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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ---- TO ----
Commission File Number 001-15713
ASIAINFO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 752506390
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4TH FLOOR, ZHONGDIAN INFORMATION TOWER
6 ZHONGGUANCUN SOUTH STREET, HAIDIAN DISTRICT
BEIJING 100086, CHINA
(Address of principal executive office, including zip code)
+8610 6250 1658
(Registrant's telephone number, including area code)
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such
reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the Registrant's common stock as of
November 8, 2002 was 44,186,985
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ASIAINFO HOLDINGS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 3
a) Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2001 and 2002 3
b) Condensed Consolidated Balance Sheets as of December 31, 2001 and September 30, 2002 5
c) Condensed Consolidated Statements of Cash Flows for the three and nine months ended September
30, 2001 and 2002 6
d) Notes to Condensed Consolidated Financial Statements for the three and nine months ended
September 30, 2001 and 2002 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 42
Item 4. Controls and Procedures 42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 43
Item 2. Changes in Securities and Use of Proceeds 43
Item 6. Exhibits and Reports on Form 8-K 44
SIGNATURE 46
CERTIFICATIONS 47
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US Dollars thousands, except per share amounts)
Three Months Ended
September 30,
----------------------------
2001 2002
------------ ------------
(unaudited)
Revenues:
Network solutions ................................................................. $ 86,323 $ 23,498
Software solutions ................................................................ 7,708 9,073
------------ ------------
Total revenues .................................................................... 94,031 32,571
------------ ------------
Cost of revenues:
Network solutions ................................................................. 77,649 20,019
Software solutions ................................................................ 842 4,052
------------ ------------
Total cost of revenues ............................................................ 78,491 24,071
------------ ------------
Gross profit ........................................................................ 15,540 8,500
------------ ------------
Operating expenses:
Sales and marketing (excluding stock-based compensation: 2001: $78;
2002: $31 and amortization of acquired intangible assets: 2001: nil;
2002: $238) ..................................................................... 6,322 3,082
General and administrative (excluding stock-based compensation: 2001:
$104; 2002: $41 and amortization of acquired intangible assets: 2001:
nil; 2002: $147) ................................................................ 3,550 2,719
Research and development (excluding stock-based compensation: 2001: $34;
2002: $10 and amortization of acquired intangible assets: 2001: nil;
2002: $92) ...................................................................... 1,945 2,097
Amortization of deferred stock compensation ....................................... 216 82
Amortization of acquired intangible assets ........................................ - 477
------------ ------------
Total operating expenses .......................................................... 12,033 8,457
------------ ------------
Income from operations .............................................................. 3,507 43
------------ ------------
Other income (expense):
Interest income ................................................................... 1,644 523
Interest expense .................................................................. (216) (1)
Other (expenses) income, net ...................................................... (5) 6
------------ ------------
Total other income (expense), net ................................................. 1,423 528
------------ ------------
Income before income taxes, minority interests and equity in loss of
affiliate ....................................................................... 4,930 571
Income tax expense .................................................................. 986 74
------------ ------------
Income before minority interests .................................................... 3,944 497
Minority interests in (income) loss of consolidated subsidiaries .................... (105) 73
Equity in loss of affiliate ......................................................... (320) (102)
------------ ------------
Net income .......................................................................... $ 3,519 $ 468
============ ============
Net income per share:
Basic ............................................................................. $ 0.08 $ 0.01
============ ============
Diluted ........................................................................... $ 0.08 $ 0.01
============ ============
Shares used in computing per share amounts:
Basic ............................................................................. 41,757,250 44,081,170
============ ============
Diluted ........................................................................... 45,159,256 44,835,907
============ ============
See notes to condensed consolidated financial statements.
-3-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In US Dollars thousands, except per share amounts)
Nine Months Ended
September 30,
-----------------------------------
2001 2002
------------- -------------
(unaudited)
Revenues:
Network solutions ............................................................ $ 130,004 $ 73,006
Software solutions ........................................................... 21,357 24,661
------------- -------------
Total revenues ............................................................... 151,361 97,667
------------- -------------
Cost of revenues:
Network solutions ............................................................ 108,628 55,835
Software solutions ........................................................... 2,565 9,006
------------- -------------
Total cost of revenues ....................................................... 111,193 64,841
------------- -------------
Gross profit ................................................................... 40,168 32,826
------------- -------------
Operating expenses:
Sales and marketing (excluding stock-based compensation: 2001: $305;
2002: $66 and amortization of acquired intangible assets: 2001:
nil; 2002: $513) ........................................................... 17,769 11,460
General and administrative (excluding stock-based compensation:
2001: $488; 2002: $206 and amortization of acquired intangible
assets: 2001: nil; 2002: $515) ............................................. 10,696 7,736
Research and development (excluding stock-based compensation: 2001:
$144; 2002: $60 and amortization of acquired intangible assets:
2001: nil; 2002: $244) ..................................................... 5,522 6,706
Amortization of deferred stock compensation .................................. 937 332
In-process research and development .......................................... - 350
Amortization of acquired intangible assets ................................... - 1,272
------------- -------------
Total operating expenses ..................................................... 34,924 27,856
------------- -------------
Income from operations ......................................................... 5,244 4,970
------------- -------------
Other income (expense):
Interest income .............................................................. 6,225 1,757
Interest expense ............................................................. (883) (75)
Other (expenses) income, net ................................................. (39) 43
------------- -------------
Total other income (expense), net ............................................ 5,303 1,725
------------- -------------
Income before income taxes, minority interests and equity in loss of
affiliate .................................................................... 10,547 6,695
Income tax expense ............................................................. 2,262 870
------------- -------------
Income before minority interests ............................................... 8,285 5,825
Minority interests in (income) loss of consolidated subsidiaries ............... (235) 63
Equity in loss of affiliate .................................................... (576) (383)
------------- -------------
Net income ..................................................................... $ 7,474 $ 5,505
============= =============
Net income per share:
Basic ........................................................................ $ 0.18 $ 0.13
============= =============
Diluted ...................................................................... $ 0.16 $ 0.12
============= =============
Shares used in computing per share amounts:
Basic ........................................................................ 41,343,389 43,387,643
============= =============
Diluted ...................................................................... 45,689,785 45,765,340
============= =============
See notes to condensed consolidated financial statements.
-4-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In US Dollars thousands, except per share amounts)
December 31, September 30,
------------ -------------
2001 2002
------------ -------------
(1) (Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents .................................................... $ 110,635 $ 118,265
Restricted cash .............................................................. 13,475 14,458
Short-term investments ....................................................... 27,184 4,010
Accounts receivable, trade (net of allowance for doubtful accounts of
$1,094 and $1,961 at December 31, 2001 and September 30, 2002,
respectively) .............................................................. 66,723 62,633
Inventories - hardware and parts ............................................. 1,180 4,357
Other receivables ............................................................ 10,533 6,128
Deferred income taxes - current .............................................. 1,689 1,893
Prepaid expenses and other current assets .................................... 1,417 4,644
----------- -------------
Total current assets ....................................................... 232,836 216,388
Property and equipment - net ................................................... 5,376 4,799
Goodwill ....................................................................... 2,188 37,255
Other acquired intangibles - net ............................................... - 4,508
Investment in affiliate ........................................................ 5,272 4,889
Deferred income taxes .......................................................... 188 -
----------- -------------
Total Assets ............................................................... $ 245,860 $ 267,839
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term bank loans ........................................................ $ 2,924 $ 72
Accounts payable ............................................................. 23,789 22,017
Other payables ............................................................... 1,682 1,837
Deferred revenue ............................................................. 4,279 5,731
Accrued employee benefits .................................................... 9,088 7,096
Accrued expenses ............................................................. 11,431 13,252
Income taxes payable ......................................................... 4,743 3,354
Other taxes payable .......................................................... 2,524 1,845
----------- -------------
Total current liabilities .................................................. 60,460 55,204
Deferred income taxes .......................................................... - 205
----------- -------------
Total Liabilities .......................................................... 60,460 55,409
----------- -------------
Minority interest .............................................................. 610 329
----------- -------------
Stockholders' Equity:
Common stock, 100,000,000 shares authorized, $0.01 par value, shares
issued and outstanding: 2001: 42,132,818; 2002: 44,152,307 ................. 421 442
Additional paid-in capital ................................................... 178,649 200,059
Deferred stock compensation .................................................. (512) (180)
Retained earnings ............................................................ 6,204 11,709
Accumulated other comprehensive income ....................................... 28 71
----------- -------------
Total stockholders' equity ................................................. 184,790 212,101
----------- -------------
Total Liabilities and Stockholders' Equity ................................. $ 245,860 267,839
=========== =============
See notes to condensed consolidated financial statements.
