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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For The Fiscal Year Ended December 31, 2002
or
[_] 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 of incorporation) (I.R.S. Employer
Identification No.)
4th Floor, Zhongdian Information Tower
6 Zhongguancun South Street, Haidian District
Beijing 100086, China
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code +8610 6250 1658
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 Par Value
(Title of Class)
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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [_]
Based on the closing sale price of the common stock on the Nasdaq National
Market System on June 28, 2002, the aggregate market value of the voting stock
held by non-affiliates of the Registrant was $260,841,487.50.
The number of shares outstanding of the Registrant's common stock, $0.01 par
value, was 44,243,527 at March 11, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information is incorporated by reference to the Proxy Statement for the
Registrant's 2003 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this Form 10-K.
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ASIAINFO HOLDINGS, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
PART I
ITEM 1. Business............................................................................ 3
ITEM 2. Properties.......................................................................... 21
ITEM 3. Legal Proceedings................................................................... 21
ITEM 4. Submission of Matters to a Vote of Security Holders................................. 22
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 22
ITEM 6. Selected Financial Data............................................................. 23
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 24
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.......................... 43
ITEM 8. Financial Statements and Supplementary Data......................................... 43
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 43
PART III
ITEM 10. Directors and Executive Officers of the Registrant.................................. 43
ITEM 11. Executive Compensation.............................................................. 44
ITEM 12. Security Ownership of Certain Beneficial Owners and Management...................... 44
ITEM 13. Certain Relationships and Related Transactions...................................... 44
ITEM 14. Controls and Procedures............................................................. 44
ITEM 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K..................... 44
SIGNATURES................................................................................... 46
Except for historical information, the statements contained in this Annual
Report on Form 10-K 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 "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation--Factors Affecting Our Operating Results and Our Common Stock."
In this report, "AsiaInfo," the "Company," "we," "us," and "our" refer to
AsiaInfo Holdings, Inc. and its subsidiaries.
PART I
ITEM 1. Business
Overview
We are a leading provider of telecommunications network integration services
and software solutions in China. Our software products and network services
enable our customers to build, maintain, operate, manage and continuously
improve their communications infrastructure and customer applications.
Our key customers are the leading telecommunications service providers in
China, including China Telecommunications Corporation, or China Telecom, China
Network Communications Group Corporation, or China Netcom Group, China Mobile
Communications Corporation, or China Mobile, China United Telecommunications
Corporation, or China Unicom, and China Railway Communications, or China
Railcom.
We founded our business in the United States in 1993 and relocated our
principal operations to China in 1995. In China we have designed and
implemented most of the nation's major commercial Internet backbone projects,
including ChinaNET for China Telecom, UniNET for China Unicom and CMCCNET for
China Mobile. Each of those projects included the carrier-class, meaning high
performance, highly fault tolerant software components that we develop and
sell. Our software products can support millions of users, are designed with
open architecture to facilitate customization, and are tailored for the
specific needs of the China market. Because those software products, along with
our network integration services, have a broad range of applications for our
customers' businesses, including their fixed-line, wireless and Internet
services, our business has grown from a pure Internet infrastructure developer
to a total telecommunications infrastructure software and services provider.
Our operations are now organized as two strategic business units:
Communications Solutions and Operation Support System Solutions.
.. Communications Solutions includes network solutions, service application
solutions, network security solutions, and network monitoring solutions.
.. Operation Support System, or OSS, Solutions includes our highly scalable
software, which is capable of automating a telecom carrier's key business
processes, such as customer care and billing, order fulfillment, and
customer relationship management.
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Although we are organized as a Delaware corporation, we conduct most of our
operations through two of our wholly-owned subsidiaries, AsiaInfo Technologies
(China), Inc., or AsiaInfo Technologies, and AsiaInfo Management Software, Inc.
(previously Guangzhou Bonson Technology Limited), or AsiaInfo Management, which
are both Chinese companies.
RECENT DEVELOPMENTS
Business Reorganization and New Segment Reporting
We conducted a business reorganization in the fourth quarter of 2002 in order
to reflect more accurately our strategic focus. As part of the reorganization,
our strategic business units, or SBUs, were restructured into two units:
Communications Solutions and Operation Support System Solutions, or OSS
Solutions. Our Communications Solutions business unit now offers network
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. The reorganization emphasizes the growing importance of our
OSS business and allows us to offer those products through an integrated
operational structure. In addition, we expect to be able to achieve cost
efficiencies as a result of the combined sales teams within both business units.
