================================================================================
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, 2003
[_] 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 9, 2003 was 44,245,377
================================================================================
-1-
ASIAINFO HOLDINGS, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
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, 2002 and 2003 ..................................... 3
b) Condensed Consolidated Balance Sheets as of December 31, 2002
and March 31, 2003 ....................................................... 4
c) Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2002 and 2003 ..................................... 5
d) Notes to Condensed Consolidated Financial Statements for the
three months ended March 31, 2002 and 2003 ............................... 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 ............... 32
Item 4. Controls and Procedures .................................................. 32
PART II. OTHER INFORMATION ........................................................ 33
Item 1. Legal Proceedings ........................................................ 33
Item 2. Changes in Securities and Use of Proceeds ................................ 33
Item 5. Other Information ........................................................ 34
Item 6. Exhibits and Reports on Form 8-K ......................................... 34
SIGNATURE ........................................................................... 36
CERTIFICATIONS ...................................................................... 37
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In US Dollars thousands, except per share amounts)
Three Months Ended
March 31,
----------------------------
2002 2003
------------ ------------
(unaudited)
Revenues:
Communications solutions ................................ $ 17,294 $ 23,127
Operation support system solutions ...................... 11,243 7,546
------------ ------------
Total revenues .......................................... 28,537 30,673
------------ ------------
Cost of revenues:
Communications solutions ................................ 12,116 18,739
Operation support system solutions ...................... 5,133 4,430
------------ ------------
Total cost of revenues .................................. 17,249 23,169
------------ ------------
Gross profit .............................................. 11,288 7,504
------------ ------------
Operating expenses:
Sales and marketing (excluding stock-based
compensation: 2002: $27; 2003: $28 and amortization
of acquired intangible assets: 2002: $225; 2003: $6)... 3,569 2,514
General and administrative (excluding stock-based
compensation: 2002: $92; 2003: $32 and amortization
of acquired intangible assets: 2002: $32; 2003: $41)... 3,545 2,317
Research and development (excluding stock-based
compensation: 2002: $33; 2003: $9 and amortization
of acquired intangible assets: 2002: $61; 2003: nil)... 2,264 2,545
Amortization of deferred stock compensation ............. 152 69
In-process research and development ..................... 350 -
Impairment of goodwill and acquired intangible assets ... - 30,221
Amortization of acquired intangible assets .............. 318 47
------------ ------------
Total operating expenses ................................ 10,198 37,713
------------ ------------
Income (loss) from operations ............................. 1,090 (30,209)
------------ ------------
Other income (expense):
Interest income ......................................... 734 454
Interest expense ........................................ (44) (1)
Other income, net ....................................... 1 -
------------ ------------
Total other income, net ................................. 691 453
------------ ------------
Income (loss) before income taxes, minority interests
and equity in loss of affiliate ......................... 1,781 (29,756)
Income tax expense (benefit) .............................. 267 (824)
------------ ------------
Income before minority interests .......................... 1,514 (28,932)
Minority interests in loss of consolidated
subsidiaries ............................................ 35 -
Equity in loss of affiliate ............................... (127) (115)
------------ ------------
Net income (loss) ......................................... $ 1,422 $ (29,047)
============ ============
Net income (loss) per share:
Basic ................................................... $ 0.03 $ (0.66)
============ ============
Diluted ................................................. $ 0.03 $ (0.66)
============ ============
Shares used in computation:
Basic ................................................... 42,430,509 44,206,625
============ ============
Diluted ................................................. 45,884,452 44,206,625
============ ============
See notes to condensed consolidated financial statements.
-3-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(In US Dollars thousands, except per share amounts)
December 31, March 31,
------------ -----------
2002 (1) 2003
------------ -----------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents ............................... $ 115,153 $ 115,200
Restricted cash ......................................... 14,458 15,273
Short-term investments .................................. 11,260 11,294
Accounts receivable, trade (net of allowance for
doubtful accounts of $1,133 and $1,418 at December 31,
2002 and March 31, 2003, respectively) ................ 49,437 64,980
Inventories ............................................. 10,934 6,952
Other receivables ....................................... 8,758 6,799
Deferred income taxes - current ......................... 1,653 1,877
Prepaid expenses and other current assets ............... 3,441 3,183
--------- ---------
Total current assets .................................. 215,094 225,558
Property and equipment - net .............................. 4,046 3,568
Goodwill .................................................. 37,255 11,255
Other acquired intangibles - net .......................... 4,031 148
Investment in affiliate ................................... 2,808 2,693
Deferred income taxes ..................................... 196 141
--------- ---------
Total Assets .......................................... $ 263,430 $ 243,363
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term bank loans ................................... $ 60 $ 60
Accounts payable ........................................ 21,708 32,475
Other payables .......................................... 2,483 2,311
Deferred revenue ........................................ 5,056 5,343
Accrued employee benefits ............................... 5,083 5,344
Other accrued expenses .................................. 13,226 11,805
Income taxes payable .................................... 2,760 1,993
Other taxes payable ..................................... 2,579 2,204
--------- ---------
Total current liabilities ............................. 52,955 61,535
--------- ---------
Minority interest ......................................... 317 452
--------- ---------
Stockholders' Equity:
Common stock, 100,000,000 shares authorized, $0.01
par value, shares issued and outstanding:
2002: 44,193,474; 2003: 44,210,949 .................... 442 442
Additional paid-in capital .............................. 200,649 200,841
Deferred stock compensation ............................. (105) (36)
Retained earnings (accumulated deficit) ................. 9,110 (19,937)
Accumulated other comprehensive income .................. 62 66
--------- ---------
Total stockholders' equity ............................ 210,158 181,376
--------- ---------
Total Liabilities and Stockholders' Equity ............ $ 263,430 243,363
========= =========
See notes to condensed consolidated financial statements.
(1) December 31, 2002 balances were obtained from audited financial statements.
-4-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In US Dollars thousands, except per share amounts)
Three Months Ended
March 31,
----------------------------------
2002 2003
------------ ----------
(unaudited)
Cash flows from operating activities:
Net income (loss) ............................................................ $ 1,422 $ (29,047)
Adjustments to reconcile net income (loss) to net cash (used in provided by
operating activities:
Depreciation ................................................................. 668 616
Amortization of other acquired intangible assets ............................. 318 47
Impairment of goodwill and acquired intangible assets ........................ - 30,221
In-process research and development .......................................... 350 -
Amortization of deferred stock compensation .................................. 152 69
Deferred income taxes ........................................................ (24) (168)
Minority interest in (loss) of consolidated subsidiaries ..................... (35) -
Equity in loss of an affiliate ............................................... 127 115
Loss on disposal of property and equipment ................................... 12 6
Bad debt expense ............................................................. 998 284
Changes in operating assets and liabilities, net of effects of business
acquired:
Restricted cash ............................................................ 1,893 (815)
Accounts receivable ........................................................ (5,089) (15,827)
Inventories (957) 3,982
Other receivables .......................................................... 1,086 1,960
Prepaid expenses and other current assets .................................. (956) 257
Accounts payable ........................................................... (3,952) 10,766
Other payables ............................................................. (1,158) (321)
Deferred revenue ........................................................... 1,408 287
Accrued employee benefits .................................................. 257 262
Other accrued expenses ..................................................... 1,521 (1,421)
Income taxes payable ....................................................... 291 (688)
Other taxes payable ........................................................ 18 (375)
------------ ----------
Net cash (used in) provided by operating activities ............................ (1,650) 210
------------ ----------
Cash flows from investing activities:
Decrease (increase) in short-term investments ................................ 8,542 (34)
Purchases of property and equipment .......................................... (397) (143)
Increase in loan receivable .................................................. (3,572) -
Purchase of a subsidiary, net of cash acquired ............................... (4,637) -
------------ ----------
Net cash used in investing activities .......................................... (64) (177)
------------ ----------
-5-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)--(CONTINUED)
(In US Dollars thousands, except per share amounts)
Three Months Ended
March 31,
-------------------------
2002 2003
---------- --------
(unaudited)
Cash flows from financing activities:
Increase in short-term bank loans ..................................... $ 701 -
Repayment of short-term bank loans .................................... (2,754) -
Proceeds on exercise of stock options ................................. 736 12
---------- --------
Net cash (used in) provided by financing activities ................... (1,317) 12
---------- --------
Net increase in cash and cash equivalents: .............................. (3,031) 45
Cash and cash equivalents at beginning of period ........................ 110,635 115,153
Effect of exchange rate changes on cash and cash equivalents ............ 16 2
---------- --------
Cash and cash equivalents at end of period .............................. $ 107,620 $115,200
========== ========
Supplemental cash flow information:
Cash paid during the period:
Interest .............................................................. $ 42 -
========== ========
Non-cash investing activity:
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson for cash of $33,387, of which $624 represented acquisition costs, and the
issuance of 1,031,686 shares of common stock with a fair market value at the
time the acquisition was announced of approximately $18,003. Of the cash amount,
$20,433 was paid on April 4, 2002. In connection with the acquisition, the
Company acquired assets with a fair value of $28,364 and assumed liabilities of
$17,737.
See notes to condensed consolidated financial statements.
