combinations." Under the terms of the share purchase agreement, the
Company acquired all outstanding capital stock of Bonson by paying $32,763 in
cash and issuing approximately 1,031,686 shares of Company common stock. The
total purchase price as of February 6, 2002 has been allocated to the assets
acquired and liabilities assumed based on their respective fair values as
follows, (in thousands):
Total purchase price:
Cash consideration $ 32,763
Common stock 18,003
Acquisition expenses 624
---------
$ 51,390
=========
Purchase Price Allocation:
Fair market value of net tangible
assets acquired at February 6, 2002 $ 10,627
Intangible assets acquired: Economic Life
-------------
Core technology 1,280 3.5 years
Trade name 700 Indefinite
Contract backlog 2,700 2 years
Favorable lease 400 2.1 years
License 700 Indefinite
In-process technology 350
Goodwill 35,067 Indefinite
Deferred tax liabilities (434)
---------
$ 51,390
=========
-12-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US thousands, except per share amounts)
10. ACQUISITION - CONTINUED
The Company recorded a one-time charge of $350 in the first quarter of 2002 for
purchased in-process technology related to a development project that had not
reached technological feasibility, had no alternative future use, and for which
successful development was uncertain. The conclusion that the in-process
development effort, or any material sub-component, had no alternative future use
was reached in consultation with the Company and Bonson's management.
The following selected unaudited pro forma combined results of operations for
the three months ended March 31, 2001 and 2002 of the Company and Bonson have
been prepared assuming that the acquisitions occurred at the beginning of the
periods presented. The following pro forma financial information is not
necessarily indicative of the results that would have occurred had the
acquisition been completed at the beginning of the period indicated nor is it
indicative of future operating results (in thousands, except per share data):
Three Months Ended March 31,
----------------------------
2001 2002
------------ -------------
Total revenue $ 39,107 $ 29,068
Net income 984 1,100
Net income per share
- Basic $ 0.02 $ 0.03
- Diluted $ 0.02 $ 0.02
Shares used in calculation of net income per share
- Basic 41,999,313 43,268,662
- Diluted 46,180,583 46,722,605
The pro forma results of operations give effect to certain adjustments,
including amortization of purchased intangibles with definite lives, associated
with the acquisition. The charge for purchased in-process research and
development of $350 has been excluded from the pro forma results, as it is a
material non-recurring charge.
-13-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US thousands, except per share amounts)
11. SEGMENT AND GEOGRAPHIC OPERATING INFORMATION
Information on the Company's operating segments is as follows:
Three Months Ended March 31,
----------------------------
2001 2002
------------ ------------
(unaudited)
Revenues net of hardware cost:
Network solutions net of
hardware cost................................ $ 8,336 $ 10,268
Software solutions........................... 5,870 6,806
------------ ------------
Consolidated revenues
net of hardware cost......................... 14,206 17,074
Consolidated cost of sales
net of hardware cost......................... 2,927 5,786
------------ ------------
Consolidated gross profit.................... $ 11,279 $ 11,288
============ ============
Gross profit:
Network solutions............................ $ 6,266 $ 6,478
Software solutions........................... 5,013 4,810
------------ ------------
Consolidated gross profit.................... $ 11,279 $ 11,288
============ ============
Depreciation and amortization:
Network solutions............................ $ 504 $ 593
Software solutions........................... 316 393
------------ ------------
$ 820 $ 986
============ ============
Amortization of deferred stock compensation:
Network solutions............................ $ 217 $ 71
Software solutions........................... 220 81
------------ ------------
$ 437 $ 152
============ ============
Amortization of acquired intangible assets:
Network solutions............................ $ - $ 155
Software solutions........................... $ - $ 163
------------ ------------
$ - $ 318
============ ============
(Loss) income from operations:
Network solutions............................ $ (138) $ 1,917
Software solutions........................... 115 (827)
------------ ------------
Consolidated (loss) income from
operations................................... $ (23) $ 1,090
============ ============
For the three months ended March 31, 2001 and 2002, almost all of the Company's
revenues have been derived from sales to customers in the People's Republic of
China. Revenues are attributed to the country based on the country of
installation of hardware, software and performance of system integration work
and software related service. Also, as of December 31, 2001 and March 31, 2002,
99% of the Company's long-lived assets are located in the People's Republic of
China.
12. COMMITMENTS AND CONTINGENCIES
On December 4, 2001, a securities class action suit was filed in the United
States against the Company, certain of the Company's directors and the co-lead
underwriters involved in the Company's Initial Public Offering ("IPO") on behalf
of all persons and entities who purchased, converted, exchanged or otherwise
acquired the common stock of the Company between March 2, 2000 and December 6,
2000, inclusive. The complaint alleges that the Company and certain of its
officers and directors at the time of the IPO violated the federal securities
laws by issuing and selling the Company's common stock pursuant to the IPO
without disclosing to investors that several of the underwriters of the IPO had
solicited and received excessive and undisclosed commissions from certain
investors. The plaintiffs seek class action certification and claim for an
unspecified amount of damages. While the outcome of this litigation is
uncertain, management believes
-14-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2001 and 2002
(In US thousands, except per share amounts)
12. COMMITMENTS AND CONTINGENCIES - CONTINUED
that the Company has meritorious defenses to the suit and intends to vigorously
defend the action. In addition, management believes that the co-lead
underwriters may have an obligation to indemnify the Company for the legal fees
and other costs of defending this suit and that the Company's directors' and
officers' liability insurance policies may also cover the defense and exposure
or settlement of the suit.
-15-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for historical information, the statements contained in this Quarterly
Report on Form 10-Q are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. The Private Securities Litigation Reform Act of 1995 (the "Reform
Act") contains certain safe harbors regarding forward-looking statements.
Certain of the forward-looking statements include management's expectations,
intentions and beliefs with respect to our growth, our operating results, the
nature of the industry in which we are engaged, our business strategies and
plans for future operations, our needs for capital expenditures, capital
resources and liquidity; and similar expressions concerning matters that are not
historical facts. Such forward-looking statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
expressed in the statements. All forward-looking statements included in this
document are based on information available to us on the date hereof, and we
assume no obligation to update any such forward-looking statements. These
cautionary statements are being made pursuant to the provisions of the Reform
Act with the intention of obtaining the benefits of the safe harbor provisions
of the Reform Act. Among the factors that could cause actual results to differ
materially are the factors discussed below under the heading "Factors Affecting
our Operating Results and our Common Stock."
OVERVIEW
We are a leading provider of telecommunications network integration and
management solutions in China. Our software products and network services
enable our customers to build, maintain, operate, manage and continuously
improve their Internet and telecommunications infrastructure.
We commenced our operations in Texas in 1993 and moved our operations from Texas
to China in 1995. We began generating significant network solutions revenues in
1996 and significant software solutions revenues in 1998. While we source
hardware for our customers through our U.S. parent company, AsiaInfo Holdings,
Inc., and certain subsidiaries, we conduct the bulk of our business through our
wholly-owned operating subsidiary, AsiaInfo Technologies (China) Inc., or
AsiaInfo Technologies, which is a Chinese company.