Our results of operations were previously reported under the segments "network
solutions" and "software solutions." In connection with the reorganization, we
have reclassified our reporting segments into OSS Solutions and Communications
Solutions in order to reflect our operations more accurately. For detailed
financial information and more information on our new reporting segments,
please refer to our consolidated financial statements and notes thereto
included in this report and the discussion below under "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operation."
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INDUSTRY BACKGROUND
According to China's Ministry of Information Industry, or MII, in 2002 China's
fixed-line phone subscribers increased by 20% to 214 million and wireless phone
users increased by approximately 43% to 207 million. During that period, total
revenue generated by the telecommunications sector reached approximately $49.8
billion, up 16% from the previous year. China's telecommunications sector
continues to serve as a growth engine for the country's overall economy, whose
GDP grew at a rate of 7% to 8% in 2002. As the overall telecommunications
market expanded in 2002, the wireless sector has grown even more rapidly.
According to the MII, the number of mobile phone users has exceeded 206 million
by the end of 2002 and China had become the largest mobile phone market in
terms of the number of mobile phone users. The following table sets forth
certain information relating to the telecommunications industry in China as of
the dates indicated:
Compound Annual
As of December 31, Growth Rate
-------------------------- ---------------
1999 2000 2001 2002 (1999-2002)
----- ----- ----- ----- ---------------
China's population (in millions)...... 1,258 1,267 1,276 1,286 0.7%
China's GDP per capita (RMB).......... 6,551 7,081 7,543 7,930 6.6%
Fixed-line Telephone
Access lines in service (in millions) 108.8 144.8 180.4 214.4 25.4%
Penetration rate /(1)/............... 8.6% 11.4% 14.1% 16.7% --
Wireless Telephone
Subscribers (in millions)............ 43.2 84.5 144.8 206.6 68.5%
Penetration rate /(1)/............... 3.4% 6.7% 11.3% 16.1% --
Internet
Users (in millions).................. 8.9 22.5 33.7 59.1 88.0%
Penetration rate /(1)/............... 0.7% 1.8% 2.6% 4.6% --
- --------
(1) Determined by dividing the number of subscribers or users by the total
population of China.
Sources: Data in respect of China's population and GDP per capita are derived
from information published by the National Statistical Bureau; data in
respect of mobile subscribers are derived from information published
by the Ministry of Information Industry; data in respect of Internet
users are derived from information published by CNNIC.
China's government has set aggressive goals for the future growth of China's
telecommunications industry. According to the MII's Tenth Five-Year Plan, the
industry will continue to grow three times as fast as China's GDP during the
period from 2001 through 2005. By 2005, the MII expects telecommunications
service revenues to reach approximately $110 billion, which is triple the
figure in 2000. The capacity of fixed switching equipment is expected to reach
300 million lines, while mobile switching capacity is expected to reach 360
million lines. According to the Tenth Five-Year Plan, there will be
approximately 500 million telephone subscribers in China by 2005, representing
a penetration rate of more than 40%. The number of fixed-line subscribers is
expected to reach 240 million to 280 million with a penetration rate of 18% in
2005, compared to 16.7% in 2002. The number of mobile subscribers is expected
to reach 260 million to 290 million with a penetration rate of 21% in 2005,
compared to 16.1% in 2002. There will be approximately 200 million subscribers
of data, multimedia and Internet services with a penetration rate of 15%. Based
on preliminary calculations, a total of approximately $150 billion will be
invested in the telecommunications industry, which is 20-30% higher than the
total investment under China's Ninth Five-Year Plan.
Over the past several years, the telecommunications industry in China has gone
through several restructurings. These restructurings have been accompanied by
industry deregulation and rapid growth in the market for telecommunications
services. Prior to a major industry restructuring in 1999, the
telecommunications market in China was dominated by the predecessor company of
China Telecom. In 1999, the predecessor company of China Telecom was divided
into the following four companies:
.. China Telecom--providing fixed-line and data communication services;
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.. China Mobile--providing mobile and data communication services;
.. China Satellite--providing satellite communications; and
.. Guoxin Paging--a paging business that was subsequently merged into China
Unicom.