-6-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(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 of America (the "US"). The Company principally
operates through the following directly owned subsidiaries, or their respective
subsidiaries: AsiaInfo Technologies (China), Inc. ("AsiaInfo Technologies")
(100% owned), incorporated in the People's Republic of China ("China" or the
"PRC"), Marsec Holdings, Inc. ("Marsec") (100% owned), and Bonson Information
Technology Holdings Limited, ("Bonson") (100% owned), both incorporated in the
Cayman Islands.
On March 2, 2000, the Company completed an initial public offering of 5,750,000
shares of its common stock, raising net proceeds of $126,610. The Company's
common stock is traded on The Nasdaq National Market in the United States.
The Company acts as a holding company and, through certain subsidiaries, sources
network-related equipment in the United States for sale to customers in the PRC.
AsiaInfo Technologies was established as a wholly foreign owned enterprise with
an initial operating term of 15 years commencing May 2, 1995 (date of
establishment). Its principal activities are conducted in the PRC and comprise
the provision of telecommunications-related information technology professional
services and software products. In November 2001, the Company merged its wholly
owned subsidiary, Zhejiang AsiaInfo Telecommunication Technology Co., Ltd. ("AI
Zhejiang"), into AsiaInfo Technologies. AI Zhejiang's activities were performed
in the PRC and comprised the development and sale of communication hardware and
software as well as providing related technology services. AI Zhejiang was
acquired in April 1999.
On December 31, 2001, AsiaInfo Technologies formed a wholly owned subsidiary,
AsiaInfo Technologies (Chengdu), Inc. ("AI Chengdu"), with an initial operating
term of 15 years to provide operational support for system integration.
Guangdong Wangying Communications Technology Co., Ltd. ("Wangying") (40% owned,
but controlled by AsiaInfo Technologies) was established on September 6, 2000
with an initial operating term of 4 years for a particular customer project in
the PRC. As of March 31, 2003, Wangying was being liquidated.
Marsec, through its wholly owned subsidiary, provides network 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 January
22, 2003, the Company entered into an agreement to acquire 250,000 common shares
of Marsec, thereby increasing its ownership interest in Marsec from 79% to 100%.
The aggregate acquisition price consisted of 14,375 shares of the Company's
common stock and approximately $150,000 in cash. The total consideration was
recorded as goodwill on the date of the transaction but the management believed
such goodwill was impaired. As a result, the full amount was charged to the
impairment of goodwill and acquired intangible assets in the condensed
consolidated statements of operations.
On April 27, 2001, the Company invested approximately $6,157 to acquire a 14.25%
interest (in the form of voting preferred shares) in Intrinsic Technology
(Holdings), Ltd. ("Intrinsic"), a Cayman Islands company engaged in wireless
infrastructure solutions development through two wholly owned subsidiaries in
the PRC. As of March 31, 2003, the Company's interest in Intrinsic had been
diluted from 14.25% to 14.22% due to another shareholder's exercise of warrants
to purchase 37,770 shares of Intrinsic's stock. The change in the interest of
Intrinsic is not material and the relevant loss as a result of such change has
been recorded as a component of equity.
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
-7-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
its subsidiary AsiaInfo Management Software, Inc. (formerly Guangzhou Bonson
Technology Limited) ("AsiaInfo Management"), based in Guangzhou, China, for
$32,763 in cash and the issuance of 1,031,686 shares of the Company's common
stock.
The consolidated financial statements include the financial statements of the
Company and its subsidiaries. All significant inter-company transactions and
balances are eliminated in consolidation. Investments in 50% or less owned
affiliates over which the Company exercises significant influence, but not
control, are accounted for using the equity method. The Company's share of
earnings (losses) of these companies is included in the accompanying
consolidated statement of operations.
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, 2002
and 2003 are included in the accompanying condensed financial statements. All
such adjustments are 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.
The Company's revenue is derived from the procurement of hardware on behalf of
customers, software license fees, and professional services for systems design,
planning, consulting, and system integration, and is recognized based on the
percentage of completion method. Revenues in both communications solutions and
operation support system solutions from customer orders requiring significant
production, modifications, or customization of the software are recognized over
the installation and customization period. 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. Revenue from packaged software license fees through
reseller arrangements is recorded when the related products are shipped and
installed. Costs related to insignificant obligations for a period of up to one
year, which include telephone support, are accrued at the time the revenue is
recorded.
Revenue in both communications solutions and operation support system solutions
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 $650 and $493
for the three months ended March 31, 2002 and 2003, 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 $28,767 at December 31, 2002 and $44,278 at March
31, 2003. 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, 2002 and March 31, 2003, the balance of trade accounts
receivable of $20,670 and $20,702, respectively, represented amounts billed but
not yet collected. All billed and unbilled amounts are expected to be collected
within 1 year.
These financial statements of the Company and its subsidiaries are prepared in
accordance with accounting principles generally accepted in the United States of
America U.S. GAAP"). This basis of accounting differs from that used in the
statutory financial statements of the PRC subsidiaries which are prepared in
accordance with the accounting principles and the relevant financial regulations
applicable to enterprises with foreign investment as established by China's
Ministry of Finance. The principal adjustments made to conform the statutory
financial statements of these subsidiaries to U.S. GAAP included an adjustment
to
-8-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
record goodwill from business acquisitions and the related impairment
provisions, and an adjustment to recognize compensation expense on the issuance
of stock options.
The preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
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, 2003 was US$1.00=RMB8.2771. No representation is made that the
Renminbi amounts could have been, or could be, converted into United States
dollars at that rate or at any other rate.
The financial records of the Company's PRC subsidiaries are maintained in
Renminbi ("RMB"), their functional currency and the currency of the PRC. Their
balance sheets are translated into United States dollars based on the rates of
exchange ruling at the balance sheet date. Their statements of operations are
translated using a weighted average rate for the period. Translation adjustments
are reflected as cumulative translation adjustments in stockholders' equity.
In August 2001, the FASB 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. The Company
adopted SFAS No. 143 on January 1, 2003. This adoption did not have a
significant impact on the Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123," which provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The amended disclosure
requirements of SFAS No. 148 are effective for years ending after December 15,
2002 and are reflected in the Company's condensed consolidated financial
statements.
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 for such investments, they are held at cost and accrued
interest. There were no realized or unrealized gains or losses as of March 31,
2003.
4. COMPREHENSIVE INCOME
The components of comprehensive income for the periods presented are as follows:
Three Months Ended March 31,
----------------------------
2002 2003
------- --------
Net income(loss) ............................... $ 1,422 $(29,047)
Change in cumulative translation adjustment .... 15 4
------- --------
Comprehensive income(loss) ..................... $ 1,437 $(29,043)
======= ========
-9-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
5. SHORT-TERM BANK LOANS
As of December 31, 2002 and March 31, 2003, the Company had total short-term
credit facilities for working capital purposes totaling $20,000 expiring by
October 2003. The facilities were secured by bank deposits of $10,000 as of
December 31, 2002 and March 31, 2003, respectively. At December 31, 2002, unused
short-term credit facilities were $18,574 and used facilities totaled $1,426.
The used facilities were pledged as security for standby letters of credit
issued to hardware suppliers and customers. Additional bank deposits of $4,458
were used for issuing standby letters of credit and guarantees as of December
31, 2002. At March 31, 2003, unused short-term credit facilities were $19,664
and used facilities totaled $336. The used facilities are pledged as security
for standby letters of credit issued to hardware suppliers and customers.
Additional bank deposits of $5,273 were used for issuing standby letters of
credit and guarantees as of March 31, 2003. Bank deposits pledged as security
for these credit facilities totaled $14,458 and $15,273 as of December 31, 2002
and March 31, 2003, respectively, and are presented as restricted cash in the
consolidated balance sheets.
In addition, as of December 31, 2002 and March 31, 2003, the Company had
short-term borrowings of $60 in RMB, the currency of the PRC, bearing an
interest rate of 4.8% and secured by AsiaInfo Management's assets.
6. 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,
------------------
2002 2003
---- ----
US federal rate ......................................... 35% (35%)
Difference between statutory rate and foreign effective
tax rate .............................................. (24) 27
Non-deductible goodwill and intangible expenses ......... - 8
Expenses not deductible for tax purposes-deferred stock
compensation expense and other ........................ 4 -
Other ................................................... - (3)
--- ---
15% (3%)
=== ===
7. CAPITAL STOCK
Option activity in the Company's stock option plans is summarized as follows:
Outstanding options
weighted average
exercise price per
Number of shares share
---------------- -----
Outstanding, January 1, 2003: ..... 9,885,565 $ 8.14
Granted ........................... 80,750 5.25
Cancelled ......................... (404,524) 10.61
Exercised ......................... (3,100) 3.83
--------- -------
Outstanding, March 31, 2003 ....... 9,558,691 $ 8.01
========= =======
-10-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
7. CAPITAL STOCK - CONTINUED
The exercise price of all options granted during the three months ended March
31, 2003 was equal to the fair market value of the Company's common stock on the
dates of grant.