Historically, our customer base was concentrated, with sales to China
Telecommunications Corporation, or China Telecom, and its provincial
subsidiaries accounting for approximately 80%, 35% and 45% of our revenues net
of hardware costs in fiscal 1999, 2000 and 2001, respectively. However, our
customer base has diversified significantly and, at March 31, 2002,
approximately 15% of our backlog net of hardware costs was attributable to China
Telecom, while 26% was attributable to China United Telecommunications
Corporation, or China Unicom, 45% was attributable to China Mobile
Communications Corporation, or China Mobile, and 4% was attributable to China
Network Communications Corporation, or China Netcom.
We believe that there are opportunities for us to expand into new business areas
and to grow our business both organically and through acquisitions. On February
6, 2002, we completed our acquisition of Bonson Information Technology Holdings
Limited, or Bonson, a leading provider of operation support system solutions to
wireless telecommunications carriers in China. The consideration paid to the
former shareholders of Bonson consisted of $32.76 million in cash and
1,031,686 shares of our common stock which were valued at approximately $18
million at the time the acquisition was announced. The cash we
-16-
paid in connection with the acquisition was paid out of our existing cash
reserves. On a stand-alone basis in 2002, we anticipate that Bonson will
generate net revenue of $12 million to $13 million, operating profit of $4.5
million to $5.5 million, and net income of $3.8 million to $4.6 million.
Bonson's operating results have been consolidated with our operating results
from February 6, 2002, and the acquisition is expected to add approximately
$0.04 to $0.05 to our 2002 earnings per share. Previously, we anticipated that
Bonson would contribute $0.08 to $0.10 to our 2002 earnings per share but have
revised this figure downwards on the basis of intangible assets we will be
required to amortize in connection with the acquisition. We will amortize a
total of $4.4 million in intangible assets, including Bonson's intellectual
property and contract backlog, over a period of two to three years. (For more
details, see Note 10 to our Financial Statements included in this Report.)
However, we have not revised our full year 2002 pro forma earnings guidance of
$0.41 to $0.43 per basic share. In view of the Bonson acquisition and potential
future acquisitions we may engage in, our historical operating results may not
be an adequate basis on which to evaluate our prospects.
As of December 31, 2001, we had invested a total of $2.7 million in our
majority-owned network security business, Marsec System Inc., or Marsec, which
focuses on high-end security services for our customers. Marsec's operating
results are consolidated with our operating results for financial reporting
purposes.
On April 27, 2001, we invested approximately $6.2 million to acquire a 14.25%
equity interest in Intrinsic Technology (Holdings), Ltd., or Intrinsic, a
company organized in the Cayman Islands and engaged in wireless Internet
application and development through its two wholly-owned subsidiaries in China.
We account for our interest in Intrinsic using the equity method.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period. On an
on-going basis, we evaluate our estimates and judgments, including those related
to revenues and cost of revenues under customer contracts, warranty obligations,
bad debts, income taxes, investment in affiliate, goodwill and other intangible
assets, and litigation. We base our estimates and judgments on historical
experience and on various other factors that we believe are reasonable. Actual
results may differ from these estimates under different assumptions or
conditions.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
REVENUES AND COST OF REVENUES. We derive a significant portion of our revenue
from fixed-price contracts using the percentage of completion method, which
relies on estimates of total expected contract revenue and costs. We follow
this method since reasonably dependable estimates of the revenue and costs
applicable to various stages of a contract can be made. Recognized revenues and
profit are subject to revisions as the contract progresses to completion.
Revisions in profit estimates are charged to income in the period in which the
facts that give rise to the revisions become known. Accordingly, changes in our
estimates would impact our future operating results.
-17-
WARRANTY OBLIGATIONS. We record our estimate of warranty costs at the time
revenue is recognized. While we obtain manufacturers' warranties for hardware
we sell, we record our obligations based on historical experience. Future
warranty costs, which vary from our past experience, could require us to adjust
our accrual for warranty obligations, thereby impacting our future operating
results.
BAD DEBTS. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the
financial condition of our customers were to change, changes to these allowances
may be required, which would impact our future operating results.
INCOME TAXES. We record a valuation allowance to reduce our deferred tax assets
to the amount that we believe is more likely than not to be realized. In the
event we were to determine that we would be able to realize our deferred tax
assets in the future in excess of their recorded amount, an adjustment to the
deferred tax asset would increase income in the period such determination was
made. Likewise, should we determine that we would not be able to realize all or
part of our net deferred tax asset in the future, an adjustment to the deferred
tax asset would be charged to income in the period such determination was made.
INVESTMENT IN AFFILIATE. We account for our 14.25% interest in Intrinsic using
the equity method. Intrinsic has incurred operating losses since our investment
in April 2001. Sustained operating losses of this affiliate or other adverse
events could result in our inability to recover the carrying value of the
investment, which may require us to record an impairment charge in the future.
Through December 31, 2001, we have not recorded an impairment charge for this
investment.
GOODWILL AND OTHER INTANGIBLE ASSETS. We make assumptions regarding estimated
future cash flows and other factors to determine the fair value of goodwill and
other intangible assets. If these estimates or their related assumptions change
in the future, we may be required to record an impairment charge if the
estimated fair value of goodwill and other intangible assets is less than its
recorded amount. Through December 31, 2001, we have not recorded an impairment
charge for goodwill and other intangible assets. Beginning January 1, 2002, we
are required to adopt Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets," and are required to analyze goodwill and
certain other intangible assets for impairment issues during the first six
months of fiscal 2002, and on a periodic basis thereafter.
LITIGATION. We record contingent liabilities relating to litigation or other
loss contingencies when we believe that the likelihood of loss is probable and
the amount of the loss can reasonably be estimated. Changes in judgments of
outcome and estimated losses are recorded, as necessary, in the period such
changes are determined or become known. Any changes in estimates would impact
our future operating results. Significant contingent liabilities, which we
believe are at least possible, are disclosed in the notes to our consolidated
financial statements.
REVENUES
At the beginning of 2002, we reorganized our operations into three strategic
business units: network infrastructure solutions, operation support system
solutions, and service application solutions. These strategic business units
comprise our three core solutions offerings. We also offer our customers network
security solutions through our majority-owned subsidiary, Marsec.
Notwithstanding this organizational structure, we continue to analyze our
revenues
-18-
on the basis of our two principal types of revenues: network solutions revenues
and software solutions revenues. For practical reasons, we cannot reclassify and
present our financial information to correspond to our four product offerings
prior to 2002. Although each of our strategic business units generates both
network solutions revenues and software solutions revenues, in 2002 the network
integration solutions unit is expected to generate approximately 70 to 80% of
our total network solutions revenues (net of hardware pass-through) and the
operation support system solutions and service application solutions units are
expected to generate approximately 90% of our total software solutions revenues.
Although we account for our network solutions revenues on a gross basis,
inclusive of hardware acquisition costs that are passed through to our
customers, we manage our business internally based on revenues net of hardware
costs, which is consistent with our strategy of providing our customers with
high value IT professional services while gradually outsourcing lower-end
services such as hardware acquisition and installation. This strategy may result
in lower growth rates for total revenues as against prior periods, but will not
adversely impact revenues net of hardware costs. The following table shows our
revenue breakdown by business line on this basis:
THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
--------------------- ------------------------------------------------------------
BUSINESS LINE 2002 2001 2001 2000 1999 1998 1997
------------- -------- -------- -------- -------- -------- -------- --------
Network solutions net of
hardware costs 60% 59% 61% 61% 74% 88% 93%
Software solutions 40% 41% 39% 39% 26% 12% 7%
---- ---- ---- ---- ---- ---- ----
Total revenues net of
hardware costs 100% 100% 100% 100% 100% 100% 100%
==== ==== ==== ==== ==== ==== ====
As demonstrated by the foregoing table, software solutions revenues have
accounted for an increasing portion of our total revenues net of hardware costs
over the past several years, increasing from 7% in 1997 to 39% in 2001 and 40%
for the first quarter of 2002. We anticipate that software solutions revenues
will account for approximately 40 to 45% of our total net revenues for 2002.