In May 2002, the telecommunications industry was further restructured with the
split of China Telecom into two independent companies. China Netcom Group was
formed by merging the telecommunications assets of China Telecom in ten
northern provinces of China with China Netcom Corporation Ltd., or China
Netcom, and Jitong Communication. The southern division of the original China
Telecom continues to operate under the China Telecom name.
At the end of 2002, there were five major licensed telecommunications operators
in China. China Telecom, China Netcom Group, China Unicom and China Railcom
provide fixed-line services while China Mobile and China Unicom are licensed to
provide wireless services. China Satellite Communications Corporation, or China
Satcom, the sixth licensed telecommunications operator in China, has smaller
operations and specializes in satellite communications. All six operators are
Internet service providers. According to the MII, China Mobile has recently
replaced China Telecom as China's largest telecommunications operator. In terms
of total income in 2002, China Mobile held 37.4% of the market in China,
followed by China Telecom with 32.5% and China Netcom Group with 16.6%. China
Unicom ranked fourth with a market share of 12.1% while China Railcom and China
Satellite together held the remaining 1.4%.
With the introduction of more competition, telecommunications service providers
are becoming more conscious of the return on their infrastructure investments.
With the rapidly increasing number of subscribers and the restructuring of
China's telecommunications industry, the competitive focus of carriers is
moving from pricing to quality and product differentiation, while their
investment focus is moving from network construction to operation support
systems that help increase service quality and customer satisfaction, and
reduce response time to market demands and trends.
Notwithstanding the growth in the number of telecommunications users, overall
capital expenditure by China's telecommunications providers declined in 2002 as
a result of the global slowdown of the telecommunications industry, the
industry restructuring in China, and the shift of focus in China from
infrastructure expansion to customer service. According to the MII, overall
capital expenditure in the telecommunications sector decreased by 20% to $24.6
billion in 2002. This decrease in overall capital expenditure caused our
revenues net of hardware costs to decrease approximately 9% to $64.7 million in
2002 from $71.4 million in 2001. We expect that capital expenditure in China's
telecommunications industry will begin to return to pre-restructuring levels in
the second half of 2003 and will increase further over the next few years.
MARKET OPPORTUNITIES
We believe that the major market opportunities for our business include the
following:
NETWORK CONSULTING, INTEGRATION AND MANAGEMENT SERVICES. With broad usage of
sophisticated technology and software applications, telecommunications networks
are becoming more complex, more customized and more difficult to manage. The
deployment of telecommunications and Internet infrastructure in a complex,
multi-vendor environment requires significant expertise that usually is not
internally available to Chinese telecommunications services providers. As a
result, they rely on experienced information technology, or IT, services
companies like ours to provide total solutions to their telecommunications
infrastructure requirements in order to increase network efficiency,
differentiate their services and ensure service quality. We believe that as the
telecommunications market develops in China, our customers will continue to
require high value IT services such as network design, network planning,
network security and project management.
MISSION CRITICAL OPERATION SUPPORT SYSTEM, OR OSS, SOFTWARE AND SERVICES. As a
result of increased competition, telecommunications service providers in China
are investing in operation support system solutions
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to manage their fast growing businesses, meet the varying needs of their
customers and reduce response time to market demands and trends.
Telecommunications and Internet service providers in China are now focusing on
differentiating their services, rather than competing solely on price. They are
investing in customer care and support in order to study customer behavior and
enhance customer satisfaction. Telecommunications and Internet service
providers in China must be able to monitor customer activity, bill customer
usage on a real-time basis, and scale services to millions of users in order to
facilitate the rapid growth of their subscriber bases. These mission-critical
needs cannot be met by traditional customer care and billing solutions that are
inflexible, capable only of period processing, and difficult to scale. Our
experience indicates that service providers in China prefer real-time, scalable
and reliable billing and business management software and services that support
their packaged services, flexible pricing policies and integrated customer care
initiatives.
Convergent application software. The emergence of convergent communications
has created an increasing demand for convergent software and solutions.
Providers of convergent communications services, such as Internet protocol
telephony and wireless data services, require customer care and billing
software that is capable of accounting for and billing their customers' voice,
data and Internet usage using common architecture. In addition, they need
software products that enable them to provide convergent communications
applications such as unified messaging products integrating email, voicemail,
fax and messaging functions.