8. ACCOUNTING FOR STOCK-BASED COMPENSATION
The following table summarizes relevant information as to reported results under
the Company's intrinsic value method of accounting for stock awards, with
supplemental information as if the fair value recognition provisions of FASB
Statement 123 had been applied:
Three Months Ended
March 31,
-------------------------
2002 2003
-------- --------
Net income (loss) as reported .................................... $ 1,422 $(29,047)
Add: Stock-based compensation included in reported net income
(loss) ......................................................... 152 69
Deduct: Total stock-based compensation expense under SFAS 123,
net of tax effect .............................................. (4,018) (5,749)
------- --------
Pro forma net loss ............................................... $(2,444) $(34,727)
Basic and diluted net income (loss) per share: ................... $ 0.03 $ (0.66)
------- --------
Reported net income (loss) per common share ......................
------- --------
Pro forma net income (loss) per common share ................... $ (0.06) $ (0.79)
======= ========
9. NET INCOME (LOSS) PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income (loss) per share computations:
Three Months Ended
March 31,
------------------------------------
2002 2003
------------ --------------
Net income (numerator):
Net income (loss)
Basic and diluted ................ $ 1,422 $ (29,047)
============ =============
Shares (denominator):
Weighted average
Common Stock Outstanding ......... 42,430,509 44,206,625
------------ -------------
Basic ............................... 42,430,509 44,206,625
Options (Treasury Method) ........... 3,453,943 -
------------ -------------
Diluted ............................. 45,884,452 44,206,625
============ =============
Net income (loss) per share:
Basic ............................... $ 0.03 $ (0.66)
============ =============
Diluted ............................. $ 0.03 $ (0.66)
============ =============
As of March 31, 2002, the Company had 1,333,140 options outstanding that 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.
-11-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
10. ACQUISITION
On February 6, 2002 (the "date of acquisition"), the Company acquired all of the
outstanding common shares of Bonson. The results of Bonson's operations have
been included in the consolidated financial statements since that date. Bonson
is a provider of operation support system solutions and other services in China.
As a result of the acquisition, the Company is expected to be the leading
provider of operation support system solutions in the China market.
The aggregate purchase price was $51,390, including $32,763 in cash, $624 of
acquisition costs and common stock valued at $18,003. The value of the 1,031,686
common shares issued was determined based on the average market price of the
Company's common shares over the 5-day period before and after the terms of the
acquisition were agreed to and announced.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition:
At February 6, 2002
-------------------
Current assets $ 27,517
Property, plant, and equipment 843
Intangible assets 6,130
Goodwill 35,067
Deferred tax assets 4
--------
Total assets acquired 69,561
Current liabilities (17,737)
Deferred tax liabilities (434)
--------
Total liabilities assumed (18,171)
--------
Net assets acquired $ 51,390
========
The total purchase price had been allocated to the assets acquired and
liabilities assumed based on their respective fair values as follows:
Purchase Price Allocation:
Fair market value of net tangible assets acquired at $ 10,627
February 6, 2002
Intangible assets acquired: Economic Life
-------------
Core technology 1,280 3.5 years
Trade name 700 Indefinite
Indefinite contract backlog 2,700 2 years
Favorable lease 400 2.1 years
License 700 Indefinite
In-process technology 350
Goodwill 35,067 Indefinite
Deferred tax liabilities (434)
-----------
$ 51,390
===========
The Company recorded a one-time charge of $350 at the date of acquisition in
accordance with FASB Interpretation No. 4, "Applicability of FASB Statement No.
2 to Business Combinations Accounted for by the Purchase Method," for purchased
in-process technology related to a development project that had not reached
technological feasibility, had no alternative future use, and for which
successful development was uncertain. The conclusion that the in-process
development effort, or any material sub-component, had no alternative future use
was reached in consultation with the Company's management and Bonson's
management.
The goodwill of $35,067 was assigned to the operation support system segment and
is not expected to be deductible for tax purposes.
-12-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
10. ACQUISITION - CONTINUED
During the quarter ended March 31, 2003, the Company completed the annual
impairment test for the goodwill and other acquired intangible assets of Bonson
and concluded that an impairment of $29,836 of the recorded goodwill and other
acquired intangible assets of Bonson was necessary due to the industry-wide
equity devaluation of the past year. Both an income (discounted cashflow)
approach and a market (guideline company) approach were employed to determine
the fair value of the net assets of Bonson. The fair value was then allocated
among all the assets of Bonson at their fair values, including previously
unrecognized intangible assets. The residual value after the allocation was then
compared to the carrying value of goodwill to determine the amount of impairment
loss. The impaired goodwill of $26,000 and other acquired intangible assets of
$3,836 are related to the Company's operation support system solutions segment.
After the impairment is recorded, the remaining goodwill and other acquired
intangible assets of Bonson were $9,067 and $148, respectively.
The following selected unaudited pro forma combined results of operations for
the three months ended March 31, 2002 of the Company and Bonson have been
prepared assuming that the acquisitions occurred at the beginning of that
period. 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:
Three Months Ended
March 31,
------------------
2002
------------------
Total revenue $ 29,068
Net income 1,100
Net income per share
- Basic $ 0.03
- Diluted $ 0.02
Shares used in calculation of net income per share
- Basic 43,268,662
- Diluted 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. Amortization of these assets ceased upon the
adoption of SFAS No. 142 on January 1, 2002.
11. SEGMENT AND GEOGRAPHIC OPERATING INFORMATION
During the fourth quarter of 2002, the Company conducted a business
reorganization in order to more accurately reflect its strategic focus. As such,
the company restructured its operations into two strategic business units
("SBUs"): Operation Support System Solutions ("OSS") and Communications
Solutions ("CS"). Operating segments are defined as components of an enterprise
about which separate financial information is available that is evaluated
regularly by the Company's chief operating decision maker. By this definition,
the Company has two operating segments (separate lines of business): OSS and CS
(each net of hardware costs). Each business line has separate operating data and
separate management individuals responsible for the sales, marketing and
development efforts. The OSS SBU is designed to offer customers a "one window"
shopping solution for all of their OSS needs. The second SBU, CS, includes all
the remaining business lines from the Company such as network solutions, service
applications solutions and network security solutions, as well as network
monitoring. Both units contain revenues previously listed under Network
Solutions and Software Solutions. The new units benefit from cost efficiencies
gained from combined sales staff and offer more integrated quality services to
their customers.
-13-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
11. SEGMENT AND GEOGRAPHIC OPERATING INFORMATION - CONTINUED
Three Months Ended
March 31,
--------------------
2002 2003
------ ------
(unaudited)
Revenues net of hardware cost:
Communications solutions net of hardware cost .... $ 9,173 $ 6,681
Operation support system solutions ............... 7,901 6,037
------- -------
Consolidated revenues net of hardware cost ....... 17,074 12,718
Consolidated cost of sales net of hardware cost .. 5,786 5,214
------- -------
Consolidated gross profit ........................ $11,288 $ 7,504
======= =======
Gross profit:
Communications solutions ......................... $ 5,178 4,388
Operation support system solutions ............... 6,110 3,116
------- -------
Consolidated gross profit ........................ $11,288 $ 7,504
======= =======
The 2002 information has been reclassified to conform to the current operating
segments.
For the three months ended March 31, 2002 and 2003, 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 services. As of December 31, 2002 and March 31, 2003, 99%
of the Company's long-lived assets are located in the People's Republic of
China.
12. COMMITMENTS AND CONTINGENCIES
IPO Litigation
On December 4, 2001, a securities class action suit was filed in the United
States against the Company, certain of the Company's directors and the co-lead
underwriters involved in the Company's Initial Public Offering (the "IPO") on
behalf of all persons and entities who purchased, converted, exchanged or
otherwise acquired the common stock of the Company between March 2, 2000 and
December 6, 2000, inclusive. The complaint alleges that the Company and certain
of its officers and directors at the time of the IPO violated the federal
securities laws by issuing and selling the Company's common stock pursuant to
the IPO without disclosing to investors that several of the underwriters of the
IPO had solicited and received excessive and undisclosed commissions from
certain investors. The plaintiffs seek class action certification and claim for
an unspecified amount of damages. On July 15, 2002, the Company, together with
other issuer defendants, filed a collective motion to dismiss the claims on
various legal grounds common to all or most of the issuer defendants.
On October 9, 2002, the United States District Court for the Southern District
of New York (the "Court") dismissed without prejudice all claims against the
individual defendants in the litigation. The dismissals were based on
stipulations signed by those defendants and the plaintiffs' representatives. On
February 19, 2003, the Court issued its ruling on the motions to dismiss filed
by the underwriter and issuer defendants. In that ruling, the Court granted in
part and denied in part those motions. As to the claims brought against the
Company under the anti-fraud provisions of the securities laws, the Court
dismissed all claims without prejudice. As regards the claims brought under the
registration provisions of the securities laws, which do not require that intent
to defraud be pleaded, the Court denied the motion to dismiss such claims as to
the Company and as to substantially all of
-14-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Ended March 31, 2002 and 2003
(In US dollars thousands, except per share amounts)
12. COMMITMENTS AND CONTINGENCIES - CONTINUED
the other issuer defendants. The Court also denied the underwriter defendants'
motion to dismiss in all respects.
While the Company cannot guarantee the outcome of the proceedings, it believes
that the final result of the actions will have no material effect on the
Company's consolidated financial condition, results of operations or cash flows.
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.
Warranty Costs
The Company's product warranty accrual reflects management's best estimate of
probable liability under its product warranties. Management determines the
warranty based on historical experience and other currently available evidence.