During 2001, we included as a component of software revenues the software
service revenue that had previously been included as a component of network
solutions revenue. Such change in classification is consistent with our internal
reporting structure through December 31, 2001. We have reclassified prior year
amounts to conform with this presentation.
BACKLOG. Most of our revenues are derived from customers' orders under separate
binding contracts for hardware, network solutions and software solutions. These
contracts constitute our backlog at any given time. Revenues for hardware,
network solutions and software solutions are recognized during the course of the
relevant project, as described in more detail below. At March 31, 2002, our
revenue backlog net of hardware costs was $51.4 million, a 16% increase over
backlog one year ago. Software solutions accounted for 50% of net revenue
backlog, a 72% increase over the period a year ago and a 11% sequential
increase. Bonson accounted for 27% of the total backlog net of hardware costs
and 31% of software backlog.
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
-19-
hardware vendors against letters of credit from our customers. We believe that
as the telecommunications-related market in China develops our customers will
increasingly purchase hardware directly from hardware vendors and pay us
separately for the full value of our professional services.
We generally charge a fixed price for network solutions projects and recognize
revenue based on the percentage of completion of the project. We use labor
costs and direct project expenses to determine the stage of completion, except
for revenues associated with the procurement of hardware on behalf of the
customer. We recognize such hardware-related revenues upon delivery. Since a
large part of the cost of a network solutions project often relates to hardware,
the timing of hardware delivery can cause our quarterly gross 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.
Network solutions projects generally have a life of nine to twelve months,
during which there are three key milestones. The first milestone occurs when
the hardware is delivered, which is usually between three and four months after
signing the contract. The second milestone in a network solutions project is at
primary acceptance, which usually occurs around five months after hardware
delivery. The third milestone is final acceptance, which occurs when the
customer agrees that we have satisfactorily completed all of our work on the
project.
SOFTWARE SOLUTIONS REVENUES. Software solutions revenues include two types of
revenues: software license revenues and software service revenues. 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 service revenues consist 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 some
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 costs and direct project expenses.
The foregoing network solutions and software solutions revenue recognition
policies result in our recognizing certain revenues even though we are not due
to receive the corresponding cash payment under the relevant contract. In the
case of hardware sales, the customer typically holds back around 10 to 20% of
the hardware contract 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
-20-
designing and implementing projects, and hardware warranty costs. We recognize
hardware costs in full upon delivery of the hardware to our customers. In order
to minimize our working capital requirements, we generally obtain from our
hardware vendors payment terms that are timed to permit us to receive payment
from our customers for the hardware before our payments to hardware vendors are
due. However, in large projects we sometimes obtain less favorable payment terms
from our customers, thereby increasing our working capital requirements. We
accrue hardware warranty costs when hardware revenue is fully recognized upon
final acceptance. We obtain manufacturers' warranties for hardware we sell,
which cover a portion of the warranties that we give to our customers. We
currently accrue 0.5% of hardware sales to cover potential warranty expenses.
This estimate of warranty cost is based on our current experience with contracts
for which the warranty period has expired.
SOFTWARE 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 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 primarily of compensation expenses, which have risen
as our business has grown and we have hired new personnel. We review salaries
on an annual basis in order to ensure that we remain competitive with the market
and 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.
We provide most of our officers, employees and directors, with stock options.
In the past, we granted a number of options with exercise prices below the fair
market value of the related shares at the time of grant, resulting in our
incurring deferred compensation expenses. Most of the options granted with
exercise prices below fair market value on the date of grant were issued prior
to 1997. We do not, however, intend to issue options below fair market value in
the future. Therefore, our deferred compensation expenses have been
significantly higher historically than we expect them to be in future years.
The difference between the exercise price and the fair market value of the
related shares is amortized over the vesting period of the options and reflected
on our income statement as amortization of deferred stock compensation. See
note 15 to our consolidated financial statements for the year ended December 31,
2001, included in our annual report on Form 10-K, filed with the Securities and
Exchange Commission on March 22, 2002.
We make bad debt provisions for accounts receivable balances based on
management's assessment of the recoverability of revenues in accordance with the
aging of the accounts receivable. Because our client base is continually
expanding to include smaller telecommunications and Internet service providers,
we revisit our
-21-
estimates on collectibility on a periodic basis. In any event, we make bad debt
provisions for accounts receivable balances which are aged over 1 year.
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 received a continuation of its preferential tax
treatment from the local tax authorities in China for an additional three years,
expiring at the end of 2003, which reduces our effective income tax rate to not
less than 10%. In 2002, we anticipate that the effective corporate income tax
rate applicable to AsiaInfo Technologies will be 10%. 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. Sales of software in China are subject to a 17% value added tax.
However, if the net amount of the value added tax payable exceeds 3% of software
sales, the excess portion of the value added tax is refundable immediately. We
therefore enjoy 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
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. Although, in general, our exposure to
foreign exchange risks should be limited, the value of our shares will be
affected by the foreign exchange rate between U.S. dollars and Renminbi because
the value of our business is effectively denominated in Renminbi, while our
shares are traded in U.S. dollars. Furthermore, a decline in the value of
Renminbi could reduce the U.S. dollar equivalent of the value of the earnings
from, and our investment in, our subsidiaries in China.
CONSOLIDATED RESULTS OF OPERATIONS
REVENUES. Gross revenues were $28.5 million in the three-month period ended
March 31, 2002, representing a decrease of 20% against the comparable period in
2001. This decrease was due to our recording a lower amount of hardware pass-
through costs in this quarter as compared to the first quarter of 2001. This
change reflects the increasing focus of our business on higher-margin software
solutions
-22-
and does not significantly affect our gross profit because hardware-related
revenues generally approximate the costs of the hardware.
Revenues net of hardware costs were $17.1 million in the three-month period
ended March 31, 2002, representing an increase of 20% over the comparable period
in 2001. Total software revenues were $6.8 million in the three-month period
ended March 31, 2002, representing an increase of 16% over the comparable period
in 2001. Bonson contributed 12% to this quarter's total revenue net of hardware
costs and 13% of software solutions revenues. Although our net revenues grew as
compared to the comparable period in 2001, we experienced a sequential decline
in net revenues during the first quarter of 2002. Software solutions revenues
were $6.8 million, up 4% as compared to the preceding quarter, and total net
revenues were $17.1 million, down approximately 15% as compared to the preceding
quarter. This sequential decline was attributable to the seasonality our
business experiences in the first quarter of each year due to the long public
holidays in China. It was also attributable to a slow-down in network
infrastructure spending resulting from the announcement last year of the
restructuring of certain state-controlled telecommunications companies in China,
including China Telecom. Although the planned restructuring has caused some
service providers to delay infrastructure expansion and improvement projects, we
anticipate that spending will resume in the second half of 2002, and that the
restructuring will be a long-term driver of telecommunications infrastructure
projects in China.