(1) Derived from the audited balance sheet included in the annual report on Form
10-K of AsiaInfo Holdings, Inc., for the year ended December 31. 2001.
-5-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In US Dollars thousands, except per share amounts)
Nine Months Ended
September 30,
----------------------------------
2001 2002
---------- ---------
(unaudited)
Cash flows from operating activities:
Net income ............................................................. $ 7,474 $ 5,505
Adjustments to reconcile net income to net
cash (used in) provided by operating
activities:
Depreciation ........................................................... 1,630 2,219
Amortization of goodwill ............................................... 818 -
Amortization of other acquired intangible
assets ............................................................... - 1,272
In-process research and development .................................... - 350
Amortization of deferred stock compensation ............................ 937 332
Deferred income taxes .................................................. (35) (275)
Minority interest in income (loss) of consolidated subsidiaries ........ 235 (63)
Equity in loss of an affiliate ......................................... 576 383
Loss on disposal of property and equipment ............................. 159 56
Bad debt expense ....................................................... 643 553
Changes in operating assets and liabilities,
net of effects of business acquired:
Restricted cash ...................................................... 969 3,544
Accounts receivable .................................................. (26,005) 14,792
Inventories .......................................................... 7,626 (1,946)
Other receivables .................................................... (788) (1,571)
Prepaid expenses and other current assets ............................ (775) (381)
Accounts payable ..................................................... (12,201) (4,106)
Other payables ....................................................... (751) 6
Deferred revenue ..................................................... (8,916) (121)
Accrued employee benefits ............................................ (826) (2,544)
Accrued expenses ..................................................... 4,276 1,559
Income taxes payable ................................................. 1,717 (589)
Other taxes payable .................................................. (285) (1,764)
---------- ---------
Net cash (used in) provided by operating
activities ............................................................. (23,522) 17,211
---------- ---------
Cash flows from investing activities:
Decrease in short-term investments ..................................... 87,990 23,174
Purchases of property and equipment .................................... (1,278) (885)
Proceeds from disposal of fixed assets ................................. 11 29
Increase in loan receivable ............................................ - (3,572)
Investment in affiliate ................................................ (6,157) -
Purchase of a subsidiary, net of cash
acquired ............................................................. - (26,063)
---------- ---------
Net cash provided by (used in) investing
activities ............................................................. 80,566 (7,317)
---------- ---------
-6-
ASIAINFO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(In US Dollars thousands, except per share amounts)
Nine Months Ended
September 30,
-----------------------------------
2001 2002
------------ ----------
(unaudited)
Cash flows from financing activities:
Increase in short-term bank loans ................................ $ 40,535 $ 2,924
Repayment of short-term bank loans ............................... (44,446) (7,636)
Proceeds on exercise of stock options ............................ 2,621 2,628
Earning distribution of consolidated subsidiaries ................ - (218)
------------ ----------
Net cash used in financing activities ............................ (1,290) (2,302)
------------ ----------
Net increase in cash and cash equivalents: ......................... 55,754 7,592
Cash and cash equivalents at beginning of period ................... 48,834 110,635
Effect of exchange rate changes on cash and cash equivalents ....... 10 38
------------ ----------
Cash and cash equivalents at end of period ......................... $ 104,598 $ 118,265
============ ==========
Supplemental cash flow information:
Cash paid during the period:
Interest ......................................................... $ 888 $ 55
Income taxes ..................................................... $ 580 $ 1,102
============ ==========
Deferred stock compensation ...................................... $ 937 $ 332
============ ==========
Non-cash investing activity:
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson for cash of $33,387, of which $624 represented acquisition costs, and the
issuance of 1,031,686 shares of common stock with a fair market value at the
time the acquisition was announced of approximately $18,003. Of the cash amount,
$20,433 was paid on April 4, 2002. In connection with the acquisition, the
Company acquired tangible assets with a fair value of $28,364 and assumed
liabilities of $17,737.
See notes to condensed consolidated financial statements.
-7-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION
Interim Financial Information - The accompanying condensed consolidated
financial statements of AsiaInfo Holdings, Inc. (the "Company"), and its
wholly-owned subsidiaries as of September 30, 2002 and for the three- and
nine-months ended September 30, 2001 and 2002 are unaudited. In the opinion of
management, the condensed consolidated financial statements include all
adjustments (consisting only of normal recurring accruals) that management
considers necessary for a fair presentation of its financial position. Operating
results and cash flows for interim periods are not necessarily indicative of
results for the entire year.
This financial data should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2001. This financial data should
also be read in conjunction with the Company's critical accounting policies
included in "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001.
AsiaInfo Holdings, Inc. is incorporated in the State of Delaware, in the United
States (the "US"). The Company principally operates through the following
directly owned subsidiaries, or their respective subsidiaries: AsiaInfo
Technologies (China), Inc. ("AsiaInfo Technologies") (100% owned), Guangdong
Wangying Information Technology Co., Ltd. ("Wangying") (40% owned, but
controlled by the Company), both incorporated in the People's Republic of China
("China" or the "PRC"), Marsec Holdings, Inc. ("Marsec") (79% owned), and Bonson
Information Technology Holdings Limited, ("Bonson") (100% owned), both
incorporated in the Cayman Islands.
On March 2, 2000, the Company completed an initial public offering of 5,750,000
shares of its common stock, raising net proceeds of $126,610. The Company's
common stock is traded on The Nasdaq National Market in the United States.
The Company acts as a holding company and, through certain subsidiaries, sources
network-related equipment in the United States for sale to customers in the PRC.
AsiaInfo Technologies was established as a wholly foreign owned enterprise with
an initial operating term of 15 years commencing May 2, 1995 (date of
establishment). Its principal activities are conducted in the PRC and comprise
the provision of telecommunications-related information technology professional
services and software products. In November 2001, the Company merged its wholly
owned subsidiary, Zhejiang AsiaInfo Telecommunication Technology Co., Ltd. ("AI
Zhejiang"), into AsiaInfo Technologies. AI Zhejiang's activities were performed
in the PRC and comprised the development and sale of communication hardware and
software as well as providing related technology services. AI Zhejiang was
acquired in April 1999, and its results of operations are included in the
Company's financial statements from the date of acquisition.
-8-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
On December 31, 2001, AsiaInfo Technologies formed a wholly owned subsidiary,
AsiaInfo Technologies (Chengdu), Inc., with an initial operating term of 15
years to provide hardware procurement support for network solution projects.
Wangying was established on September 6, 2000 with an initial operating term of
4 years for a particular customer project in the PRC. As of September 30, 2002,
Wangying is being liquidated.
Marsec, through its wholly owned subsidiary, provides internet security
consulting and services in the PRC. In September 2001, the Company exercised
warrants to purchase 200,000 additional voting preferred shares of Marsec at
$3.50 a share, increasing its investment in Marsec from 75% to 79%.
On April 27, 2001, the Company invested $6,157 to acquire a 14.25% interest (in
the form of voting preferred shares) in Intrinsic Technology (Holdings), Ltd.