Changes in the product warranty accrual for the 3 months ended March 31, 2003
were as follows:
Balance, beginning of period ..................................... $2,229
Payments made .................................................... (13)
Change in liability for warranties issued during the period ...... 196
------
Balance, end of period ........................................... $2,412
======
13. RELATED PARTY TRANSACTION
On May 16, 2002, China Merchants Bank, Beijing Branch ("Merchants Bank") entered
into an agreement to provide a revolving credit facility to China Netcom of up
to approximately $9,061 in connection with China Netcom's past and future
purchases of communications solutions and operation support system solutions
from AsiaInfo Technologies. China Netcom may draw on the facility to fund
amounts that will become payable to AsiaInfo Technologies under bankers'
acceptances and the amount drawn down by China Netcom was approximately $2,055
as of March 31, 2003. AsiaInfo Technologies has guaranteed China Netcom's
obligations to Merchants Bank under the facility and will pay the Merchants Bank
principal plus interest of the drawn loan if China Netcom defaults on the loan
and interest. The facility will expire on May 16, 2003.
-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 solutions and software
solutions in China. Our software products and network services enable our
customers to build, maintain, operate, manage and continuously improve their
telecommunications infrastructure.
We commenced our operations in the United States in 1993 and moved our
operations from the United States to China in 1995. We began generating
significant network solutions revenues in 1996 and significant software
solutions revenues in 1998. We conduct the bulk of our business through our
wholly-owned operating subsidiaries, AsiaInfo Technologies (China) Inc., or
AsiaInfo Technologies, and AsiaInfo Management Software, Inc. (formerly
Guangzhou Bonson Technology Limited), or AsiaInfo Management, which are both
Chinese companies.
We develop, market and sell our products and services through our two strategic
business units, or SBUs: Communications Solutions, or CS, and Operation Support
System Solutions, or OSS. Communications Solutions offers network infrastructure
solutions, service application solutions, network security solutions and network
monitoring solutions. We had previously offered network security solutions
through a majority-owned subsidiary, Marsec Holdings Inc., or Marsec, but have
integrated Marsec's network security business into our Communications Solutions
business unit. We acquired the outstanding minority shares of Marsec in January
2003. Operation Support System Solutions offers customer care and billing,
customer relationship management (including Business Intelligence and Decision
Support Systems) and order fulfillment management solutions for
telecommunications providers.
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 (net of acquisition costs) in cash and 1,031,686 shares of our common
stock, which were valued at approximately $18 million at the time the
acquisition was announced. The cash we paid in connection with the acquisition
was paid out of our existing cash reserves. Bonson's operating results have been
consolidated with our operating results from February 6, 2002. During the first
quarter of 2003, we completed an annual impairment test as required by the
Statement of Financial Accounting Standard ("SFAS") No.142 and recorded a
one-time, non-cash impairment charge of $30.2 million relating to the goodwill
and acquired intangible assets mainly attributable to our acquisition of Bonson.
The impairment resulted primarily from the industry-wide equity devaluation of
the past year. As the market valuation for the global telecommunications
industry has declined as compared to a year ago, comparable recent transactions
have involved much lower valuations and control premiums. Therefore, though we
still strongly believe in the strategic benefit of the Bonson acquisition to our
overall business, and have gained significant market share in the OSS area as a
result of the acquisition, we have determined that an impairment charge is
appropriate under applicable accounting principles.
-16-
We believe that there are opportunities for us to expand into new business areas
and to grow our business both organically and through acquisitions. 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 a result of a restructuring in China's telecommunications industry that
occurred in 2002, new orders for telecommunications infrastructure expansion and
improvement projects have decreased over the past several quarters, adversely
affecting our net revenue and profitability. According to China's Ministry of
Information Industry, or MII, overall capital expenditure by telecommunications
service providers decreased by 20% to 24.6 billion in 2002. Although we expect
that the restructuring will have a positive impact on growth in the
telecommunications industry in China in the long-term, most of China's
telecommunications carriers have indicated that their capital expenditures in
2003 will not increase significantly as compared to 2002. Continued delays in
capital expenditure projects could continue to negatively affect our growth in
the near-term. At the same time, however, we expect the investment focus of our
customers to continue to shift towards value-added products and services,
including establishing and enhancing their management and operation support
systems, which we believe will bring growth opportunities to our business.
The outbreak of Severe Acute Respiratory Syndrome, or SARS, is believed to have
started in Guangdong Province, China in late 2002 or early 2003 and to have
later spread to Beijing. The situation in Beijing, where our headquarters are
located, is currently rather severe compared to other areas affected by SARS.
Adding to the difficulties of containing the spread of SARS is that the medical
community worldwide has not fully understood the origin of SARS and has not
found a well-recognized effective treatment for SARS. The potential effects of
SARS on China's telecommunications and information technology industries, and on
our business, are still unknown. It is possible that telecommunications
infrastructure projects and related investment plans could be delayed, which
could in turn influence our order flow and revenue temporarily.
REVENUES
We reorganized our operating units in the fourth quarter of 2002 in order to
more accurately reflect our strategic focus. Our operations are now organized
into two strategic business units: Communications Solutions and Operation
Support System Solutions. Communications Solutions, or CS, includes the
following business lines: network solutions, service application solutions,
network security solutions and network monitoring solutions. Operation Support
System Solutions, or OSS, includes our highly scalable customer care and billing
software capable of automating a telecommunications carrier's key business
processes, such as billing and order management. Our results of operations were
previously reported under the segments "network solutions" and "software
solutions."
Although we report our 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 and, where efficient, outsourcing lower-end services such as hardware
acquisition and installation. This strategy may result in lower growth rates for
total revenues as against prior periods, but will not adversely impact revenues
net of hardware costs. The following table shows our revenue breakdown on this
basis:
THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
-------------------- -------------------
BUSINESS LINE 2003 2002 2002 2001
------------- ------ ------ ------ ------
Communications Solutions net 53% 54% 48% 73%(1)
of hardware costs --- --- --- ---
Operation Support System 47% 46% 52% 27%(1)
Solutions net of hardware costs === === === ===
---------------
(1) Reclassified to conform with 2002 presentation
-17-
As indicated in the foregoing table, OSS solutions revenues as a percentage of
total net revenues increased from 27% in 2001 to 52% in 2002 and 47% for the
first quarter of 2003. The increase in 2002 was largely attributable to our
acquisition of Bonson, a leading player in China's OSS market in February of
that year. We anticipate that OSS solutions revenues will account for more than
50% of our total net revenues for 2003.
Most of the projects we undertake for our customers, both in the Communications
Solutions business unit and the OSS Solutions business unit include revenue from
hardware, software and professional services.
HARDWARE REVENUE. We generate significant revenue through hardware sales for
equipment we procure from hardware vendors on behalf of our customers. We
procure hardware for our customers as part of our total solutions strategy. We
minimize our exposure to hardware risks by sourcing some equipment from hardware
vendors against letters of credit from our customers. We believe that as the
telecommunications-related market in China develops our customers will
increasingly purchase hardware directly from hardware vendors and hire us for
our professional services and software solutions.
SOFTWARE LICENSE REVENUE. We generate revenue in the form of fees received from
customers for licenses to use our software products in perpetuity, typically up
to a specified maximum number of users. In most cases, our customers must
purchase additional user licenses from us when the number of users exceeds the
specified maximum. We also include in revenue 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.
SERVICES REVENUE. Services revenue consists of revenue for the professional
services we provide to our customers for network planning, design and systems
integration, software customization and installation, and related training
services.
We generally charge a fixed price for all of our projects and recognize revenue
based on the percentage of completion of the project. Revenues in both
Communications Solutions and Operation Support System Solutions from customer
orders requiring significant production, modifications, or customization of the
software are recognized over the installation and customization period. We use
labor costs and direct project expenses to determine the stage of completion,
except for revenue associated with the procurement of hardware on behalf of the
customer. We recognize such hardware-related revenues upon delivery. Since a
large part of the cost of certain projects, particularly network solutions,
often relates to hardware, the timing of hardware delivery can cause our
quarterly gross revenue to fluctuate significantly. However, those fluctuations
do not significantly affect our gross profit because hardware-related revenues
generally approximate the costs of the hardware.
Our 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 project is at primary acceptance, which
usually occurs around three to four months after hardware delivery. At primary
acceptance, most of the services and products are delivered. The third milestone
is final acceptance, which occurs when the customer agrees that we have
satisfactorily completed all of our work on the project.
UNBILLED REVENUE. Our revenue recognition policies result in our recognizing
certain revenues even though we are not due to receive the corresponding cash
payment under the relevant contract. In the case of hardware sales, the customer
typically holds back around 10 to 20% of the hardware contract payments at the
time of delivery until final project acceptance. Although we record all hardware
revenue at the time of delivery, the 10 to 20% held back by the customer is
recorded as unbilled receivables and does not become billable until final
project acceptance. In the case of services and software license revenues, most
of the revenue becomes billable at the time of primary acceptance, but the
customer typically holds back around 10 to 20% of the services and software
contract payments until
-18-
final acceptance. Unpaid amounts for services and software, as well as for
hardware, become payable at the time of final project acceptance. When we
recognize revenue for which payments are not yet due, we book unbilled accounts
receivable until the corresponding amounts become billable.