COST OF REVENUES. Our cost of revenues decreased to $17.2 million in the first
quarter of 2002, from $24.5 million in the first quarter of 2001. These costs
of revenue include hardware pass-through costs.
GROSS PROFIT. Our gross profit remained relatively constant in the first
quarter of 2002 at $11.3 million, as compared to the first quarter of 2001.
Gross profit as a percentage of gross revenues, or gross margin, increased to
40% in the first quarter of 2002, as compared to 32% in the first quarter of
2001. The increased gross margin is attributable to the continued growth in our
higher-margin software revenues and the increased contribution of high-end
services (as opposed to hardware acquisition and installation) in our network
solution projects.
OPERATING EXPENSES. Total operating expenses, including the contribution from
Bonson, decreased 9% to $10.2 million in the first quarter of 2002, from $11.3
million (excluding Bonson) in the first quarter of 2001.
Sales and marketing expenses decreased 37% to $3.6 million in the first quarter
of 2002, from $5.6 million in the first quarter of 2001, reflecting our
continued efforts to lower costs and increase operating efficiency. We believe
that sales and marketing expenses equalling 20-25% of net revenues are at a
sustainable level for our business over the long term.
Research and development expenses increased 39% to $2.3 million in the first
quarter of 2002 from $1.6 million in the first quarter of 2002 due to our
increased focus on developing new products and solutions for China's telecom
carriers, such as advanced operation support systems solutions.
General and administrative expenses decreased 2% to $3.5 million in the first
quarter of 2002, from $3.6 million in the first quarter of 2001. We expect
general and administrative expenses to remain relatively constant as our
business continues to achieve economies of scale.
In the first quarter of 2002 we recognized a one-time charge of approximately
$350,000 for in-process research and development related to our acquisition of
-23-
Bonson. We also recognized a charge of $318,000 for amortization of intangible
assets resulting from our acquisition of Bonson. We will amortize a total of
$4.4 million in intangible assets over a period of two to three years, $1.7
million of which will be amortized in 2002.
INCOME (LOSS) FROM OPERATIONS. Our operating income for the quarter increased
to $1.1 million in the first quarter of 2002 from an operating loss or $23,000
in the comparable period in 2001. Our expanding profitability has been driven
by increasing revenues net of hardware costs, increasing contributions from
high-end solutions and software, and effective expense control. The Bonson
acquisition contributed 6% of our operating profit for the quarter.
OTHER INCOME (EXPENSE). Other income and expenses, consisting primarily of net
interest income and expense, decreased from income of approximately $2.1 million
in the first quarter of 2001 to income of $691,000 in the first quarter of 2002,
primarily due to a decrease in interest rates and our having less cash invested
in interest bearing investments.
EQUITY IN LOSS OF AFFILIATE. Equity in loss of affiliate of approximately
$127,000 represented our proportionate share of the loss incurred by Intrinsic.
NET INCOME. We recorded net income of $1.4 million, or $0.03 basic earnings per
share, for the quarter ended March 31, 2002. The Bonson acquisition contributed
3% of the total net income this quarter. Although net income this quarter
remained the same as compared to the comparable period last year, over 60% of
this quarter's net income was generated by operations while 100% of net income
was generated by interest income in the first quarter of 2001.
LIQUIDITY AND CAPITAL RESOURCES
Our capital requirements are primarily working capital requirements related to
hardware sales and costs associated with the expansion of our business, such as
research and development and sales and marketing expenses. We recognize
hardware costs in full upon delivery of the hardware to our customers. In order
to minimize our working capital requirements, we generally obtain from our
hardware vendors payment terms that are timed to permit us to receive payment
from our customers for the hardware before our payments to hardware vendors are
due. However, we sometimes obtain less favorable payment terms from our
customers, thereby increasing our working capital requirements. See "Factors
Affecting our Operating Results and our Common Stock - Our working capital
requirements may increase significantly." We have historically financed our
working capital and other financing requirements through careful management of
our billing cycle, private placements of equity securities, our initial public
offering in March of 2000 and, to a limited extent, bank loans.
Our accounts receivable balance at March 31, 2002 was $82.1 million, consisting
of $26.4 million in billed receivables and $55.7 million in unbilled
receivables. Our billed receivables are based on revenue we have booked and
billed. Our unbilled receivables are based on revenue we have booked through
the percentage completion method, but for which we have not yet billed the
customer. For example, we recognize revenues for hardware pass-through at the
time the hardware is accepted by the customer, based on the cost of the
underlying hardware. However, our contracts with our customers will often allow
the customers to withhold 10-20% of the total contract payments until final
project acceptance, which on average is eight to nine months after hardware
delivery. As a result, revenues from hardware pass-through generally represent
a significant portion of
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our unbilled receivables and can cause the aging of these receivables to be
relatively long.
At the end of the first quarter, our days sales outstanding were 259 days. Our
billed receivables were 83 days sales outstanding and our unbilled receivables
were 176 days sales outstanding. The longer-than-normal level of days sales
outstanding is partially attributable to the large network construction project
we are currently undertaking for China Unicom, which accounted for 46% of our
total accounts receivable. We expect this project to be completed by the end of
the next quarter. The longer days sales outstanding are also partly due to the
inclusion of Bonson's accounts receivable which have longer days sales
outstanding than ours. We have changed Bonson's contract terms to bring them
more in line with our normal level of days sales outstanding. We expect days
sales outstanding to be 125 days by the end of 2002. In connection with the
inclusion of Bonson's accounts receivable on our balance sheet as of February 6,
2002, we have increased our bad debt provision by $0.35 million to $2.4 million
as of March 31, 2002, consistent with our policies of provisioning for all
receivables aged over 1 year. Historically, Bonson has never written off any
bad debt.
Our inventory position at the end of the quarter was approximately $3.4 million.
Inventories increased this quarter due to the addition of Bonson's inventory
balance of $1.8 million.
Other total assets increased to $42.7 million, due to the addition of goodwill
of $35 million and other intangible assets from the Bonson acquisition.
Deferred revenue was $7.3 million due to an increase in software down payments
and the addition of Bonson's deferred revenue balance. Other current
liabilities increased from $13.1 million to $36.8 million due to cash payable to
Bonson's shareholders of $21 million.
As of March 31, 2002, we had total short-term credit facilities totaling $23.9
million, expiring by June, 2002, for working capital purposes, of which unused
short-term credit facilities were $20.1 million at that date. At March 31,
2002, borrowings under these facilities totaled $2.3 million, and $1.5 million
had been used to issue a letter of credit. Additional borrowings of
approximately $0.4 million were secured by bank deposits of $0.35 million and
Bonson's net assets which are approximately $10.5 million. All the borrowings
were in Renminbi. The loans carry interest from 4.8% to 5.73% per annum and are
repayable within one year. Bank deposits pledged as security for these bank
loans and short-term credit facilities totaled $16.1 million as of March 31,
2002, and are presented as restricted cash in our consolidated balance sheets.
We ended the quarter with a cash position of $142.4 million, of which $18.7
million was in short term investments, $16.1 million was in restricted cash for
the purpose of securing local currency loans, and $107.6 million of which was in
cash and cash equivalents. Our short-term investments feature fixed income,
liquidity and low risk. The cash equivalents include investments in cash
management accounts to enhance our interest income. The decrease in our cash
position reflects a $4.6 million payment representing part of the cash
consideration used in the Bonson acquisition net of cash acquired. The final
portion of the cash consideration for Bonson, totalling approximately $20.4
million, was paid in the second quarter of 2002.