("Intrinsic"), a Cayman Islands company engaged in wireless infrastructure
solutions development through two wholly-owned subsidiaries in the PRC.
In 2000, the Company dissolved its subsidiary AsiaInfo-CTC Network Systems Inc.
In February 2002, the Company acquired 100% of the outstanding equity shares of
Bonson, a leading developer of wireless telecommunications software and
solutions, operating through its subsidiary Guangzhou Bonson Technology Limited,
based in Guangzhou, China, for $32,763 in cash and the issuance of 1,031,686
shares of the Company's common stock. (See Note 10).
The consolidated financial statements of the Company include the accounts of the
Company and its subsidiaries. Intercompany transactions and balances have been
eliminated. Investments in 50% or less owned affiliates over which the Company
exercises significant influence, but not control, are accounted for using the
equity method.
Revenue from network solutions contracts, which includes the procurement of
hardware on behalf of customers, systems design, planning, consulting and system
integration is recognized based on the percentage of completion method. Labor
costs and direct project expenses are used to determine the stage of completion
except for revenues associated with the procurement of hardware. Such
hardware-related revenues are recognized upon delivery. Estimates of hardware
warranty costs are included in determining project costs.
Software solutions revenues represent license fees and related services that
allow customers to use the Company's software products in perpetuity up to a
maximum number of users. Contract revenue from software license fees and
software implementation services represent customer orders requiring significant
production, modifications, or customization of the software. Contract revenue
for software is recognized in conjunction with the revenues of the related
solutions project over the installation and customization period based on the
percentage of completion of the project as measured by labor costs and direct
project expenses. The Company may also sell packaged software occasionally, and
license fees from such software sales are recognized as revenue upon the
-9-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
occurrence of the following events: an agreement is close to being entered into,
the fee is determined, collection of the fee is reasonably assured, and the
delivery to or acceptance by the customer of the software product has occurred.
Costs related to insignificant obligations for a period up to one year, which
include telephone support, are accrued at the time the revenue is recorded.
Software revenues include the benefit of the rebate of value added taxes on
sales of software received from the tax authorities as part of the PRC
government's policy of encouragement of software development in the PRC. The
rebate was approximately $759 and $550 for the three months ended September 30,
2001 and 2002, respectively, and $2,454 and $1,813 for the nine months ended
September 30, 2001 and 2002, respectively.
Revisions in estimated contract profits are made in the period in which the
circumstances requiring the revision become known. Provisions, if any, are made
currently for anticipated losses on uncompleted contracts. Revenue in excess of
billings is recorded as unbilled receivables and included in trade accounts
receivable, and amounted to $45,910 at December 31, 2001 and $36,354 at
September 30, 2002. Billings in excess of revenues recognized are recorded as
deferred income. Billings are rendered based on agreed milestones included in
the contracts with customers. At December 31, 2001 and September 30, 2002, the
balance of trade accounts receivable of $20,813 and $26,279, respectively,
represented amounts billed but not yet collected. All billed and unbilled
amounts are expected to be collected within 1 year. The Company revisits its
estimate on collectibility on a periodic basis. As a result, bad debt expenses
were $162 and $568 for the three months ended September 30, 2001 and 2002,
respectively. Bad debt expenses were $643 and $553 for the nine months ended
September 30, 2001 and 2002, respectively.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at December 31, 2001 and September 30, 2002
and the reported amounts of revenues and expenses during the three and nine
months ended September 30, 2001 and 2002. Actual results could differ from those
estimates.
The financial records of the Company's PRC subsidiaries are maintained in
Renminbi ("RMB"), their functional currency and the currency of the PRC. Their
balance sheets are translated into United States dollars based on the rates of
exchange ruling at the balance sheet date. Their statements of operations are
translated using a weighted average rate for the period. Translation adjustments
are reflected as cumulative translation adjustments in the statement of
stockholders' equity.
The Renminbi is not fully convertible into United States dollars or other
foreign currencies. The rate of exchange quoted by the People's Bank of China on
September 30, 2002 was US$1.00=RMB8.2771. No representation is made that the
Renminbi amounts could have been, or could be, converted into United States
dollars at that rate or at any other rate.
-10-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires, among other things, the discontinuance of goodwill amortization.
Effective January 1, 2002, the Company discontinued amortization of its existing
goodwill, which arose from the acquisition of AI Zhejiang and the Company's
investment in Intrinsic, and was being amortized over 5 years.
In addition, the standard includes provisions for the reclassification of
certain existing recognized intangibles such as goodwill, reassessment of the
useful lives of existing recognized intangibles, reclassification of certain
intangibles out of previously reported goodwill and the identification of
reporting units for purposes of assessing potential future impairment of certain
intangible assets, including goodwill. The effects of adopting the
non-amortization provisions of SFAS No. 142, assuming these provisions were
adopted as of January 1, 2001, are summarized at Note 4. SFAS No. 142 also
requires the Company to complete a transitional goodwill impairment test six
months from the date of adoption. The Company has completed the transitional
goodwill impairment test and concluded that no impairment of recorded goodwill
was necessary as of January 1, 2002.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations," which addresses the accounting
for the recognition of obligations associated with the retirement of tangible
long-lived assets. SFAS No. 143 is effective for financial statements issued for
years beginning after June 15, 2002. Management does not believe that the
adoption of SFAS No. 143 will have a significant impact on its financial
position or results of operations.
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses the financial accounting and reporting requirements for the impairment
or disposal of long-lived assets and discontinued operations. SFAS No. 144
applies to all recorded long-lived assets that are held for use or that will be
disposed of, but excludes goodwill and other intangible assets that are not
amortized. SFAS No. 144 was adopted by the Company on January 1, 2002. Adoption
of SFAS No. 144 did not have a significant effect on the Company's financial
position or results of operations.
In July 2002, the Financials Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities" which
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Such costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. SFAS No. 146 replaces the previous accounting guidance
provided by the Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
-11-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
1. GENERAL AND BASIS OF PREPARATION - CONTINUED
an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
is to be applied prospectively to exit or disposal activities initiated after
December 31, 2002 and the Company does not anticipate that the statement will
have a material impact on the Company's financial statements or results of
operations.
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, demand deposits and highly
liquid investments, which are unrestricted as to withdrawal or use, and which
have maturities of three months or less when purchased.
3. SHORT-TERM INVESTMENTS
Short-term investments are classified as available for sale and consist
principally of certificates of deposit issued by major financial institutions,
and have maturities of between 6 and 12 months. As there are no significant
market price movements for such investments, they are held at cost and accrued
interest. There were no realized or unrealized gains or losses as of September
30, 2002.
4. GOODWILL - ADOPTION OF STATEMENT 142
The following table summarizes the effect of adopting the non-amortization
provisions of SFAS No. 142, assuming these provisions were adopted as of January
1, 2001.