REVENUE BACKLOG. Most of our revenues are derived from customers' orders under
contracts for hardware, software and services. Our backlog at any given time
includes the contracts we have signed but have not yet commenced and the portion
of uncompleted contracts for which revenue has not yet been recognized. Revenues
are recognized during the course of the relevant project, as described above. At
March 31, 2003, our revenue backlog net of hardware costs was $41.3 million, a
2% increase over the previous quarter and a 20% decrease compared to backlog one
year ago. This sequential increase is the first after three consentive decreases
in 2002. We believe the increase is primarily due to a shift in focus among
China's telecommunications carriers towards greater investments in value-added
products and services and establishing and enhancing their management and
operation support systems.
COST OF REVENUES
Costs of revenues in both the Communications Solutions business unit and the OSS
Solutions business unit include hardware costs, software-related costs and
compensation and travel expenses for the professionals involved in the relevant
projects.
Hardware costs consist primarily of third party hardware costs and related
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-related costs consist primarily of packaging and written manual
expenses for our proprietary software products and software license fees paid to
third-party software providers for the right to sublicense their products to our
customers as part of our solutions offerings. We do not accrue any software
warranty costs for our proprietary software and accrue 0.5% of sales of third
party software as warranty costs when such revenue is recognized upon final
acceptance. The costs associated with creating and enhancing our proprietary
software are classified as research and development expenses as incurred.
OPERATING EXPENSES
Operating expenses are comprised of sales and marketing expenses, research and
development expenses, general and administrative expenses, and amortization
expenses for intangible assets and deferred stock compensation.
Sales and marketing expenses include compensation expenses for employees in our
sales and marketing departments, third party advertising expenses, as well as
sales commissions and sales agency fees.
Research and development expenses relate to the development of new software and
the enhancement and upgrading of existing software. We expense these costs as
they are incurred.
Overall operating expenses include significant compensation expenses. In the
third quarter of 2002, in an effort to scale our business to accommodate lower
market demand, we reduced those costs through a 10% headcount reduction.
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 deferred
compensation expenses. Most of
-19-
the options granted with exercise prices below fair market value on the date of
grant were issued prior to 1997 and we do not 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 consolidated statement of operations as amortization of
deferred stock compensation. For more information on our deferred compensation
expenses, please see note 8 to our consolidated financial statements included in
this report.
We make bad debt provisions for accounts receivable balances based on
management's assessment of their recoverability. In any event, we make bad debt
provisions for all accounts receivable balances that are aged over one year. We
include those bad debt provisions in general and administrative expenses.
TAXES
Except for certain of our hardware procurement and resale transactions, we
conduct substantially all of our business through our Chinese operating
subsidiaries. Our Chinese subsidiaries are generally subject to a 30% state
corporate income tax and a 3% local income tax.
Pursuant to the income tax laws of China, foreign invested enterprises meeting
certain criteria set out by the relevant tax authorities can enjoy various
preferential tax treatments. AsiaInfo Technologies is registered and operates in
the Beijing Zhongguancun Science Park, and is classified as a "new technology
enterprise." The effective income tax rate for "new technology enterprises"
registered and operating in the Beijing Zhongguancun Science Park is 15%. "New
technology enterprises," including AsiaInfo Technologies, are also exempt from
Chinese state and local corporate income tax for three years, beginning with
their first year of operations, and are entitled to a 50% tax reduction at the
rate of 7.5% for the subsequent three years. The tax exemption 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 10%.
AsiaInfo Management is registered and operates in the High and New Technology
Industry Development Zone in Guangzhou, and is classified as a "high and new
technology enterprise." The effective income tax rate, subject to the approval
of the relevant tax authorities, for "high and new technology enterprises"
registered in High and New Technology Industry Development Zones is 15%. "High
and new technology enterprises," including AsiaInfo Management are also exempt
from Chinese state and local corporate income tax for two years, beginning with
their first profitable year of operations, and are entitled to a 50% tax
reduction at the rate of 7.5% for the subsequent three years. The tax exemption
for AsiaInfo Management expired on December 31, 2001 and the 50% tax reduction
will expire on December 31, 2004.
AsiaInfo Technologies (Chengdu), Inc., or AsiaInfo Chengdu, is registered in the
High and New Technology Industry Development Zone in Chengdu and is classified
as a "high and new technology enterprise." Subject to the approval of the
relevant tax authorities, "high and new technology enterprises" registered in
the Chengdu High and New Technology Industry Development Zone should be exempt
from Chinese state and local corporate income tax for two years, beginning with
their first year of operations, which is year 2002 for AsiaInfo Chengdu, and are
entitled to a tax reduction at the rate of 15% for the subsequent years.
Sales of hardware procured in China are subject to a 17% value added tax. Most
of our sales of hardware procured outside China are made through our U.S. parent
company, AsiaInfo Holdings, Inc., or our Hong Kong subsidiary, AsiaInfo H.K.
Limited, or AsiaInfo H.K., and thus are not subject to the value added tax. We
effectively pass value-added taxes on hardware sales through to our customers
and do not include them in revenues reported in our financial statements.
Although sales of software in China are subject to a 17% value added tax,
companies that develop their own proprietary software are generally entitled to
a value added tax refund. If the net amount of the value added tax payable
exceeds 3% of software sales, the excess portion of the value added tax is
refundable immediately. This policy is
-20-
effective until 2010. Changes in Chinese tax laws may adversely affect our
future operations.
We are also subject to U.S. income taxes on revenues generated in the United
States, including revenues from our limited hardware procurement activities
through our U.S. parent company, AsiaInfo Holdings, Inc., and interest income
earned in the United States.
FOREIGN EXCHANGE
A majority of our revenues and expenses relating to hardware sales are
denominated in U.S. dollars, and substantially all of our revenues and expenses
relating to the software and service components of our 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 $30.7 million in the three-month period ended
March 31, 2003, representing a increase of 7% against the comparable period in
2002. This increase was due to significant equipment delivery for certain
network solution projects in the first quarter and the recognition of
corresponding hardware revenues. Revenues net of hardware costs were $12.7
million in the three-month period ended March 31, 2003, representing a 5%
decrease over the previous quarter and a decrease of 26% over the comparable
period in 2002. OSS Solutions revenue was $6 million in the three-month period
ended March 31, 2003, representing a 16% decrease over the previous quarter and
a decrease of 24% over the comparable period in 2002. Communications Solutions
revenue was $6.7 million in the three-month period ended March 31, 2003,
representing an 8% increase over the previous quarter and a decrease of 27% over
the comparable period in 2002. The year-over-year decreases in net revenues were
attributable to the prolonged telecommunications industry restructuring in
China.
COST OF REVENUES. Our cost of gross revenues increased 34% to $23 million in the
first quarter of 2003, from $17 million in the first quarter of 2002. The
increase in cost of gross revenue was mainly attributable to the significant
hardware passthrough in the first quarter, described above.
GROSS PROFIT. Our gross profit of $7.5 million represented a 34% decrease in the
first quarter of 2003, as compared to the first quarter of 2002. Gross profit as
a percentage of gross revenues, or gross margin, decreased to 24% in the first
quarter of 2003, as compared to 40% in the first quarter of 2002. Gross profit
as a percentage of net revenues decreased to 59% in the first quarter of 2003,
as compared to 66% in the same period of 2002. These decreases are attributable
to the higher labor costs related to the expansion of our OSS business.
OPERATING EXPENSES. Total operating expenses, increased 270% to $37.7 million in
the first quarter of 2003, from $10.2 million in the first quarter of 2002. This
increase was due to a one-time, non-cash impairment charge of $29.8 million we
recorded in the first quarter of 2003 as a result of an independent valuation of
the goodwill and acquired intangible assets mainly attributable to our
acquisition of Bonson in February of 2002. In addition, we recognized an
impairment change of $0.38 million for the goodwill arising from our acquisition
of the minority interest in Marsec. Excluding such charges, total operating
expenses would have fallen to $7.5 million, a 27% decrease over the same period
in 2002.
Sales and marketing expenses decreased 30% to $2.5 million in the first quarter
of 2003, from $3.6 million in the first quarter of 2002, reflecting our
continued efforts to lower costs and increase operating efficiency.
Research and development expenses increased 12% to $2.5 million in the first
quarter of 2003 from $2.3 million in the first quarter of 2002 due to our
increased focus on developing new products and solutions for China's
telecommunications carriers, such as advanced operation
-21-
support systems solutions. We anticipate that our research and development
expenses will continue to increase in the coming quarters.
General and administrative expenses decreased 35% to $2.3 million in the first
quarter of 2003, from $3.5 million in the first quarter of 2002. We plan to
continue to reduce general and administrative expenses as part of our cost
cutting efforts.
INCOME (LOSS) FROM OPERATIONS. Our operating loss was $30.2 million in the first
quarter of 2003, as compared to operating income of $1.1 million in the
comparable period in 2002. This loss was due to the one-time, non-cash
impairment charge of $30.2 million as a result of an independent valuation of
the goodwill and acquired intangible assets mainly attributable to our
acquisition of Bonson in February of 2002. Excluding such impairment charge, we
would have recorded a net operating income of $12,000.