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 2002. We may need to raise
additional funds in the
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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
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No.142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires, among other things, the discontinuance of goodwill amortization.
Effective January 1, 2002, we discontinued amortization of existing goodwill of
approximately $7.1 million, which arose from the acquisition of Zhejiang
AsiaInfo Telecommunication Technology Co., Ltd. in April 1999 and the investment
in Intrinsic in April 2001, and was being amortized over five years. This
resulted in the elimination of amortization expenses of $546,000 in the three
months ended March 31, 2002. In addition, the standard includes provisions for
the reclassification of certain existing recognized intangibles, reassessment of
the useful lives of existing recognized intangibles, reclassification of certain
intangibles out of previously reported goodwill and the identification of
reporting units for purposes of assessing potential future impairment of certain
intangible assets, including goodwill. See Note 4 to our Financial Statements
included in this Report for a summary of the effects of adopting the non-
amortization provisions of SFAS No. 142, assuming these provisions were adopted
as of January 1, 2001. SFAS No. 142 also requires us to complete a transitional
goodwill impairment test six months from the date of adoption. We are currently
performing, but have not yet completed the transitional goodwill impairment test
which is expected to be completed by June 30, 2002.
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses the financial accounting and reporting requirements for the impairment
or disposal of long-lived assets and discontinued operations. SFAS No. 144
applies to all recorded long-lived assets that are held for use or that will be
disposed of, but excludes goodwill and other intangible assets that are not
amortized. We adopted SFAS No. 144 on January 1, 2002. Adoption of SFAS No. 144
did not have a significant effect on our financial position, results of
operations or cash flows.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations," which addresses the accounting
for the recognition of obligations associated with the retirement of tangible
long-lived assets. SFAS No. 143 is effective for financial statements issued
for years beginning after June 15, 2002. We do not believe that the adoption
of SFAS Nos. 143 will have a significant impact on our financial position or
results of operations.
FACTORS AFFECTING OUR OPERATING RESULTS AND OUR COMMON STOCK
In addition to the other information in this report, the following factors
should be considered in evaluating our business and our future prospects:
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THE GROWTH OF OUR BUSINESS IS DEPENDENT ON GOVERNMENT BUDGETARY POLICY,
PARTICULARLY THE ALLOCATION OF FUNDS TO SUSTAIN THE GROWTH OF THE
TELECOMMUNICATIONS INDUSTRY AND THE INTERNET IN CHINA.
Virtually all of our large customers are directly or indirectly owned or
controlled by the government of China. Accordingly, their business strategies,
capital expenditure budgets and spending plans are largely decided in accordance
with government policies, which, in turn, are determined on a centralized basis
at the highest level by the State Development and Planning Commission of China.
As a result, the growth of our business is heavily dependent on government
policies for telecommunications and Internet infrastructure. Despite the high
priority currently accorded by the government to the development of China's
telecommunications industry and Internet infrastructure, and a high level of
funding allocated by the government to these sectors, insufficient government
allocation of funds to sustain the growth of China's telecommunications and
Internet industries in the future could reduce the demand for our products and
services and have a material adverse effect on our ability to grow our business.
On December 11, 2001, in an effort to increase the efficiency of
telecommunications service providers through competition, the State Council of
China announced that it would split China Telecom geographically into a northern
division (comprising ten provinces) and a southern division (comprising 21
provinces). Under the State Council's plan, the northern division of China
Telecom will merge with China Netcom and Jitong Communication, and will use the
China Netcom name, while the southern division will continue to operate under
the China Telecom name. As a result of the planned restructuring, new orders
for telecommunications infrastructure expansion and improvement projects
decreased in the third and fourth quarters of 2001, adversely affecting our
backlog and our rate of net revenue growth on a sequential basis. Although we
expect that spending will resume in the second half of 2002 and that the
restructuring will have a positive impact on growth in the telecommunications
industry in China in the long-term, similar restructurings of this nature could
cause our operating results to vary unexpectedly from quarter to quarter.
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. 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.
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
government 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.
In September 2000, China's Ministry of Information Industry promulgated the
Administrative Measures on Internet Information Services and related
implementing
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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 telecommunications and Internet infrastructure
development, we do not expect these 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 slowdown 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 software products.
THE LONG AND VARIABLE SALES CYCLES FOR OUR PRODUCTS AND SERVICES CAN CAUSE OUR
REVENUES AND OPERATING RESULTS TO VARY SIGNIFICANTLY FROM PERIOD TO PERIOD AND
MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our revenues and operating results will vary significantly from quarter to
quarter due to a number of factors, many of which are outside of our control and
any of which may cause our stock price to fluctuate. A customer's decision to
purchase our services and products involves a significant commitment of its
resources and an extended evaluation. As a result, our sales cycle tends to be
lengthy. We spend considerable time and expense educating and providing
information to prospective customers about features and applications of our
services and products. Because our major customers operate large and complex
networks, they usually expand their networks in large increments on a sporadic
basis. The combination of these factors can cause our revenues and results of
operations to vary significantly and unexpectedly from quarter to quarter.
Other factors that may affect us include the following:
.. fluctuation in demand for our products and services as a result of the
budgetary cycles of our large customers, particularly state-owned
enterprises;
.. the reduction, delay, interruption or termination of one or more
infrastructure projects; and
.. our ability to introduce, develop and deliver new software products that meet
customer requirements in a timely manner.
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A large part of the contract amount of a network solutions project usually
relates to hardware procurement. Since we recognize most of the revenues
relating to hardware plus a portion of contract services revenues at the time of
hardware delivery, the timing of hardware delivery can cause our quarterly gross
revenues to fluctuate significantly. Due to the foregoing factors, we believe
that quarter to quarter comparisons of our operating results are not a good
indication of our future performance and should not be relied upon. It is
likely that our operating results in some periods may be below the expectations
of public market analysts and investors. In this event, the price of our common
stock will probably decline, perhaps significantly more in percentage terms than
any corresponding decline in our operating results.
OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE SIGNIFICANTLY.
We typically purchase hardware for our customers as part of our turn-key total
solutions services. We generally require our customers to pay 80 to 90% of the
invoice value of the hardware upon delivery. We typically place orders for
hardware against back-to-back orders from customers and seek favorable payment
terms from hardware vendors. This policy has historically minimized our working
capital requirements. However, for certain large and strategically important
projects, we have agreed to payment of less than 80 to 90% of the invoice value
of the hardware upon delivery in order to maintain competitiveness. Wider
adoption of less favorable payment terms or delays in hardware deliveries will
require us to increase our working capital needs significantly.
Our working capital requirements may also increase significantly in order to
fund more rapid expansion and acquisitions, to develop new or enhanced services
or products, to respond to competitive pressure to compete successfully for
larger projects involving higher levels of hardware purchases or otherwise if
our business grows more rapidly than we currently predict. An increase in our
working capital needs may require that we raise additional funds sooner than we
presently expect.
WE HAVE SUSTAINED LOSSES IN PRIOR YEARS AND MAY INCUR SLOWER EARNINGS GROWTH,
EARNINGS DECLINES OR NET LOSSES IN THE FUTURE.
Although we have recently achieved operating profitability and had net income in
1998 and 2001, we sustained net losses in 1997, 1999 and 2000. There are no
assurances that we can sustain profitability or avoid net losses in the future.