Three Months Ended September 30,
--------------------------------------
2001 2002
----------------- ------------------
Reported net income $3,519 $468
Add back: Goodwill amortization 290 -
----------------- ------------------
Adjusted net income $3,809 $468
================= ==================
Basic earnings per share:
Reported net income $ 0.08 $0.01
Goodwill amortization 0.01 -
----------------- ------------------
Adjusted net income $ 0.09 $0.01
================= ==================
Diluted earnings per share:
Reported net income $ 0.08 $0.01
Goodwill amortization $ 0.01 -
----------------- ------------------
Adjusted net income $ 0.09 $0.01
================= ==================
-12-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
4. GOODWILL - ADOPTION OF STATEMENT 142 - CONTINUED
Nine Months Ended September 30,
--------------------------------------------------
2001 2002
---------------------- ------------------------
Reported net income $7,474 $5,505
Add back: Goodwill amortization 818 -
---------------------- ------------------------
Adjusted net income $8,292 $5,505
====================== ========================
Basic earnings per share:
Reported net income $ 0.18 $ 0.13
Goodwill amortization 0.02 -
---------------------- ------------------------
Adjusted net income $ 0.20 $ 0.13
====================== ========================
Diluted earnings per share:
Reported net income $ 0.16 $ 0.12
Goodwill amortization 0.02 -
---------------------- ------------------------
Adjusted net income $ 0.18 $ 0.12
====================== ========================
5. COMPREHENSIVE INCOME
The components of comprehensive income for the periods presented are as follows:
Three Months Ended September 30,
--------------------------------
2001 2002
---------------- --------------
Net income ............................................................. $3,519 $ 468
Change in cumulative translation adjustment ............................ 2 6
---------------- --------------
Comprehensive income ................................................... $3,521 $ 474
================ ==============
Nine Months Ended September 30,
--------------------------------
2001 2002
---------------- --------------
Net income ............................................................. $7,474 $5,505
Change in cumulative translation adjustment ............................ 10 43
---------------- --------------
Comprehensive income ................................................... $7,484 $5,548
================ ==============
6. SHORT-TERM BANK LOANS
As of September 30, 2002, the Company had total short-term credit facilities for
working capital purposes totaling $23,000 ($3,000 expiring in October 2002 and
$20,000 expiring in October 2003). The facilities were secured by bank deposits
of $10,900 as of December 31, 2001 and $10,000 as of September 30, 2002. At
September 30, 2002, unused short-term credit facilities were $21,701 and used
facilities totaled $1,299. The used facilities are pledged for issuing letters
of credit to hardware suppliers and customers. In addition, as of September 30,
2002, the Company had short-term borrowings of $72 in RMB, the currency of the
PRC, secured by Bonson's assets.
-13-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
6. SHORT-TERM BANK LOANS - CONTINUED
The RMB loan bears interest at a rate of 4.8% per annum and are repayable upon
demand by the lending bank. Additional bank deposits of $4,458 were used for
issuing standby letters of credit and guarantees as of September 30, 2002. Bank
deposits pledged as security for these credit facilities totaled $13,475 and
$14,458 as of December 31, 2001 and September 30, 2002, respectively, and are
presented as restricted cash in the condensed consolidated balance sheets.
7. INCOME TAXES
The Company is subject to US federal and state income taxes. The Company's
subsidiaries incorporated in the PRC are subject to PRC income taxes.
A reconciliation between the provision for income taxes computed by applying the
US federal tax rate to income before income taxes, minority interest and equity
in loss of affiliate and the actual provision for income taxes is as follows:
Three Months Ended
September 30,
---------------------------------
2001 2002
---------- --------
US federal rate ........................................... 35% 35%
Difference between statutory rate and
foreign effective tax rate ............................... (21) (23)
Expenses not deductible for tax purpose --
deferred stock compensation expense ...................... 6 4
Other ..................................................... - (3)
---------- --------
20% 13%
========== ========
Nine Months Ended
September 30,
---------------------------------
2001 2002
---------- --------
US federal rate ........................................... 35% 35%
Difference between statutory rate and
foreign effective tax rate ............................... (20) (23)
Expenses not deductible for tax purpose --
deferred stock compensation expense ...................... 6 4
Other ..................................................... - (3)
---------- --------
21% 13%
========== ========
Change in valuation allowance represented a reduction of valuation allowance of
approximately $180 that was recorded to reduce the deferred tax assets arising
from the tax loss carry forward which was approved by the PRC taxing authority
during the second quarter of 2002.
-14-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
8. CAPITAL STOCK
Option activity in the Company's stock option plans is summarized as follows:
Outstanding options
weighted average
Number of shares exercise price per share
---------------- ------------------------
Outstanding, January 1, 2002: ....... 8,309,168 $ 9.40
Granted ............................. 24,600 14.56
Cancelled ........................... (255,740) 11.58
Exercised ........................... (172,563) 4.26
----------- -------
Outstanding, March 31, 2002 ......... 7,905,465 $ 9.46
=========== =======
Granted ............................. 51,000 11.89
Cancelled ........................... (230,790) 14.21
Exercised ........................... (666,340) 2.56
----------- -------
Outstanding, June 30, 2002 .......... 7,059,335 $ 9.97
=========== =======
Granted ............................. 3,171,317 4.03
Cancelled ........................... (164,690) 12.56
Exercised ........................... (148,900) 1.25
----------- -------
Outstanding, September 30, 2002 ..... 9,917,062 $ 8.16
=========== =======
The exercise price of all options granted during the three months and the nine
months ended September 30, 2002 was equal to the fair market value of the
Company's common stock on the dates of grant.
9. NET INCOME PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share computations:
Three Months Ended
September 30,
-------------------------------
2001 2002
------------- ------------
Net income (numerator):
Net income used in computing basic and diluted net
income per share ............................................... $ 3,519 $ 468
============= ============
Shares (denominator):
Weighted average
Common Stock Outstanding .................................... 41,757,250 44,081,170
------------- ------------
Shares used in computing basic net income per share ............ 41,757,250 44,081,170
Dilutive effect of stock options outstanding using the
treasury stock method .......................................... 3,402,006 754,737
------------- ------------
Shares used in computing net income per share .................. 45,159,256 44,835,907
Net income per share:
Basic .......................................................... $ 0.08 $ 0.01
============= ============
Diluted ........................................................ $ 0.08 $ 0.01
============= ============
-15-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
9. NET INCOME PER SHARE - CONTINUED
Nine Months Ended
September 30,
-----------------------------
2001 2002
------------ ------------
Net income (numerator):
Net income used in computing basic and diluted net
income per share ............................................ $ 7,474 $ 5,505
============ ============
Shares (denominator):
Weighted average
Common Stock Outstanding ................................. 41,343,389 43,387,643
------------ ------------
Shares used in computing basic net income per share ......... 41,343,389 43,387,643
Dilutive effect of stock options outstanding using the
treasury stock method ....................................... 4,346,396 2,377,697
------------ ------------
Shares used in computing net income per share ............... 45,689,785 45,765,340
============ ============
Net income per share:
Basic ....................................................... $ 0.18 $ 0.13
============ ============
Diluted ..................................................... $ 0.16 $ 0.12
============ ============
As of September 30, 2001 and 2002, the Company had 2,434,520 and 8,100,297
options outstanding, respectively, which could have potentially diluted earnings
per share ("EPS") in the future, but which were excluded in the computation of
diluted EPS in these periods, as their exercise prices were above the average
market values in such periods.
10. ACQUISITION
On February 6, 2002, the Company completed the acquisition of Bonson. The
acquisition was accounted for as a purchase in accordance with SFAS No. 141,
"Business Combinations." Under the terms of the share purchase agreement, the
Company acquired all outstanding capital stock of Bonson for $32,763 in cash and
1,031,686 shares of the Company's common stock. The total purchase price as of
February 6, 2002 had been allocated to the assets acquired and liabilities
assumed based on their respective fair values as follows, (in thousands):
Total purchase price:
Cash consideration $32,763
Common stock 18,003
Acquisition expenses 624
-------
$51,390
=======
-16-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
10. ACQUISITION - CONTINUED
Purchase Price Allocation:
Fair market value of net tangible assets $10,627
acquired at February 6, 2002
Intangible assets acquired: Economic Life
---------------
Core technology 1,280 3.5 years
Trade name 700 Indefinite
Contract backlog 2,700 2 years
Favorable lease 400 2.1 years
License 700 Indefinite
In-process technology 350
Goodwill 35,067 Indefinite
Deferred tax liabilities (434)
-------
$51,390
=======
The Company recorded a one-time charge of $350 in the first quarter of 2002 for
purchased in-process technology related to a development project that had not
reached technological feasibility, had no alternative future use, and for which
successful development was uncertain. The conclusion that the in-process
development effort, or any material sub-component, had no alternative future use
was reached in consultation with the Company's and Bonson's management.