OTHER INCOME (EXPENSE). Other income and expenses, consisting primarily of net
interest income and expense, decreased from income of approximately $0.69
million in the first quarter of 2002 to income of $0.45 in the first quarter of
2003, primarily due to a decrease in interest rates and our having less cash
invested in interest bearing investments.
TAX. We recorded a tax benefit of $824,000 in the first quarter mainly due to an
adjustment for "cheap stock" amortization in previous periods, which are now
deemed deductible.
EQUITY IN LOSS OF AFFILIATE. Equity in loss of affiliate of approximately
$115,000 represented our proportionate share of the loss incurred by Intrinsic.
NET INCOME (LOSS). We recorded net loss of $29 million, or $0.66 basic loss per
share, for the quarter ended March 31, 2003. Excluding the impairment charge
related to Bonson, we would have had net income of $1.2 million, or $0.03 basic
earnings per share, for the first quarter of 2003. We expect net revenue for the
second quarter of 2003 to be between $14 to $15 million, or $0.01 to $0.02 per
basic share.
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, 2003 was $65 million, consisting of
$20.7 million in billed receivables and $44.3 million in unbilled receivables.
Our billed receivables are based on revenue we have booked and billed. Our
unbilled receivables are based on revenue we have booked through the percentage
completion method, but for which we have not yet billed the customer. For
example, we recognize revenues for hardware pass-through at the time the
hardware is accepted by the customer, based on the cost of the underlying
hardware. However, our contracts with our customers will often allow the
customers to withhold 10-20% of the total contract payments until final project
acceptance, which on average is eight to nine months after hardware delivery. As
a result, revenues from hardware pass-through generally represent a significant
portion of our unbilled receivables and can cause the aging of these receivables
to be relatively long.
At the end of the first quarter, our days sales outstanding were 190 days, as
compared to 147 days at the end of December 31, 2002. Our billed receivables
were 61 days sales outstanding and our unbilled receivables were 129 days sales
outstanding. The higher day sales outstanding were caused by some aging account
receivables forwarded from last year and lower revenues in the first quarter of
this year.
-22-
As of March 31, 2003, we had total short-term credit facilities totaling $20
million, expiring by October, 2003, for working capital purposes, of which
unused short-term credit facilities were $19.66 million at that date. At March
31, 2003, $0.34 million had been used to issue a letter of credit. Additional
borrowings of approximately $0.06 million were secured by AsiaInfo Management's
net assets. All the borrowings were in Renminbi. The loans carry interest 4.8%
per annum and are repayable within one year. Bank deposits pledged as security
for these bank loans and short-term credit facilities totaled $15.27 million as
of March 31, 2003, and are presented as restricted cash in our consolidated
balance sheets.
We ended the quarter with a cash position of $141.8 million, of which $11.3
million was in short term investments and $15.3 million was in restricted cash.
Restricted cash consisted of $10 million used to secure our $20 million credit
facility, $4.83 million pledged as security for issuing standby letter of
credits and $0.44 million held by Bonson and pledged as security for a
guarantee, and $115.2 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.
We had net operating cash inflow of $1 million in first quarter of 2003,
primarily attributable to the reduction of our inventory. Our inventory position
at the end of the quarter was approximately $7 million, representing a 36% drop
over the previous quarter's $11 million.
Our accounts receivable increased 31% as compared to December 31, 2002, and
accounts payable increased 50%. Both of these increases were caused by
significant equipment delivery for certain network solution projects in the
first quarter of 2003.
We anticipate that the net proceeds of our initial public offering in March
2000, together with available funds and cash flows generated from operations,
will be sufficient to meet our anticipated needs for working capital, capital
expenditures and business expansion through 2003. We may need to raise
additional funds in the future, however, in order to fund acquisitions, develop
new or enhanced services or products, respond to competitive pressures to
compete successfully for larger projects involving higher levels of hardware
purchases, or if our business otherwise grows more rapidly than we currently
predict. 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.
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
-23-
dependable estimates of the revenue and costs applicable to various stages of a
contract can be made. Recognized revenues and profit are subject to revisions as
the contract progresses to completion. Accordingly, changes in our estimates
would impact our future operating results.
WARRANTY OBLIGATIONS. We record our estimate of warranty costs at the time of
final project acceptance, when all hardware pass-through revenue has been
recognized. Revisions for estimated warranties may be required in the period in
which actual warranty costs become known, thereby impacting our future operating
results.
BAD DEBTS. We maintain allowances for doubtful accounts for estimated losses
resulting from the aging of accounts receivables or 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 minority interest in Intrinsic
Technology (Holdings), Ltd., or Intrinsic, using the equity method. Intrinsic
has incurred operating losses since our investment in April 2001. We conducted
an asset impairment test during the fourth quarter of 2002 in connection with
our private equity investments, including our 14.25% interest in Intrinsic,
which is recorded on our balance sheet as an "investment in affiliate". As a
result of this test, we have recorded an impairment charge of approximately $2.0
million in investments in affiliates. 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 additional
impairment charge in the future. As of March 31, 2003, the Company's interest in
Intrinsic had been diluted from 14.25% to 14.22% due to another shareholder's
exercise of warrants to purchase 37,770 shares of Intrinsic's stock. The change
in our equity interest in Intrinsic is not material and the relevant loss as a
result of such change has been recorded as a component of equity.
GOODWILL AND OTHER INTANGIBLE ASSETS. We make assumptions regarding estimated
future cash flows and other factors to determine the fair value of goodwill and
other intangible assets. If these estimates or their related assumptions change
in the future, we may be required to record an impairment charge if the
estimated fair value of goodwill and other intangible assets is less than its
recorded amount. As required under SFAS No.142, we have completed an annual
goodwill impairment test and have recorded a one-time, non-cash impairment
charge of $29.8 million relating to the goodwill and acquired intangible assets
attributable to our acquisition of Bonson in February of 2002, as well as a
$0.38 million impairment charge relating to the goodwill arising from our
acquisition of the minority interest of Marsec. The impairment resulted
primarily from the industry-wide equity devaluations of the past year. As the
market valuation for the global telecommunications industry has declined as
compared to a year ago, comparable recent transactions have involved much lower
valuations and control premiums. Therefore, though we still strongly believe in
the strategic benefit of the Bonson acquisition to our overall business, and
have gained significant market share in the OSS area as a result of the
acquisition, we have determined that an impairment charge is appropriate under
applicable accounting principles. Continued deterioration of market conditions
may require us to record an additional impairment charge in the future.
COMMITMENTS. Our contractual obligations consist of noncancellable operating
lease agreements. As of March 31, 2003, future minimum lease payments under
noncancellable operating leases are expected to be approximately $3.1 million,
and become due as presented in the table below:
Operating Leases
----------------
Less than 1 year ............................... $1.5 million
1 to 3 years ................................... 1.6 million
4 years and thereafter -
------------
Total minimum lease payments $3.1 million
============
-24-
On May 16, 2002, China Merchants Bank, Beijing Branch ("Merchants Bank") entered
into an agreement to provide a revolving credit facility to China Netcom of up
to approximately $9.1 million in connection with China Netcom's past and future
purchases of communications solutions and operation support system solutions
from AsiaInfo Technologies. China Netcom may draw on the facility to fund
amounts that will become payable to AsiaInfo Technologies under bankers'
acceptances and the amount drawn down by China Netcom was approximately $2.1
million as of March 31, 2003. We have guaranteed China Netcom's obligations to
Merchants Bank under the facility and will pay the principle and interest of the
drawn loan if China Netcom defaults. The facility will expire on May 16, 2003.
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.
ACCOUNTING PRONOUNCEMENTS RECENTLY ADOPTED
In August 2001, the FASB 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. We adopted SFAS
No. 143 on January 1, 2003. This adoption did not have a significant impact on
our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123," which provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The amended disclosure
requirements of SFAS No. 148 are effective for years ending after December 15,
2002 and are reflected in our condensed consolidated financial statements.
FACTORS AFFECTING OUR OPERATING RESULTS AND OUR COMMON STOCK
In addition to the other information in this report, the following factors
should be considered in evaluating our business and our future prospects:
THE GROWTH OF OUR BUSINESS IS DEPENDENT ON GOVERNMENT TELECOMMUNICATIONS
INFRASTRUCTURE AND BUDGETARY POLICY, PARTICULARLY THE ALLOCATION OF FUNDS TO
SUSTAIN THE GROWTH OF THE TELECOMMUNICATIONS INDUSTRY 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 Reform Commission of China. As
a result, the growth of our business is heavily dependent on government policies
for telecommunications and Internet infrastructure. Insufficient government
allocation of funds to sustain the growth of China's telecommunications
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 has merged with China Netcom and Jitong Communication, and has been
renamed China Network Communications Group Corporation, or China Netcom Group,
while the southern division operates under the China Telecom name. As a result
of the restructuring, new orders for telecommunications infrastructure expansion
and improvement projects have decreased over the past several quarters,
adversely affecting our backlog and our net revenue. Although we expect that the
restructuring will have a positive impact on growth in the telecommunications
industry in China in the long-term, most of China's telecommunications carriers
have indicated that their capital expenditures in 2003 will not increase
significantly as compared to 2002. Continued delays in capital expenditure
projects could continue to negatively affect our growth in the near-term. In
addition,
-25-
similar restructurings of this nature could cause our operating results to vary
unexpectedly from quarter to quarter in the future.