We continue to expect that certain of our operating expenses will increase as
our business grows. The level of these expenses will be largely based on
anticipated organizational growth and revenue trends and a high percentage will
be fixed. As a result, any delays in expanding sales volume and generating
revenue could result in substantial operating losses. Any such developments
could cause the market price of our common stock to decline.
OUR ACQUISITION OF BONSON HAS BEEN, AND ANY ACQUISITIONS WE UNDERTAKE IN THE
FUTURE MAY BE, COSTLY, AND WE MAY REALIZE LOSSES ON OUR INVESTMENTS
As a key component of our business and growth strategy, we have recently
acquired Bonson Information Technology Holdings Limited, or Bonson. In the
future, we may acquire other companies or assets that we feel will enhance our
revenue growth, operations and profitability. Such acquisitions could result in
the use of significant amounts of cash, dilutive issuances of our common stock
and amortization expenses related to goodwill and other intangible assets, each
of which could materially and adversely affect our business. Such acquisitions
involve other significant risks, including:
-29-
.. the difficulties of integrating, assimilating and managing the operations,
technologies, intellectual property, products and personnel of the acquired
business;
.. the diversion of management attention from other business concerns;
.. the additional expense associated with acquired contingent liabilities;
.. the loss of key employees in acquired businesses; and
.. the risk of being sued by terminated employees and contractors.
We will need to integrate and manage Bonson and any other businesses we
determine to acquire in the future. Our failure to do so successfully could have
a material adverse effect on our business, results of operations and financial
condition.
MANAGEMENT'S ABILITY TO IMPLEMENT ADEQUATE CONTROL SYSTEMS WILL BE CRITICAL TO
THE SUCCESSFUL MANAGEMENT OF OUR FUTURE GROWTH.
In recent years, we have been expanding our operations rapidly, both in size and
scope. Our growth places a significant strain on our management systems and
resources. Our ability to market our products successfully and implement our
business plan in a rapidly evolving market requires an effective planning and
management process. We will need to continue to improve our financial,
managerial and operational controls and reporting systems, and to expand, train
and manage our work force. Our future growth will be compromised if we cannot
implement adequate control systems in an efficient and timely manner.
WE ARE HIGHLY DEPENDENT ON OUR EXECUTIVE OFFICERS.
Each of our executive officers is responsible for an important segment of our
operations. Although we believe that we have significant depth at all levels of
management, the loss of any of our executive officers' services could be
detrimental to our operations. To ensure continuity of management, we have
entered into employment agreements with all of our executive officers. We do
not have, and do not plan to obtain, "key man" life insurance on any of our
employees.
WE FACE A COMPETITIVE LABOR MARKET IN CHINA FOR SKILLED PERSONNEL AND THEREFORE
ARE HIGHLY DEPENDENT ON THE SKILLS AND SERVICES OF OUR EXISTING KEY SKILLED
PERSONNEL AND OUR ABILITY TO HIRE ADDITIONAL SKILLED EMPLOYEES.
Competition for highly skilled software design, engineering and sales and
marketing personnel is intense in China. Our failure to attract, assimilate or
retain qualified personnel to fulfill our current or future needs could impair
our growth. Competition for skilled personnel comes primarily from a wide range
of foreign companies active in China, many of which have substantially greater
resources than we have. Limitations on our ability to hire and train a
sufficient number of personnel at all levels would limit our ability to
undertake projects in the future and could cause us to lose market share.
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 founded our business in Texas in 1993, moved our operations from Texas to
China in 1995, and began generating significant network solutions revenue in
1996 and significant software solutions revenues in 1998. We expect our
business to
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continue to evolve as the Internet and telecommunications markets in China
change and expand. 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
telecommunications and Internet-related, professional IT services and software
products in China.
WE EXTEND WARRANTIES TO OUR CUSTOMERS THAT EXPOSE US TO POTENTIAL LIABILITIES.
We customarily provide our customers with one to three year warranties, under
which we agree to maintain installed systems at no additional cost to our
customers. The maintenance services cover both hardware and our proprietary and
third party software products. Although we seek to arrange back-to-back
warranties with hardware and software vendors, we have the primary
responsibility to maintain the installed hardware and software. Our contracts
do not have disclaimers or limitations on liability for special, consequential
and incidental damages, nor do we cap the amounts our customers can recover for
damages. In addition, we do not currently maintain any insurance policy with
respect to our exposure to warranty claims. The failure of our installed
projects to operate properly could give rise to substantial liability for
special, consequential or incidental damages, that in turn could materially and
adversely affect us.
WE SELL OUR LARGE SYSTEMS INTEGRATION PROJECTS ON A FIXED-PRICE, FIXED-TIME
BASIS WHICH EXPOSES US TO RISKS ASSOCIATED WITH COST OVERRUNS AND DELAYS.
We sell substantially all of our systems integration projects on a fixed-price,
fixed-time basis. In contracts with our customers, we typically agree to pay
late completion fines of up to 5% of the total contract value. In large scale
telecommunications infrastructure projects, there are many factors beyond our
control which could cause delays or cost overruns. In this event, we would be
exposed to cost overruns and liable for late completion fines. Our failure to
complete a fixed-price, fixed-time project within budget and the required time
frame would expose us to cost overruns and penalties that could have a material
adverse effect on our business, operating results and financial condition. A
part of our business is installing network hardware. If we are unable to obtain
access to such equipment in a timely manner or on acceptable commercial terms,
our business, particularly our relationships with our customers, may be
materially and adversely affected.
WE MAY BECOME LESS COMPETITIVE IF WE ARE UNABLE TO DEVELOP OR ACQUIRE NEW
PRODUCTS OR ENHANCEMENTS TO OUR SOFTWARE PRODUCTS THAT ARE MARKETABLE ON A
TIMELY AND COST-EFFECTIVE BASIS.
We continually develop new services and proprietary software products.
Unexpected technical, operational, distribution or other problems could delay or
prevent the introduction of one or more of these products or services or any
products or services that we may plan to introduce in the future. Moreover, we
cannot be sure that any of these products and services will achieve widespread
market acceptance or generate incremental revenues.
OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED AND THERE IS A RISK OF POOR
ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS IN CHINA.
Our success and ability to compete depend substantially upon our intellectual
property rights, which we protect through a combination of copyright, trade
secret law and trademark law. We have registered some marks and filed trademark
-31-
applications for other marks with the United States Patent and Trademark Office,
the Trademark Bureau of the State Administration of Industry and Commerce in
China and the Trade Marks Registry in Hong Kong. We have also registered
copyrights with the State Copyright Bureau in China with respect to
telecommunications-related software products, although we have not applied for
copyright protection elsewhere (including the United States, which does not
require registration for protection of copyrights). 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 addition, litigation may be necessary to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others, which could result in
substantial costs and diversion of our resources.
WE ARE EXPOSED TO CERTAIN BUSINESS AND LITIGATION RISKS WITH RESPECT TO
TECHNOLOGY RIGHTS HELD BY THIRD PARTIES.
We currently license technology from third parties and intend to do so
increasingly in the future as we introduce services that require new technology.
There can be no assurance that these technology licenses will be available to us
on commercially reasonable terms, if at all. Our inability to obtain any of
these licenses could delay or compromise our ability to introduce new services.
In addition, we may or may allegedly breach the technology rights of others and
incur legal expenses and damages, which could be substantial.