The following selected unaudited pro forma combined results of operations for
the three months and nine months ended September 30, 2001 and 2002 of the
Company and Bonson have been prepared assuming that the acquisitions occurred at
the beginning of the periods presented. The following pro forma financial
information is not necessarily indicative of the results that would have
occurred had the acquisition been completed at the beginning of the periods
indicated nor is it indicative of future operating results:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2001 2002 2001 2002
------------ ------------ ------------- -----------
Total revenue $ 98,615 $ 32,571 $ 168,939 $ 98,198
Net income 3,766 468 7,549 5,184
Net income per share
- Basic $ 0.09 $ 0.01 $ 0.18 $ 0.12
- Diluted $ 0.08 $ 0.01 $ 0.16 $ 0.11
Shares used in calculation of
net income per share
- Basic 42,788,936 44,081,170 42,375,075 43,669,661
- Diluted 46,190,942 44,835,907 46,721,471 46,047,359
The pro forma results of operations give effect to certain adjustments,
including amortization of purchased intangibles with definite lives, associated
with the acquisition. The charge for purchased in-process research and
development of $350 has been excluded from the pro forma results, as it is a
material non-recurring charge.
-17-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
11. SEGMENT INFORMATION
Information on the Company's operating segments is as follows:
Three Months Ended September 30,
(unaudited)
-----------------------------------------------------------------
2001/1/ 2002
---------- -----------------------------------------------------
Strategic Business Units and Product Offerings
-----------------------------------------------------
Operation Network
Support Security
Communications System Solutions
Solutions Solutions (Marsec) Total
---------------- ----------- ------------ -------
Revenues net of hardware cost:
Network solutions net of hardware cost .......... $12,437 $ 4,299 $ 1,007 $ 308 $ 5,614
Software ........................................ 7,708 1,651 7,422 - 9,073
------- ----------- --------- --------- -------
Consolidated revenues net of hardware cost ...... 20,145 5,950 8,429 308 14,687
Consolidated cost of sales net of
hardware cost ................................. 4,605 2,076 3,896 215 6,187
------- ----------- --------- --------- -------
Consolidated gross profit ....................... $15,540 $ 3,874 $ 4,533 $ 93 $ 8,500
======= =========== ========= ========= =======
Gross profit:
Network solutions ............................... $ 8,674 $ 2,581 $ 804 $ 93 $ 3,478
Software ........................................ 6,866 1,293 3,729 - 5,022
------- ----------- --------- --------- -------
Consolidated gross profit ....................... $15,540 $ 3,874 $ 4,533 $ 93 $ 8,500
======= =========== ========= ========= =======
Depreciation and amortization:
Network solutions ............................... $ 506 $ 225 $ 53 $ 34 $ 312
Software ........................................ 313 87 389 - 476
------- ----------- --------- --------- -------
$ 819 $ 312 $ 442 $ 34 $ 788
======= =========== ========= ========= =======
Amortization of deferred stock compensation:
Network solutions ............................... $ 106 $ 29 $ 5 $ - $ 34
Software ........................................ 110 11 37 - 48
------- ----------- --------- --------- -------
$ 216 $ 40 $ 42 $ - $ 82
======= =========== ========= ========= =======
Amortization of acquired intangible assets:
Network solutions ............................... $ - $ - $ 57 $ - $ 57
Software ........................................ - - 420 - 420
------- ----------- --------- --------- -------
$ - $ - $ 477 $ - $ 477
======= =========== ========= ========= =======
Income from operations:
Network solutions ............................... $ 2,446 $ (98) $ 278 $ (248) $ (68)
Software ........................................ 1,061 264 (153) - 111
------- ----------- --------- --------- -------
Consolidated income from operations ............. $ 3,507 $ 166 $ 125 $ (248) $ 43
======= =========== ========= ========= =======
-18-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
11. SEGMENT INFORMATION - CONTINUED
Nine Months Ended September 30,
(unaudited)
---------------------------------------------------------------------
2001/1/ 2002
---------- ---------------------------------------------------------
Strategic Business Units and Product Offerings
---------------------------------------------------------
Operation Network
Support Security
Communications System Solutions
Solutions Solutions (Marsec) Total
----------------- ----------- ------------ ---------
Revenues net of hardware cost:
Network solutions net of hardware cost ........... $30,021 $ 20,145 $ 5,354 $ 1,214 $26,713
Software ......................................... 21,357 3,676 20,985 - 24,661
------- --------- --------- -------- -------
Consolidated revenues net of hardware cost ....... 51,378 23,821 26,339 1,214 51,374
Consolidated cost of sales net of
hardware cost .................................. 11,210 9,161 8,727 660 18,548
------- --------- --------- -------- -------
Consolidated gross profit ........................ $40,168 $ 14,660 $ 17,612 $ 554 $32,826
======= ========= ========= ======== =======
Gross profit:
Network solutions ................................ $21,376 $ 12,377 $ 4,240 $ 554 $17,171
Software ......................................... 18,792 2,283 13,372 - 15,655
------- --------- --------- -------- -------
Consolidated gross profit ........................ $40,168 $ 14,660 $ 17,612 $ 554 $32,826
======= ========= ========= ======== =======
Depreciation and amortization:
Network solutions ................................ $ 1,431 $ 858 $ 228 $ 84 $ 1,170
Software ......................................... 1,017 156 893 - 1,049
------- --------- --------- -------- -------
$ 2,448 $ 1,014 $ 1,121 $ 84 $ 2,219
======= ========= ========= ======== =======
Amortization of deferred stock compensation:
Network solutions ................................ $ 464 $ 151 $ 31 $ - $ 182
Software ......................................... 473 28 122 - 150
------- --------- --------- -------- -------
$ 937 $ 179 $ 153 $ - $ 332
======= ========= ========= ======== =======
Amortization of acquired intangible assets:
Network solutions ................................ $ - $ - $ 259 $ - $ 259
Software ......................................... - - 1,013 - 1,013
------- --------- --------- -------- -------
$ - $ - $ 1,272 $ - $ 1,272
======= ========= ========= ======== =======
Income from operations:
Network solutions ................................ $ 4,196 $ 2,029 $ 1,265 $ (432) $ 2,862
Software ......................................... 1,048 394 1,714 - 2,108
------- --------- --------- -------- -------
Consolidated income from operations .............. $ 5,244 $ 2,423 $ 2,979 $ (432) $ 4,970
======= ========= ========= ======== =======
/1/ No strategic business unit and product offering information available for
2001.
-19-
ASIAINFO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three and Nine Months Ended September 30, 2001 and 2002
(In US dollars thousands, except per share amounts)
12. COMMITMENTS AND CONTINGENCIES
On December 4, 2001, a securities class action suit was filed in the United
States against the Company, certain of the Company's directors and the co-lead
underwriters involved in the Company's Initial Public Offering (the "IPO") on
behalf of all persons and entities who purchased, converted, exchanged or
otherwise acquired the common stock of the Company between March 2, 2000 and
December 6, 2000, inclusive. The complaint alleges that the Company and certain
of its officers and directors at the time of the IPO violated the federal
securities laws by issuing and selling the Company's common stock pursuant to
the IPO without disclosing to investors that several of the underwriters of the
IPO had solicited and received excessive and undisclosed commissions from
certain investors. The plaintiffs seek class action certification and claim for
an unspecified amount of damages. While the outcome of this litigation is
uncertain, management believes that the Company has meritorious defenses to the
suit and intends to vigorously defend the action. In addition, management
believes that the co-lead underwriters may have an obligation to indemnify the
Company for the legal fees and other costs of defending this suit and that the
Company's directors' and officers' liability insurance policies may also cover
the defense and exposure or settlement of the suit. On October 9, 2002, the
United States District Court for the Southern District of New York dismissed
without prejudice all claims against the individual defendants in the litigation
(Louis Lau, Chairman of the Board, James Ding, President and Chief Executive
Officer and Ying Han, Chief Financial Officer). The dismissals were based on
stipulations signed by those defendants and the plaintiffs' representatives. The
case remains pending against the Company.