OUR CUSTOMER BASE IS CONCENTRATED AND THE LOSS OF ONE OR MORE OF OUR CUSTOMERS
COULD CAUSE OUR BUSINESS TO SUFFER SIGNIFICANTLY.
We have derived, and believe that we will continue to derive, a significant
portion of our revenues from a limited number of large customers, such as China
Telecom, China United Telecommunications Corporation, or China Unicom, China
Mobile Communications Corporation, or China Mobile and China Netcom Group. The
pre-restructuring China Telecom accounted for almost all of our revenues in 1997
and 1998. In 1999, the pre-restructuring China Telecom, together with China
Unicom, accounted for almost all of our revenues. China Mobile accounted for 46%
of our revenues net of hardware cost in 2002 and for 43% of our revenue backlog
net of hardware cost as of March 31, 2003. The loss, cancellation or deferral of
any large contract by any of our large customers would have a material adverse
effect on our revenues, and consequently our profits.
THE LONG AND VARIABLE SALES CYCLES FOR OUR PRODUCTS AND SERVICES CAN CAUSE OUR
REVENUES AND OPERATING RESULTS TO VARY SIGNIFICANTLY FROM PERIOD TO PERIOD AND
MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our revenues and operating results will vary significantly from quarter to
quarter due to a number of factors, many of which are outside of our control and
any of which may cause our stock price to fluctuate. A customer's decision to
purchase our services and products involves a significant commitment of its
resources and an extended evaluation. As a result, our sales cycle tends to be
lengthy. We spend considerable time and expense educating and providing
information to prospective customers about features and applications of our
services and products. Because our major customers operate large and complex
networks, they usually expand their networks and/or apply new features to 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.
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.
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, 2001 and 2002, we sustained net losses in 1999 and 2000. Recently, we have
experienced a decline in earnings growth and had a net loss in the first quarter
of 2003 after impairment charges. 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
-26-
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 losses.
BUSINESS ACQUISITIONS WE UNDERTAKE MAY BE CHALLANGING, AND WE MAY REALIZE LOSSES
ON OUR INVESTMENTS
In February of 2002, as a key component of our business and growth strategy, we
acquired Bonson, a leading provider of operation support system solutions in
China. 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. Such acquisitions involve other significant risks, including:
.. the difficulties of integrating, assimilating and managing the operations,
technologies, intellectual property, products and personnel of the acquired
business;
.. the diversion of management attention from other business concerns;
.. the additional expense associated with acquired contingent liabilities;
.. the loss of key employees in acquired businesses; and
.. the risk of being sued by terminated employees and contractors.
We will need to integrate and manage any 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.
ASSET IMPAIRMENT REVIEWS MAY RESULT IN FUTURE PERIODIC WRITE-DOWNS.
Effective January 1, 2002, we adopted SFAS No. 142 which requires us, among
other things, to review goodwill and intangible assets for impairment annually.
In connection with our business acquisitions, we make assumptions regarding
estimated future cash flows and other factors to determine the fair value of
goodwill and intangible assets. In assessing the related useful lives of those
assets, we have to make assumptions regarding their fair value, our
recoverability of those assets and our ability to successfully develop and
ultimately commercialize acquired technology. If those assumptions change in the
future when we conduct our periodic reviews in accordance with accounting
standards, we may be required to record impairment charges. We have conducted an
asset impairment test during the fourth quarter of 2002 and recorded an
impairment charge of approximately $2.0 million from our investment in
Intrinsic. We also recorded a one-time, non-cash impairment charge of $30.2
million as a result of an independent valuation during the first quarter of 2003
of the goodwill and acquired intangible assets mainly attributable to our
acquisition of Bonson in February 2002. There is no assurance that future
reviews will not result in further write-downs to goodwill and other intangible
assets.
THE OUTBREAK OF SERVERE ACUTE RESPIRATORY SYNDROME MAY HAVE AN IMPACT ON OUR
BUSINESS
The outbreak of Severe Acute Respiratory Syndrome, or SARS, is believed to have
started in Guangdong Province, China in late 2002 or early 2003 and to have
later spread to Beijing. The situation in Beijing, where our headquarters are
located, is currently rather severe compared to other areas affected by SARS.
Adding to the difficulties of containing the spread of SARS is that the medical
community worldwide has not fully understood the origin of SARS and has not
found a well-recognized effective treatment for SARS. The potential effects of
SARS on China's telecommunications and information technology industries, and on
our business, are still unknown. It is possible that telecommunications
infrastructure projects and related investment plans could be delayed, which
could in turn influence our order flow and revenue temporarily.
WE ARE HIGHLY DEPENDENT ON OUR EXECUTIVE OFFICERS.
-27-
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. We do not have, and do not plan to obtain, "key
man" life insurance on any of our employees.
WE FACE A COMPETITIVE LABOR MARKET IN CHINA FOR SKILLED PERSONNEL AND THEREFORE
ARE HIGHLY DEPENDENT ON THE SKILLS AND SERVICES OF OUR EXISTING KEY SKILLED
PERSONNEL AND OUR ABILITY TO HIRE ADDITIONAL SKILLED EMPLOYEES.
Competition for highly skilled software design, engineering and sales and
marketing personnel is intense in China. Our failure to attract, assimilate or
retain qualified personnel to fulfill our current or future needs could impair
our growth. Competition for skilled personnel comes primarily from a wide range
of foreign companies active in China, many of which have substantially greater
resources than we have. Limitations on our ability to hire and train a
sufficient number of personnel at all levels would limit our ability to
undertake projects in the future and could cause us to lose market share.
WE EXTEND WARRANTIES TO OUR CUSTOMERS THAT EXPOSE US TO POTENTIAL LIABILITIES.
We customarily provide our customers with one to three year warranties, under
which we agree to maintain installed systems at no additional cost to our
customers. The maintenance services cover both hardware and our proprietary and
third party software products. Although we seek to arrange back-to-back
warranties with hardware and software vendors, we have the primary
responsibility to maintain the installed hardware and software. Our contracts do
not have disclaimers or limitations on liability for special, consequential and
incidental damages, nor do we cap the amounts our customers can recover for
damages. In addition, we do not currently maintain any insurance policy with
respect to our exposure to warranty claims. The failure of our installed
projects to operate properly could give rise to substantial liability for
special, consequential or incidental damages, that in turn could materially and
adversely affect us.
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 our large 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.
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 confidentiality
agreements and copyright and trademark registration. We have registered some
marks and filed trademark applications for other marks with the United States
Patent and Trademark Office, the Trademark Bureau of the State Administration of
Industry and Commerce in China and the Trade Marks Registry in Hong Kong. We
have also registered copyrights with the State Copyright Bureau in China with
respect to telecommunications-related software products, although we have not
applied for copyright protection elsewhere (including the United States).
Despite these precautions, the legal regime protecting intellectual property
rights in China is weak. Moreover, Bonson, which we acquired in February, 2002,
had never registered copyrights for its software products prior to the
acquisition, although we subsequently registered copyrights for all of
-28-
its software products. Because the Chinese legal system in general, and the
intellectual property regime in particular, are relatively weak, it is often
difficult to enforce intellectual property rights in China. In addition, there
are other countries where effective copyright, trademark and trade secret
protection may be unavailable or limited.
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.
A portion of our business involves the development and customization of software
applications for customers. We generally retain significant ownership or rights
to use and market such software for other customer projects, where possible.
However, our customers sometimes retain co-ownership and rights to use the
applications, processes, and intellectual property so developed. In some cases,
we may have no right or only limited rights to reuse or provide these
developments in projects involving other customers. To the extent that we are
unable to negotiate contracts which permit us to reuse source-codes and
methodologies, or to the extent that we have conflicts with our customers
regarding our ability to do so, we may be unable to provide similar solutions to
our other customers.
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 those persons within the United States;
or
.. enforce against us or those persons judgments obtained in United States
courts, including judgments relating to the federal securities laws of the
United States.
WE DO NOT INTEND TO PAY AND MAY BE RESTRICTED FROM PAYING DIVIDENDS ON OUR
COMMON STOCK.
We have never declared or paid dividends on our capital stock and we do not
intend to declare any dividends in the foreseeable future. We currently intend
to retain future earnings to fund our growth. Furthermore, if we decide to pay
dividends, foreign exchange and other regulations in China may restrict our
ability to distribute retained earnings from China or convert these payments
from Renminbi, the currency of China, into foreign currencies.
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
-29-
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 network solutions in China is new and rapidly changing. Our
competitors in the network solutions market mainly include domestic systems
integrators such as Zoom Networks, Openet Information Technology (Shenzhen)
Corporation, Digital China Holdings Limited and Legend Group Limited. Although
we are a leading player in this market, there are many large multinational
companies with substantial, existing information technology operations in other
markets in China that have significantly greater financial, technological,
marketing and human resources. Should they decide to enter the network solutions
market, this could hurt our profitability and erode our market share.
The service application solutions sector is highly competitive. Our principal
competitor in that sector is Openwave Systems Inc. (formerly Software.com and
Phone.com). In the network security solutions market, we mainly compete with
Information Security One Limited, Nsfocus Information Technology Co., Ltd., and
21ViaNet China Inc. An increasing number of companies are devoting their
resources to this sector in developing network security products. In the network
monitoring solutions market, our principal competitor is Emerson Electric Co.