Broadband network services and application software. As a result of increased
competition in China's telecommunications and Internet markets, carriers with
narrowband networks are continuing to upgrade to broadband networks with new
service offerings. As a result, service providers in China are investing in
broadband solutions for their backbone and provincial access networks, such as
unified messaging, media streaming, video conferencing and wireless data
related applications, to boost network usage and to generate revenue.
OUR STRATEGY
Our vision is to be the leading China-based company providing world class
network integration and management solutions by continuing to enable our
customers to build, maintain, operate, manage and continuously improve their
telecommunications and network infrastructure. The key aspects of our strategy
include the following:
Expand and deepen our software solutions to support the overall
telecommunications industry in China. With over seven years of experience in a
fast-growing market, we are a leading provider of network integration services
and software solutions to the largest telecommunications companies in China.
Our reputation has allowed us to grow our business as a provider of software
solutions in vertical telecommunications markets. For example, our suite of
operation support system solutions has allowed us to capitalize on
opportunities in the wireless telecommunications market. With our acquisition
of Bonson in 2002, we have established a leadership position in the wireless
and data communication OSS market and increased our OSS Solutions revenues net
of hardware costs by 75%. In 2002, we won nine provincial installations with
China Mobile for their full scale billing operation support systems, which is
twice the number of installations by any of our closest competitors. Although
there has been a recent decline in capital expenditure as a result of the
industry restructuring, based on our communications with our customers and
government agencies, we expect investment in China's telecommunications
industry to resume and continue to grow rapidly in the long term, despite
cyclical adjustments. We expect most investment to be made through our
customers, which are the largest telecommunications service providers in China.
We believe that our close relationships with our customers, our unique
understanding of the China market, our technical capabilities and our proven
track record will allow us to capitalize on these growth opportunities. In the
process, we plan to continue our transition from a pure systems integration
business to a software solutions dominant business.
Focus on high value information technology professional services. Currently,
we offer our information technology professional services primarily in the
context of total solutions, which include systems integration and customization
of our proprietary and third party software. We minimize our exposure to
hardware risks by
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placing orders from hardware vendors only against back-to-back orders from
customers and having the equipment delivered by the vendor directly to the
customers' premises. As the IT market matures in China, we are focusing on
providing our customers with high value IT professional services, such as
network planning, design and optimization, while gradually outsourcing lower
end services, such as hardware installation, and encouraging customers to
purchase hardware directly from equipment vendors. We believe the service
components of our telecommunications solutions will become increasingly
important as telecommunications networks become more complex and more
customized. As such, we intend to continue to develop our services business to
include more high-value consulting services.
LEVERAGE OUR HIGH QUALITY CUSTOMER BASE TO GENERATE RECURRING REVENUES. We
have a high quality group of customers and, through our customers' end users,
one of the largest installed software customer bases (as measured by the number
of licensed end users) for leading telecommunications service providers and
Internet content and service providers in China. Our customers include China
Telecom, China Netcom Group, China Mobile, China Unicom, and China Railcom,
which together have accounted for a majority of the investment in
telecommunications infrastructure in China. Our high quality customer base
enables us to foster close relationships with our customers and develop
in-depth understandings of their specific needs. Furthermore, our customers may
face significant costs and technological risks by switching from our services
and products to others. We generate recurring revenues from our existing
customer base through upgrades of their networks and implementation of new
services and products, including outsourced applications.
ATTRACT AND RETAIN HIGHLY QUALIFIED PERSONNEL. We intend to continue our
strategy to attract and retain the best and most qualified personnel in China's
IT industry. In view of the specific needs of the China market, we target our
recruitment effort on Chinese citizens who have information technology and
professional competence and extensive exposure to western education and
management practices. We believe that we have been able to attract and retain
qualified personnel by offering attractive compensation packages, a challenging
and rewarding work environment, and the opportunity to work for a leading
company in China. Given our continuing transition to a software dominant
business, we are focusing our recruitment efforts on more highly-skilled
software engineers.