13. RELATED PARTY TRANSACTION
On May 16, 2002, China Merchants Bank, Beijing Branch ("Merchants Bank") entered
into an agreement to provide a revolving credit facility to China Netcom
Corporation Ltd. ("China Netcom") of up to approximately $9,061 in connection
with China Netcom's past and future purchases of telecommunications network
infrastructure software and solutions from AsiaInfo Technologies. China Netcom
may draw on the facility to fund amounts that will become payable to AsiaInfo
Technologies under bankers' acceptances. AsiaInfo Technologies has guaranteed
China Netcom's obligations to Merchants Bank under the facility. The facility
will expire on May 16, 2003. Edward Tian, a director and major shareholder of
the Company, is the Chief Executive Officer of China Netcom, as well as a Vice
President of China Netcom's parent company, China Netcom Communication Group
Corporation.
-20-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for historical information, the statements contained in this Quarterly
Report on Form 10-Q are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. The Private Securities Litigation Reform Act of 1995 (the "Reform Act")
contains certain safe harbors regarding forward-looking statements. Certain of
the forward-looking statements include management's expectations, intentions and
beliefs with respect to our growth, our operating results, the nature of the
industry in which we are engaged, our business strategies and plans for future
operations, our needs for capital expenditures, capital resources and liquidity;
and similar expressions concerning matters that are not historical facts. Such
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those expressed in the
statements. All forward-looking statements included in this document are based
on information available to us on the date hereof, and we assume no obligation
to update any such forward-looking statements. These cautionary statements are
being made pursuant to the provisions of the Reform Act with the intention of
obtaining the benefits of the safe harbor provisions of the Reform Act. Among
the factors that could cause actual results to differ materially are the factors
discussed below under the heading "Factors Affecting our Operating Results and
our Common Stock."
OVERVIEW
We are a leading provider of telecommunications software solutions in China. Our
software products and network services enable our customers to build, maintain,
operate, manage and continuously improve their Internet and telecommunications
infrastructure.
We commenced our operations in Texas in 1993 and moved our operations from Texas
to China in 1995. We began generating significant network solutions revenues in
1996 and significant software solutions revenues in 1998. We conduct the bulk of
our business through our wholly-owned operating subsidiaries, AsiaInfo
Technologies (China) Inc., or AsiaInfo Technologies, and Guangzhou Bonson
Technology Limited, or Guangzhou Bonson, which are both Chinese companies.
We believe that there are opportunities for us to expand into new business areas
and to grow our business both organically and through acquisitions. On February
6, 2002, we completed our acquisition of Bonson Information Technology Holdings
Limited, or Bonson, a leading provider of operation support system solutions to
wireless telecommunications carriers in China through its operating subsidiary,
Guangzhou Bonson. The consideration paid to the former shareholders of Bonson
consisted of $32.76 million in cash and 1,031,686 shares of our common stock
which were valued at approximately $18 million at the time the acquisition was
announced. The cash we paid in connection with the acquisition was paid out of
our existing cash reserves. Bonson's operating results have been consolidated
with our operating results from February 6, 2002. In view of the Bonson
acquisition and potential future acquisitions we may engage in, our historical
operating results may not be an adequate basis on which to evaluate our
prospects.
We had invested a total of $2.7 million in our majority-owned network security
business, Marsec System Inc., or Marsec, which focuses on high-end security
-21-
services for our customers. Marsec's operating results are consolidated with our
operating results, with a provision for minority interest.
On April 27, 2001, we invested approximately $6.2 million to acquire a 14.25%
equity interest in Intrinsic Technology (Holdings), Ltd., or Intrinsic, a
company organized in the Cayman Islands and engaged in wireless Internet
application and development through its two wholly-owned subsidiaries in China.
We account for our interest in Intrinsic using the equity method.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period. On an
on-going basis, we evaluate our estimates and judgments, including those related
to revenues and cost of revenues under customer contracts, warranty obligations,
bad debts, income taxes, investment in affiliate, goodwill and other intangible
assets, and litigation. We base our estimates and judgments on historical
experience and on various other factors that we believe are reasonable. Actual
results may differ from these estimates under different assumptions or
conditions.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
REVENUES AND COST OF REVENUES. We derive a significant portion of our revenue
from fixed-price contracts using the percentage of completion method, which
relies on estimates of total expected contract revenue and costs. We follow this
method since reasonably dependable estimates of the revenue and costs applicable
to various stages of a contract can be made. Recognized revenues and profit are
subject to revisions as the contract progresses to completion. Accordingly,
changes in our estimates would impact our future operating results.
WARRANTY OBLIGATIONS. We record our estimate of warranty costs at the time of
final project acceptance, when all hardware pass-through revenue has been
recognized. Revisions for estimated warranties may be required in the period in
which actual warranties are known, thereby impacting our future operating
results.
BAD DEBTS. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the
financial condition of our customers were to change, changes to these allowances
may be required, which would impact our future operating results.
INCOME TAXES. We record a valuation allowance to reduce our deferred tax assets
to the amount that we believe is more likely than not to be realized. In the
event we were to determine that we would be able to realize our deferred tax
assets in the future in excess of their recorded amount, an adjustment to the
deferred tax asset would increase income in the period such determination was
made. Likewise, should we determine that we would not be able to realize all or
part of our net deferred tax asset in the future, an adjustment to the deferred
tax asset would be charged to income in the period such determination is made.
-22-
INVESTMENT IN AFFILIATE. We account for our 14.25% interest in Intrinsic using
the equity method. Intrinsic has incurred operating losses since our investment
in April 2001. Sustained operating losses of this affiliate or other adverse
events could result in our inability to recover the carrying value of the
investment, which may require us to record an impairment charge in the future.
Through September 30, 2002, we have not recorded an impairment charge for this
investment. In accordance with applicable accounting principles, we will conduct
an asset impairment test in the fourth quarter of 2002 in connection with our
private equity investments. This will include our 14% interest in Intrinsic
which is recorded on our balance sheet as an "investment in affiliate" of $4.9
million as of the end of the third quarter. We will report our findings at the
fourth quarter earnings announcement.
GOODWILL AND OTHER INTANGIBLE ASSETS. We make assumptions regarding estimated
future cash flows and other factors to determine the fair value of goodwill and
other intangible assets. If these estimates or their related assumptions change
in the future, we may be required to record an impairment charge if the
estimated fair value of goodwill and other intangible assets is less than its
recorded amount. As required under Statement of Financial Accounting Standards
No. 142, we have completed a transitional goodwill impairment test and have
concluded that no impairment of recorded goodwill was necessary as of January 1,
2002.
LITIGATION. We record contingent liabilities relating to litigation or other
loss contingencies when we believe that the likelihood of loss is probable and
the amount of the loss can reasonably be estimated. Changes in judgments of
outcome and estimated losses are recorded, as necessary, in the period such
changes are determined or become known. Any changes in estimates would impact
our future operating results. Significant contingent liabilities, which we
believe are at least possible, are disclosed in the notes to our consolidated
financial statements.
REVENUES
Currently, our operations are organized into two strategic business units:
communications solutions and operation support system solutions. Communications
solutions and operation support system solutions comprise two of our core
solutions offerings. We also offer our customers service application solutions
(through our communications solutions business unit) and network security
solutions (through our majority-owned subsidiary, Marsec). In deciding how to
allocate our company's resources and assess performance, we frequently evaluate
the separate operating results of our two strategic business units and Marsec.
However, we also rely extensively in this process on our evaluation of the two
primary types of revenue derived from our business: network solutions revenue
and software solutions revenue (each described in greater detail below).