INVESTORS MAY NOT BE ABLE TO ENFORCE JUDGMENTS BY UNITED STATES COURTS AGAINST
US.
We are incorporated in the State of Delaware. However, a majority of our
directors, executive officers and principal shareholders live outside the United
States, principally in Beijing and Hong Kong. As a result, you may not be able
to:
.. effect service of process upon us or these persons within the United States;
or
.. enforce against us or these persons judgments obtained in United States
courts, including judgments relating to the federal securities laws of the
United States.
WE DO NOT INTEND TO PAY AND MAY BE RESTRICTED FROM PAYING DIVIDENDS ON OUR
COMMON STOCK.
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We have never declared or paid dividends on our capital stock and we do not
intend to declare any dividends in the foreseeable future. We currently intend
to retain future earnings to fund our growth. Furthermore, if we decide to pay
dividends, foreign exchange and other regulations in China may restrict our
ability to distribute retained earnings from China or convert these payments
from Renminbi, the currency of China, into foreign currencies. In addition,
loan agreements and contractual arrangements we enter into in the future may
also restrict our ability to pay dividends.
THE FACT THAT OUR BUSINESS IS CONDUCTED IN BOTH U.S. DOLLARS AND RENMINBI MAY
SUBJECT US TO CURRENCY EXCHANGE RATE RISK DUE TO FLUCTUATIONS IN THE EXCHANGE
RATE BETWEEN THESE TWO CURRENCIES.
Substantially all of our revenues, expenses and liabilities are denominated in
either U.S. dollars or Renminbi. As a result, we are subject to the effects of
exchange rate fluctuations between these currencies. Because of the unitary
exchange rate system introduced in China on January 1, 1994, the official bank
exchange rate for conversion of Renminbi to U.S. dollars experienced a
devaluation of approximately 50%. We report our financial results in U.S.
dollars, therefore, any future devaluation of the Renminbi against the U.S.
dollar may have an adverse effect on our reported net income.
Substantially all our revenues and expenses relating to hardware sales are
denominated in U.S. dollars, and substantially all our revenues and expenses
relating to the software and services component of our business are denominated
in Renminbi. Although, in general, our exposure to foreign exchange risks
should be limited, the value in our shares may be affected by the foreign
exchange rate between the U.S. dollar and the Renminbi because the value of our
business is effectively denominated in Renminbi, while our shares are traded in
U.S. dollars. Furthermore, a decline in the value of the Renminbi could reduce
the U.S. dollar value of earnings from, and our investments in, our subsidiaries
in China.
THE MARKETS IN WHICH WE SELL OUR SERVICES AND PRODUCTS ARE COMPETITIVE AND WE
MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The market for telecommunications and Internet infrastructure solutions in China
is new and rapidly changing. Our competitors in the network infrastructure
solutions market mainly include domestic systems integrators such as Zoom
Networks and Openet Information Technology (Shenzhen) Corporation. Although we
are a leading player in this market, there are many large multinational
companies with substantial, existing information technology operations in other
markets in China, that have significantly greater financial, technological,
marketing and human resources. Should they decide to enter the network
infrastructure solutions market, this could hurt our profitability and erode our
market share. In the operation support system solutions market, we compete with
both international and local software and solutions providers.
In the online billing segment, we compete primarily with Portal Software, MIND
C.T.I. Ltd. and Zoom Networks, and in the wireless billing segment, we compete
with more than ten local competitors. Currently, due in part to a stringent
approval system for providers of wireless billing software in China and
competitive pricing offered by domestic companies, some multinational
information technology companies have been deterred from entering this market.
In view of the gradual deregulation of the Chinese telecommunications industry
and China's entry into the WTO, we anticipate the entrance of new competitors
into the operation support system solutions market.
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The service application solutions sector is highly competitive. Our principal
competitor in this sector is Openwave Systems Inc. (formerly Software.com).
In the network security solutions market, we mainly compete with Information
Security One Limited, Nsfocus Information Technology Co., Ltd., and 21ViaNet
China Inc. An increasing number of companies are devoting their resources to
this sector in developing network security products. Through mergers and
acquisitions, many information technology companies are entering the network
security solutions market as part of their strategy of providing a full range of
system integration services.
Our competitors, some of whom have greater financial, technical and human
resources than us, may be able to respond more quickly to new and emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of new products or services. It is possible
that competition in the form of new competitors or alliances, joint ventures or
consolidation among existing competitors may decrease our market share.
Increased competition could result in lower personnel utilization rates, billing
rate reductions, fewer customer engagements, reduced gross margins and loss of
market share, any one of which could materially and adversely affect our profits
and overall financial condition.
POLITICAL AND ECONOMIC POLICIES OF THE CHINESE GOVERNMENT COULD AFFECT OUR
INDUSTRY IN GENERAL AND OUR COMPETITIVE POSITION IN PARTICULAR.
Since the establishment of the People's Republic of China in 1949, the Communist
Party has been the governing political party in China. The highest bodies of
leadership are the Politburo of the Communist Party, the Central Committee and
the National People's Congress. The State Council, which is the highest
institution of government administration, reports to the National People's
Congress and has under its supervision various commissions, agencies and
ministries, including The Ministry of Information Industry, the
telecommunications regulatory body of the Chinese government. Since the late
1970s, the Chinese government has been reforming the Chinese economic system.
Although we believe that economic reform and the macroeconomic measures adopted
by the Chinese government have had and will continue to have a positive effect
on economic development in China, there can be no assurance that the economic
reform strategy will not from time to time be modified or revised. Such
modifications or revisions, if any, could have a material adverse effect on the
overall economic growth of China and investment in the Internet and the
telecommunications industry in China. Such developments could reduce, perhaps
significantly, the demand for our products and services. There is no guarantee
that the Chinese government will not impose other economic or regulatory
controls that would have a material adverse effect on our business.
Furthermore, changes in political, economic and social conditions in China,
adjustments in policies of the Chinese government or changes in laws and
regulations could adversely affect our industry in general and our competitive
position in particular.
UNCERTAINTIES WITH RESPECT TO THE CHINESE LEGAL SYSTEM COULD ADVERSELY AFFECT
US.
Our principal operating 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 certain of our other subsidiaries, are subject to laws and regulations
applicable to foreign investment in China in general and laws applicable to
wholly foreign owned enterprises in particular. Legislation and regulations
over the past 20
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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.
IF OUR STOCK PRICE IS VOLATILE, WE MAY BECOME SUBJECT TO SECURITIES LITIGATION
WHICH IS EXPENSIVE AND COULD RESULT IN A DIVERSION OF RESOURCES.
In the past, following periods of volatility in the market price of a particular
company's securities, securities class action litigation has often been brought
against that company. Many companies in our industry have been subject to this
type of litigation in the past, and we have recently become the subject of this
type of litigation. For more information on this litigation, see the discussion
under the heading "Item 3. Legal Proceedings" in our annual report on Form 10-K
for the year ended December 31, 2001 filed with the U.S. Securities and Exchange
Commission on March 22, 2002. Litigation is often expensive and diverts
management's attention and resources, which could materially and adversely
affect our business.
FUTURE SALES OF SHARES BY OUR COMPANY OR EXISTING SHAREHOLDERS COULD CAUSE THE
MARKET PRICE OF OUR COMMON STOCK TO FALL.