(through its acquisition of Avansys Power Co., Ltd. from Huawei Technologies).
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 mainly with more than
eight local competitors, including Linkage System Integration Co. Ltd.
(Changsha) and SI-TECH Computer System Engineering Ltd. (Beijing). We also
expect to compete with more than ten local competitors in the fixed-line OSS
market. Currently, due in part to each telecommunication provider's 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.
However, multinational companies have recently formed alliances with Chinese
companies to expand into China's telecommunications solutions market. For
example, CSG Systems, or CSG, has formed a strategic alliance with a subsidiary
of Legend Group Limited to develop a suite of customer care and billing
solutions for China's telecommunications carriers. 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 market.
Our competitors, some of whom have greater financial, technical and human
resources than us, may be able to respond more quickly to new and emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of new products or services. It is possible
that competition in the form of new competitors or alliances, joint ventures or
consolidation among existing competitors may decrease our market share.
Increased competition could result in lower personnel utilization rates, billing
rate reductions, fewer customer engagements, reduced gross margins and loss of
market share, any one of which could materially and adversely affect our profits
and overall financial condition.
POLITICAL AND ECONOMIC POLICIES OF THE CHINESE GOVERNMENT COULD AFFECT OUR
INDUSTRY IN GENERAL AND OUR COMPETITIVE POSITION IN PARTICULAR.
-30-
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.
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 investments relating to China and Asia, as well
as developments in the Internet and telecommunications industries. 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 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 are currently involved in this type of
litigation as a result of allegedly improper allocation procedures relating to
the sale of our common stock in connection with our initial public offering in
March of 2000. For more information on this litigation, see the discussion under
the heading "Item 1. Legal Proceedings" in Part II of this report. Litigation is
often expensive and diverts management's attention and resources, which could
materially and adversely affect our business.
FUTURE SALES OF SHARES BY OUR COMPANY OR EXISTING SHAREHOLDERS COULD CAUSE THE
MARKET PRICE OF OUR COMMON STOCK TO FALL.
If our stockholders sell substantial amounts of our common stock in the public
market, including shares issued upon the exercise of outstanding options, the
market price of our common stock could fall. Such sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate.
A SMALL NUMBER OF SHAREHOLDERS CONTROLS US.
A small number of shareholders, including Warburg-Pincus Ventures, ChinaVest
Group, and their affiliates, as well as Edward Tian, one of our directors, James
Ding, our Chairman, and Louis Lau, one of our directors, control over 50% of our
voting stock. As a result, these shareholders collectively are able to control
all matters requiring shareholder approval, including election of directors and
approval of significant corporate transactions, such as a sale of our assets and
the terms of future equity financings. The combined voting power of our large
shareholders could have the effect of delaying or preventing a change in
control.
WE ARE SUBJECT TO ANTI-TAKEOVER PROVISIONS THAT COULD PREVENT A CHANGE OF
CONTROL AND PREVENT OUR SHAREHOLDERS FROM REALIZING A PREMIUM ON THEIR COMMON
STOCK.
-31-
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
nine-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
2006; 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, 2003. 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, 2003, a hypothetical 10% immediate increase or decrease in interest
rates would increase our annual interest expense by approximately $73 and
decrease our annual interest income by approximately $45,365, respectively. The
effect of changes in exchange rates on our results of operations has been
insignificant.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the filing date of this quarterly report, we carried out
an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as
amended. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures are
effective. There were no significant changes in our internal controls or in
other factors that could significantly affect those controls subsequent to the
date of our evaluation.
-32-
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
On December 4, 2001, a securities class action case was filed in New York City
against us, certain of our current officers and directors and the underwriters
of our initial public offering, or IPO. The lawsuit alleged violations of the
federal securities laws and was docketed in the United States District Court for
the Southern District of New York, or the Court, as Hassan v. AsiaInfo Holdings,
Inc., et al. The lawsuit alleged, among other things, that the underwriters of
our IPO improperly required their customers to pay the underwriters excessive
commissions and to agree to buy additional shares of our common stock in the
aftermarket as conditions to their purchasing shares in our IPO. The lawsuit
further claimed that these supposed practices of the underwriters should have
been disclosed in our IPO prospectus and registration statement. The suit seeks
rescission of the plaintiffs' alleged purchases of our common stock as well as
unspecified damages. In addition to the case against us, various other
plaintiffs have filed approximately 1,000 other, substantially similar class
action cases against approximately 300 other publicly traded companies and their
IPO underwriters in New York City, which along with the case against us have all
been transferred to a single federal district judge for purposes of case
management. On July 15, 2002, together with the other issuer defendants, we
filed a collective motion to dismiss the consolidated, amended complaints
against the issuers on various legal grounds common to all or most of the issuer
defendants. The underwriters also filed separate motions to dismiss the claims
against them.
On October 9, 2002, the Court dismissed without prejudice all claims against the
individual defendants in the litigation. The dismissals were based on
stipulations signed by those defendants and the plaintiffs' representatives.
On February 19, 2003, the Court issued its ruling on the motions to dismiss
filed by the underwriter and issuer defendants. In that ruling the Court granted
in part and denied in part those motions. As to the claims brought against us
under the anti-fraud provisions of the securities laws, the Court dismissed all
such claims without prejudice. As to the claims brought under the registration
provisions of the securities laws, which do not require that intent to defraud
be pleaded, the Court denied the motion to dismiss such claims as to us and as
to substantially all of the other issuer defendants. The Court also denied the
underwriter defendants' motion to dismiss in all respects. While we cannot
guarantee the outcome of these proceedings, we believe that the final result of
these actions will have no material effect on our consolidated financial
condition, results of operations or cash flows. Moreover, we believe that the
underwriters may have an obligation to indemnify us for the legal fees and other
costs of defending this suit and that our directors' and officers' liability
insurance policies will also cover the defense and potential exposure or
settlement of the suit.
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, 2003, the net
proceeds have been used for the following purposes:
Purchase and installation of machinery and equipment ......... $ 7,260,000
Temporary investments, including cash and cash equivalents ... 32,800,000
Investments in subsidiaries .................................. 51,000,000
Research and development and sales and marketing expenses .... 35,550,000
------------
$126,610,000
============
-33-
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
ANNUAL MEETING OF STOCKHOLDERS
We held our Annual Meeting of Shareholders on April 18, 2003. For more
information on the following proposals, please refer to our definitive proxy
statement dated March 21, 2003, 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
-------- --- --------
James Ding 38,263,439 980,476
Alan D. Bickell 38,088,566 1,155,349
Steve Chang 38,380,884 863,031
(2) Our shareholders ratified the appointment of Deloitte Touche Tohmatsu as our
independent auditors:
For 38,933,951
Against 308,493
Abstain 1,471
-----------
Total 39,243,915
(3) Our shareholders approved the AsiaInfo Holdings, Inc. 2002 Stock Option
Plan:
For 22,915,133
Against 6,517,743
Abstain 18,228
-----------
Total 29,451,104
APPOINTMENT OF XINGSHENG ZHANG TO BOARD OF DIRECTORS
Our board of directors resolved on April 18, 2003 to appoint Xingsheng Zhang,
our current President and Chief Executive Officer, as a Class II director of the
Company. Xingsheng Zhang accepted the appointment and became a member of our
board of directors. As with our other Class II directors, Xingsheng Zhang's
current term as a director will expire at our annual meeting of stockholders to
be held in 2004, at which time we anticipate that he will stand for election for
a new term.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as a part of this Report.
-34-
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 2002 Stock Option Plan, approved and adopted as of April 18,
2003 /****/
10.2 Lease of AsiaInfo's headquarters at 6 Zhongguancun South
Street, Beijing, China, dated August 31, 1999/*/
10.3 Agreement for the Establishment of a Limited Liability Company
(Guangdong Wangying Communications Technology Company Limited)
and Capital Contribution /**/
11.1 Statement regarding computation of per share earnings
(included in note 9 to condensed consolidated financial
statements)
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
/*/ Incorporated by reference to our Registration Statement on Form S-1 (No.333-
93199).
/**/ Incorporated by reference to our 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.
/****/ Incorporated by reference to our Proxy Statement for the 2003 Annual
Meeting of Stockholders filed on March 21, 2003.
(b) Reports on form 8-K
We furnished a Current Report on Form 8-K on April 22, 2003 relating to our
quarterly earnings announcement for the quarter ended March 31, 2003, pursuant
to the requirements of Regulation G.
-35-
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, 2003 By: /s/ Ying Han
-------------------------------
Name: Ying Han
Title: Chief Financial Officer
(duly authorized officer
and principal financial officer)
-36-
Certification
I, Xingsheng Zhang, certify that:
1. I have reviewed this quarterly report on Form 10-Q of AsiaInfo Holdings,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/s/ Xingsheng Zhang
---------------------------
Xingsheng Zhang
Chief Executive Officer
-37-
Certification
I, Ying Han, certify that:
1. I have reviewed this quarterly report on Form 10-Q of AsiaInfo Holdings,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/s/ Ying Han
--------------------------
Ying Han
Chief Financial Officer
-38-