Although both of our strategic business units generate network solutions revenue
and software solutions revenue, the communications solutions business unit
generates a majority of our total network solutions revenues, while the
operation support system solutions business unit generates a majority of our
total software solutions revenue. The following table illustrates our revenue
breakdown both in terms of our strategic business units (communications
solutions, operation support system solutions and network security solutions),
and in terms of our two principal types of revenue (network solutions and
software solutions):
-23-
THREE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------------------
STRATEGIC BUSINESS UNITS AND PRODUCT OFFERINGS
---------------------------------------------------------
Operation Network
Support Security
Communications System Solutions
BUSINESS LINE Solutions Solutions (Marsec) Total
- ------------- -------------- ------------ ------------- -------------
Network solutions net of
hardware costs ........................... $4,299,234 $1,006,812 $308,050 $ 5,614,096
Software solutions ....................... 1,650,662 7,422,659 - 9,073,321
---------- ---------- -------- -----------
Total revenues net of hardware costs ..... $5,949,896 $8,429,471 $308,050 $14,687,417
========== ========== ======== ===========
Although we account for our network solutions revenues on a gross basis,
inclusive of hardware acquisition costs that are passed through to our
customers, we manage our business internally based on revenues net of hardware
costs, which is consistent with our strategy of providing our customers with
high value IT professional services while gradually outsourcing lower-end
services such as hardware acquisition and installation. This strategy may result
in lower growth rates for total revenues as against prior periods, but will not
adversely impact revenues net of hardware costs. The following table shows our
revenue breakdown on this basis:
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
------------------------- ------------------------------------------------
2002 2001 2001 2000 1999 1998 1997
--------- ----------- -------- ------- -------- -------- ---------
Network solutions net of hardware
costs .................................. 52% 58% 61% 61% 74% 88% 93%
Software solutions ....................... 48% 42% 39% 39% 26% 12% 7%
--------- --------- -------- ------- -------- -------- ---------
Total revenues net of hardware costs ..... 100% 100% 100% 100% 100% 100% 100%
========= ========= ======== ======= ======== ======== =========
As demonstrated by the foregoing table, software solutions revenue has accounted
for an increasing portion of our total revenue net of hardware costs over the
past several years, increasing from 7% in 1997 to 39% in 2001 and 48% for the
first three quarters of 2002. We anticipate that software solutions revenue will
account for approximately 40% to 42% of our total net revenues for 2002.
REVENUE BACKLOG. Most of our revenues are derived from customers' orders under
separate binding contracts for hardware, network services, and software products
and services. These contracts constitute our backlog at any given time. Revenues
for hardware, network solutions and software solutions are recognized during the
course of the relevant project, as described in more detail below. At September
30, 2002, our revenue backlog net of hardware
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costs was $41.3 million, a 12% decrease compared to backlog one year ago. The
decrease in total net revenue backlog was primarily due to the prolonged delays
in the restructuring of certain state-controlled telecommunications companies in
China, including China Telecommunications Corporation, or China Telecom, causing
the carriers to delay their orders longer than previously expected. Software
solutions backlog was $19.0 million, or 46% of net revenue backlog, a 13%
increase over the period a year ago. Orders under contracts generated by Bonson
accounted for 23% of the total backlog net of hardware costs and 34% of software
solutions backlog. The software services component of net revenue backlog
increased by 61% year-over-year while the hardware margin (derived from our
hardware sales to customers as part of our services) component decreased 37%
over the same period. We believe that these changes illustrate our successful
transition from a pure systems integration company to a provider of total
software solutions to China's telecommunications service providers.
NETWORK SOLUTIONS REVENUE. Network solutions revenue consists of hardware sales
for equipment procured by us on behalf of our customers from hardware vendors,
as well as services for planning, design, systems integration and training. We
procure for and sell hardware to our customers as part of our total solutions
strategy. We minimize our exposure to hardware risks by sourcing equipment from
hardware vendors against letters of credit from our customers. We believe that
as the telecommunications-related market in China develops our customers will
increasingly purchase hardware directly from hardware vendors and hire us for
our professional services.
We generally charge a fixed price for network solutions projects and recognize
revenue based on the percentage of completion of the project. We use labor costs
and direct project expenses to determine the stage of completion, except for
revenue associated with the procurement of hardware on behalf of the customer.
We recognize such hardware-related revenues upon delivery. Since a large part of
the cost of a network solutions project often relates to hardware, the timing of
hardware delivery can cause our quarterly gross revenue to fluctuate
significantly. However, these fluctuations do not significantly affect our gross
profit because hardware-related revenues generally approximate the costs of the
hardware.
Network solutions projects generally have a life of nine to twelve months,
during which there are three key milestones. The first milestone occurs when the
hardware is delivered, which is usually between three and four months after
signing the contract. The second milestone in a network solutions project is at
primary acceptance, which usually occurs around three to four months after
hardware delivery. At primary acceptance, all services and products are
delivered. The third milestone is final acceptance, which occurs when the
customer agrees that we have satisfactorily completed all of our work on the
project.
SOFTWARE SOLUTIONS REVENUE. Software solutions revenues include two types of
revenues: software license revenue and software services revenue. Software
license revenue consists of fees received from customers for licenses to use our
software products in perpetuity, typically up to a specified maximum number of
users. In most cases, our customers must purchase additional user licenses from
us when the number of users exceeds the specified maximum. Our software license
revenue also includes the benefit of value added tax rebates on software license
sales, which are part of the Chinese government's policy of encouraging China's
software industry. Software services revenue consists of revenue from software
installation, customization, training and other services. To date, substantially
all of our revenue from both software
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licenses and software services has been derived from customer orders for
projects requiring some modifications or customization of our software. We
recognize substantially all software revenue over the installation and
customization periods, based on the percentage of completion of the related
project as measured by labor costs and direct project expenses.
UNBILLED REVENUE. The foregoing network solutions and software solutions revenue
recognition policies result in our recognizing certain revenues even though we
are not due to receive the corresponding cash payment under the relevant
contract. In the case of hardware sales, the customer typically holds back
around 10 to 20% of the hardware contract payments at the time of delivery until
final project acceptance. Although we record all hardware revenue at the time of
delivery, the 10 to 20% held back by the customer is recorded as unbilled
receivables and does not become billable until final project acceptance.
In the case of services, most of the revenue becomes billable at the time of
primary acceptance, but the customer typically holds back around 10 to 20% of
the services and software contract payments until final acceptance. Unpaid
amounts for services, as well as for hardware, become payable at the time of
final project acceptance. When we recognize revenue for which payments are not
yet due, we book unbilled accounts receivable until the corresponding amounts
become billable.
COST OF REVENUES
NETWORK SOLUTIONS COSTS. Network solutions costs consist primarily of third
party hardware costs, compensation and travel expenses for the professionals
involved in designing and implementing projects, and hardware warranty costs. We
recognize hardware costs in full upon delivery of the hardware to our customers.
In order to minimize our working capital requirements, we generally obtain from
our hardware vendors payment terms that are timed to permit us to receive
payment from our customers for the hardware before our payments to hardware
vendors are due. However, in large projects we sometimes obtain less favorable
payment terms from our customers, thereby increasing our working capital
requirements. We accrue hardware warranty costs when hardware revenue is fully
recognized upon final acceptance. We obtain manufacturers' warranties for
hardware we sell, which cover a portion of the warranties that we give to our
customers. We currently accrue 0.5% of hardware sales to cover potential
warranty expenses. This estimate of warranty cost is based on our current
experience with contracts for which the warranty period has expired.
SOFTWARE SOLUTIONS COSTS. Software solutions costs consist primarily of three
components:
.. packaging and written manual expenses for our proprietary software
products;
.. compensation and travel expenses for the professionals involved in
modifying, customizing or installing our software products and in providing
consultation, training and support services; and
.. software license fees paid to third-party software providers for the right
to sublicense their products to our customers as part of our solutions
offerings.
The costs associated with creating and enhancing our proprietary software are
classified as research and development expenses as incurred.