OUR COMPETITIVE STRENGTHS
We believe that we are well positioned to continue meeting our customers'
network infrastructure and application needs in China. The key factors that
contribute to our strong competitive position are:
TELECOMMUNICATIONS INFRASTRUCTURE TECHNOLOGY LEADERSHIP IN CHINA. Our
engineering personnel have industry-leading expertise in telecommunications
infrastructure technologies in China. This expertise enables us to design and
implement network technology that is suitable for the Chinese market and that
employs high quality design and validated hardware and software components, and
to deliver solutions with high performance-to-cost ratios for our customers.
COMBINED INTERNATIONAL AND CHINA EXPERTISE. Our senior management is a Chinese
team, a majority of whom have been educated in the United States or have worked
with leading multinational companies in or outside of China. They have an
in-depth understanding of the China market, combined with a knowledge of best
management practices gained from some of the world's leading information
technology companies. We have well defined performance evaluation and reward
systems and a strong emphasis on sound, accountable corporate governance. We
believe that the unique strengths of our management team make us one of the
best managed companies in Asia, and make us well positioned to anticipate and
capitalize on market opportunities for our business in China.
REAL-TIME, SCALABLE AND ADAPTABLE SOFTWARE. Our software allows service
providers to monitor user activity and analyze service usage data in real time.
The real time feature enables service providers to increase billing accuracy,
accelerate the time-to-market for new services and improve the effectiveness of
marketing and
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targeting efforts. The scalability of our software allows telecommunications
service providers to develop their network infrastructure incrementally as
their level of business grows, without the need for architecture re-engineering
or large-scale system replacements. In addition, our software products are
designed with fully documented, open architecture that allows our customers, as
well as third party systems integrators and software developers, to integrate
our software with existing applications and services with minimal effort and
programming overhead.
CUSTOMER-CENTRIC AND COST-EFFECTIVE PROJECT MANAGEMENT CAPABILITY. Our project
delivery time with key customers usually lasts between three to six months, and
at times may last over a year. We believe customer satisfaction is essential to
preserve customer loyalty. As such, we remain in close contact with our
customers to meet their needs and demands during the course of these projects.
Through experience and time, we have developed a unique project management
system to achieve maximum customer satisfaction in a cost-effective manner. We
believe our effective project management system distinguishes us from of our
competitors in China.
ESTABLISHED CUSTOMER RELATIONSHIPS. We have close relationships with all
leading telecommunications service providers in China and have provided our
services and products to most of them. Our in-depth understanding of their
requirements allows us to successfully deliver customized solutions and
maximize the opportunities created by investment in communications
infrastructure in China. Moreover, we have strong customer service and research
and development teams based in China, which allows us to respond quickly and
efficiently to the needs of our customers.
PRODUCTS AND SERVICES
We provide telecommunications network integration services and software
solutions to the leading telecommunications service providers in China. We
offer these solutions to our customers by leveraging our core strengths in
information technology services and software, and maintaining close
relationships with multiple hardware and third party software vendors.
Substantially all of our network integration and software solutions business is
accounted for by the various provincial entities of China Telecom, China Mobile
and China Netcom Group, as well as China Unicom and China Railcom. Our
longstanding relationships with these customers and our understanding of their
specific requirements make us well positioned to respond to their requests for
proposals.
We develop, market and produce our offerings, or "solutions," through our two
strategic business units:
.. Communications Solutions (which includes network solutions, service
application solutions, network security solutions and network monitoring
solutions); and
.. Operation Support System, or OSS, Solutions.
We provide maintenance and technical support in connection with all our
projects, including assistance with the implementation of new information
technology functions and/or features, configuration and programming services
for new business processes, warranty repairs, and assistance in the case of
technology upgrading. Our policy of on-going maintenance and technical support
helps us to foster long-term relationships with our customers. We also provide
technical training to our customers and strategic partners to increase their
awareness and knowledge of network technologies and software in the Chinese
information technology market and to support the operations of our customers'
integrated network systems.
COMMUNICATIONS SOLUTIONS
NETWORK SOLUTIONS--The core area of our Communications Solutions business unit
is network solutions, which represented approximately 72% of our net revenues
in the Communications Solutions business unit in 2002. Network solutions
includes network access and backbone infrastructure design and implementation
for
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telecommunications and Internet service providers. Network solutions support a
wide array of network technologies and generally involve one or more of the
following services:
.. Network planning. We provide our customers with strategic and tactical
reviews of their current network operations and future network
requirements. We do much of this work before the customer awards a contract
in order to assist them in developing an appropriate request for proposal
and to improve our chances in winning the contract. The planning includes
defining client business requirements, developing appropriate information
architectures and selecting preferred technology.