If our stockholders sell substantial amounts of our common stock in the public
market, including shares issued upon the exercise of outstanding options, the
market price of our common stock could fall. Such sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate.
A SMALL NUMBER OF SHAREHOLDERS CONTROLS US.
A small number of shareholders, including Warburg-Pincus Ventures, ChinaVest
Group, and their affiliates, as well as Edward Tian, one of our directors, James
Ding, our President and Chief Executive Officer, and Louis Lau, our Chairman,
control over 60% of our voting stock. As a result, these shareholders
collectively are able to control all matters requiring shareholder approval,
including election of directors and approval of significant corporate
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transactions, such as a sale of our assets and the terms of future equity
financings. The combined voting power of our large shareholders could have the
effect of delaying or preventing a change in control.
WE ARE SUBJECT TO ANTI-TAKEOVER PROVISIONS THAT COULD PREVENT A CHANGE OF
CONTROL AND PREVENT OUR SHAREHOLDERS FROM REALIZING A PREMIUM ON THEIR COMMON
STOCK.
Our board of directors has the authority to issue up to 10,000,000 shares of our
preferred stock. Without any further vote or action on the part of our
stockholders, the board of directors has the authority to determine the price,
rights, preferences, privileges and restrictions of the preferred stock. This
preferred stock, if it is ever issued, may have preference over and harm the
rights of the holders of our common stock. Although the issuance of this
preferred stock will provide us with flexibility in connection with possible
acquisitions and other corporate purposes, this issuance may make it more
difficult for a third party to acquire a majority of our outstanding voting
stock.
We currently have authorized the size of our board of directors to be not less
than three nor more than nine directors. The terms of the office of the eight-
member board of directors have been divided into three classes: Class I, whose
term will expire at the annual meeting of the stockholders to be held in 2003;
Class II, whose term will expire at the annual meeting of stockholders to be
held in 2004; and Class III, whose term will expire at the annual meeting of
stockholders to be held in 2005. This classification of the board of directors
may have the effect of delaying or preventing changes in our control or
management.
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. In general, the statute prohibits a publicly-held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date when the person became
an interested stockholder unless, subject to exceptions, the business
combination or the transaction in which the person became an interested
stockholder is approved in a prescribed manner. Generally, a "business
combination" includes a merger, asset or stock sale, or other transaction
resulting in a financial benefit to the stockholder.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest-rate risk primarily associated with our cash, short-
term investments and short-term bank loans. To date, we have not entered into
any types of derivatives to hedge against interest-rate changes, nor do we
speculate in foreign currency. However, we do maintain a significant portion of
our cash deposits in U.S. dollars to avoid currency risk related to Renminbi. A
portion of these U.S. dollar deposits are used to collateralize Renminbi-
denominated loans from Chinese banks.
Because substantially all of our revenues and expenses relating to hardware
sales are denominated in U.S. dollars, and substantially all of our revenues and
expenses relating to the service component of our network solutions business and
software business are denominated in Renminbi, we do not have significant
exposure to either the U.S. dollar or Renminbi. Thus, we do not believe that it
is necessary to enter into derivatives contracts to hedge our exposures to
either currency.
There have been no significant changes in our exposure to changes in either
interest rates or foreign currency exchange rates for the quarter ended March
31,
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2002. Our exposure to interest rates is limited as we do not have variable rate
and long-term borrowings. We are subject to variable interest rates on our bank
deposits that are cash and short-term investments. As there are no significant
market price movements, such investments are held at cost. As of March 31, 2002,
a hypothetical 10% immediate increase or decrease in interest rates would
increase or decrease our annual interest expense and income by approximately
$73,000 and $4,000, respectively.
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 $126,610,000. From the
effective date of the Registration Statement through March 31, 2002, the net
proceeds have been used for the following purposes:
Purchase and installation of machinery and equipment.............. $ 6,700,000
Temporary investments, including cash and cash equivalents........ 68,290,000
Investments in subsidiaries....................................... 29,320,000
Research and development and sales and marketing expenses......... 22,300,000
-------------
$126,610,000
=============
The net proceeds will be used for general corporate purposes, including working
capital, and expenses such as research and development and sales and marketing.
A portion of the net proceeds may also be used to acquire or invest in
complementary businesses or products. None of the net proceeds of the offering
have been paid directly or indirectly to our directors, officers or their
associates, to persons owning ten percent or more of our common stock, or to our
affiliates.
ITEM 5. OTHER INFORMATION
We held our Annual Meeting of Shareholders on April 23, 2002. For more
information on the following proposals, please refer to our definitive proxy
statement dated March 22, 2002, the relevant portions of which are incorporated
herein by reference.
(1) Our shareholders elected each of the three nominees to our Board of
Directors for a three-year term:
DIRECTOR FOR WITHHELD
-------- --- --------
Edward Tian 31,879,656 83,867
Chang Sun 31,885,656 77,867
Michael Zhao 31,327,801 635,722
(2) Our shareholders ratified the appointment of Deloitte Touche Tohmatsu as our
independent auditors:
For 31,767,922
Against 91,847
Abstain 103,754
-------------
Total 31,963,523
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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
-------------- --------------------
2.1 Share Purchase Agreement for the acquisition of Bonson
Information Technology Holdings Limited/****/
3.1 Certificate of Incorporation of AsiaInfo Holdings, Inc.,
dated June 8, 1998/*/
3.2 Certificate of Amendment to Certificate of Incorporation of
AsiaInfo Holdings, Inc., dated August 27, 1999/*/
3.3 Certificate of Amendment to Certificate of Incorporation of
AsiaInfo Holdings, Inc., dated November 15, 2000/***/
3.4 Certificate of Correction to Certificate of Amendment to
Certificate of Incorporation of AsiaInfo Holdings, Inc.,
dated January 18, 2001/***/
3.5 By-Laws of AsiaInfo Holdings, Inc., dated December 19,
2000/***/
4.1 Specimen Share Certificate representing AsiaInfo Holdings,
Inc. shares of common stock/*/
10.1 2000 Stock Option Plan, approved and adopted as of October
18, 2000/**/
10.2 Shareholders' Agreement of Marsec Holdings, Inc., dated as
of September 15, 2000, by and among AsiaInfo Holdings, Inc.
and the Founders (as defined therein) of Marsec Holdings,
Inc./**/
10.3 Lease of AsiaInfo's headquarters at 6 Zhongguancun South
Street, Beijing, China, dated August 31, 1999/*/
10.4 Agreement for the Establishment of a Limited Liability
Company (Guangdong Wangying Communications Technology
Company Limited) and Capital Contribution/***/
11.1 Statement regarding computation of per share earnings
(included in note 9 to condensed consolidated financial
statements)
/*/ 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.
/***/ Incorporated by reference to our Current Report on Form 8-K filed on
February 21, 2002.
(b) Reports on form 8-K
We filed a Current Report on Form 8-K on February 21, 2002 relating to the
completion of our acquisition of Bonson Information Technology Holdings Limited,
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or Bonson, pursuant to a Share Purchase Agreement dated as of January 20, 2002
by and among the Company, Bonson and the shareholders of Bonson.
We filed a Current Report on Form 8-K/A on April 22, 2002 attaching certain
audited financial statements of Bonson and certain of our pro forma financial
statements.
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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: May 14, 2002 By: /s/ Ying Han
-------------------------------
Name: Ying Han
Title: Chief Financial Officer
(duly authorized officer
and principal financial officer)
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