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OPERATING EXPENSES
Operating expenses are comprised of sales and marketing expenses, research and
development expenses, general and administrative expenses, and amortization
expenses for intangible assets and deferred stock compensation.
Operating expenses consist primarily of compensation expenses. Recently, in an
effort to scale our business to accommodate lower market demand, we have reduced
these costs through a 10% headcount reduction and a 10% salary cut for employees
at the manager level and above.
Research and development expenses relate almost entirely to the development of
new software and the enhancement and upgrading of existing software. We expense
these costs as they are incurred.
We provide most of our officers, employees and directors, with stock options. In
the past, we granted a number of options with exercise prices below the fair
market value of the related shares at the time of grant, resulting in our
incurring deferred compensation expenses. Most of the options granted with
exercise prices below fair market value on the date of grant were issued prior
to 1997. We do not, however, intend to issue options below fair market value in
the future. Therefore, our deferred compensation expenses have been
significantly higher historically than we expect them to be in future years. The
difference between the exercise price and the fair market value of the related
shares is amortized over the vesting period of the options and reflected on our
income statement as amortization of deferred stock compensation. For further
information, please see note 15 to our consolidated financial statements for the
year ended December 31, 2001, included in our annual report on Form 10-K, filed
with the Securities and Exchange Commission on March 22, 2002.
We make bad debt provisions for accounts receivable balances based on
management's assessment of their recoverability. In any event, we make bad debt
provisions for all accounts receivable balances that are aged over one year. We
include those bad debt provisions in general and administrative expenses.
TAXES
Except for certain of our hardware procurement and resale transactions, we
conduct substantially all of our business through our Chinese operating
subsidiaries. Our Chinese subsidiaries are generally subject to a 30% state
corporate income tax and a 3% local income tax. AsiaInfo Technologies, our
principal operating subsidiary, is classified as a "foreign invested enterprise"
and as a "high technology" company for purposes of Chinese tax law and, as such,
is entitled to preferential tax treatment in China. AsiaInfo Technologies
operated free of Chinese state corporate income tax for three years, beginning
with its first year of operation, and was entitled to a 50% tax reduction for
the subsequent three years. The tax holiday for AsiaInfo Technologies expired on
December 31, 1997 and the 50% tax reduction expired on December 31, 2000.
However, AsiaInfo Technologies received a continuation of its preferential tax
treatment from the local tax authorities in China for an additional three years,
expiring at the end of 2003, which reduces our effective income tax rate to not
less than 10%. In 2002, we anticipate that the effective corporate income tax
rate applicable to AsiaInfo Technologies will be 10%.
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AsiaInfo Technologies (Chengdu), Inc., or AsiaInfo Chengdu, our subsidiary which
sources hardware in China for our customers, is classified as a "foreign
invested enterprise" in China. AsiaInfo Chengdu operates free of Chinese state
and local corporate income tax for two years beginning from its first year of
operation, and is entitled to a 50% tax reduction for the subsequent three
years. As such, the tax holiday for AsiaInfo Chengdu will expire on December 31,
2003 and the 50% tax reduction will expire on December 31, 2006.
Guangzhou Bonson is classified as a "foreign invested enterprise" and as a "high
technology" company for purposes of Chinese tax laws. Guangzhou Bonson operated
free of Chinese state and local corporate income tax for two years, beginning
with its first year of operation, and is entitled to a 50% tax reduction for the
subsequent three years. The tax holiday for Guangzhou Bonson expired on December
31, 2001 and the 50% tax reduction will expire on December 31, 2004. In 2002,
the current corporate income tax rate for Guangzhou Bonson is 7.5%.
Sales of hardware procured in China are primarily made through AsiaInfo Chengdu
and are subject to a 17% value added tax. Most of our sales of hardware procured
outside China are made through our Hong Kong subsidiary, AsiaInfo H.K. Limited,
or AsiaInfo H.K., and thus are not subject to the value added tax. We
effectively pass value-added taxes on hardware sales through to our customers
and do not include them in revenues reported in our financial statements. Sales
of software in China are subject to a 17% value added tax. However, for
companies that develop their own proprietary software, a value added tax refund
is available. If the net amount of the value added tax payable exceeds 3% of
software sales, the excess portion of the value added tax is refundable
immediately. This policy is effective until 2010. Changes in Chinese tax laws
may adversely affect our future operations.
We are also subject to U.S. income taxes on revenues generated in the U.S.,
including revenues from our limited hardware procurement activities through our
U.S. parent company and interest income earned in the U.S.
FOREIGN EXCHANGE
A majority of our revenues and expenses relating to hardware sales are
denominated in U.S. dollars, and substantially all of our revenues and expenses
relating to the service component of our network solutions business and software
business are denominated in Renminbi. Although, in general, our exposure to
foreign exchange risks should be limited, the value of our shares will be
affected by the foreign exchange rate between U.S. dollars and Renminbi because
the value of our business is effectively denominated in Renminbi, while our
shares are traded in U.S. dollars. Furthermore, a decline in the value of
Renminbi could reduce the U.S. dollar equivalent of the value of the earnings
from, and our investment in, our subsidiaries in China.
CONSOLIDATED RESULTS OF OPERATIONS
REVENUES. Gross revenues were $32.6 million and $97.7 million, respectively, in
the three- and nine-month periods ended September 30, 2002, representing
decreases of 65% and 35%, respectively, against the comparable periods in 2001.
These decreases are primarily attributable to a shift in our customer's focus
from increasing network capacity to increasing network productivity through the
provision of more advanced applications.
Revenues net of hardware costs were $14.7 million and $51.4 million,
respectively, in the three- and nine-month periods ended September 30, 2002,
representing a decrease of 27% compared to the three-month period ended
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September 30, 2001 and remaining relatively unchanged as compared to the
nine-month period ended September 30, 2001. Total software revenues were $9.1
million and $24.7 million, respectively, in the three- and nine-month periods
ended September 30, 2002, representing increases of 18% and 15%, respectively,
over the comparable periods in 2001. Bonson contributed 34% to this quarter's
total revenue net of hardware costs and 40% of software solutions revenue. As
compared to the preceding quarter, software solutions revenues were up 3% and
total net revenues were down approximately 25%. The year-over-year and
sequential decrease in total net revenues was primarily attributable to the
prolonged telecommunications industry restructuring in China. We expect further
delays in order decisions from our major customers, affecting both our network
solutions revenues and our software solutions revenues. We expect our net
revenue to be approximately $12 million to $13 million for the fourth quarter of
2002 and in the range of $63.4 million to $64.4 million for the full year 2002,
in line with our earnings guidance of July 23, 2002.
COST OF REVENUES. Our cost of revenues decreased 69% to $24.1 million and 42% to
$64.8 million, respectively, in the three- and nine-month periods ended
September 30, 2002, as compared to the same periods in 2001. These decreases in
costs of revenues are attributable to lower hardware pass through costs in the
third quarter of 2002 as compared to the third quarter of 2001 when we made a
major hardware delivery in connection with a backbone project for China Unicom.
GROSS PROFIT. Gross profit was $8.5 million and $32.8 million, respectively, in
the three- and nine-month periods ended September 30, 2002, representing
decreases of 45% and 18%, respectively, against the comparable periods in 2001.
Gross profit as a percentage of gross revenues, or gross margin, increased to
26% and 34%, respectively, in the three- and nine-month periods ended September
30, 2002, as compared to 17% and 27%, respectively, in the comparable periods of
2001. These increases in gross margin are primarily attributable to the smaller
amount of low margin hardware pass through revenue recognized in the relevant
periods of 2002. Gross profit as a percentage of net revenues decreased to 58%
and 64%, respectively, in the three- and nine-month periods ended September 30,
2002, as compared to 77% and 78%, respectively, in the comparable periods of
2001.
OPERATING EXPENSES. Total operating expenses decreased 30% and 20%,
respectively, to