.. Network design. We detail the network specifications and implementation
tactics necessary to achieve our customers' objectives. We also consider
how the new technology will integrate with the customer's existing hardware
and software and how it will be managed on an ongoing basis.
.. Network implementation. We install recommended systems to meet our
customers' network requirements. Key activities include project management,
hardware and software procurement, configuration and field installation and
testing, building network management centers and developing customized
network and services management applications. We believe that our expertise
in integrating new systems without disrupting our customers' ongoing
business operations adds significant value and reduces risks.
.. Network performance optimization. We maximize the efficiency of
communications networks by improving network utilization. Examples of these
services include network traffic analysis and identification of
bottlenecks, recommendations for efficient allocation of bandwidth, fault
detection and isolation, and performance audit and tuning.
Network solutions projects give us an intricate understanding of our customers'
infrastructure requirements and allow us to understand the software
requirements that are needed to support those infrastructures. Software
products within network solutions include AINetXpert and AsiaInfo VisionXpert.
AINetXpert. AINetXpert is a service-oriented network management software
product with high-end features. AINetXpert manages all aspects of a network
environment, including hardware, applications, services and customers at four
different layers: equipment, application, service and business. Several unique
characteristics of AINetXpert differentiate it from other network management
software products. Through its multi-vendor support feature, AINetXpert
significantly increases the cost efficiency of network management activities.
Further, by monitoring and assessing network traffic in real time, AINetXpert
collects and analyzes statistical data on the system by service category, which
can be used to manage service level agreements and make sound investment
decisions for network expansion. For large-scale networks, AINetXpert groups
and manages systems by service category such as leased line services, dial-up
services and Web services, enabling operators to streamline management
processes and prioritize management tasks. Furthermore, while traditional
network management software products only deal with static network elements
such as hardware, AINetXpert also manages dynamic factors such as usage
patterns. AINetXpert also facilitates many customer-oriented value-added
services such as customer self-evaluation on service usage. AINetXpert has a
modular design to adapt flexibly to the actual needs of customers.
AsiaInfo VisionXpert (AIVX). AIVX is a support system for video-conferencing
operations, providing the following functions:
.. Conference management--scheduling users' participation in conferences and
booking meeting times and venues;
.. Resource management--carrying out deployment strategies over system
resources, supporting products of different manufacturers and providing
inter-operator development and redundancy design;
.. User management--managing users' data and users' rights, and matching users
and terminals;
.. Billing management--collecting billing records, generating billing
messages, answering billing inquiries and performing bill payment functions.
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SERVICE APPLICATION SOLUTIONS--We design and provide applications for Internet
access, Internet protocol telephony and virtual private networks that allow our
clients to provide commercial services to their customers. We also provide high
volume messaging software and services, and Web-based as well as other Internet
applications. Software products within our service application solutions
include AsiaInfo Mail Center (AIMC), AsiaInfo Unified Messaging System (AIUM)
and AsiaInfo Internet Short Messaging Gateway (AIISMG).
AsiaInfo Mail Center (AIMC). Our flagship online messaging software, AIMC, is
an integral part of our service application offerings. AIMC is carrier-scale
messaging software designed to support electronic mail systems from small
Internet service providers to large-scale mail hosting providers with millions
of mailboxes and thousands of domains. Its flexible design allows service
providers to offer web-based free e-mail, basic e-mail service and premium
business secure e-mail to end-users. The ability to scale both horizontally and
vertically allows rapid expansion when more capacity is needed. The system is
built to accommodate clustering technology and is highly fault tolerant. In
addition to major telecommunications and Internet service providers, top
Internet content providers in China such as chinadotcom and 21cn.com are among
the key customers for AIMC. To meet the demand for more efficient and secure
electronic message exchanges, AIMC provides innovative functions and anti-spam
control. The wireless application protocol, or WAP, and short messaging system,
or SMS, functions allow the end user to access email at any time with a mobile
connection. AIMC also enhances user experience with its stream-based video mail
function.
AsiaInfo Unified Messaging System (AIUM). AIUM is an information-exchanging
platform for wire, wireless and Internet networks providing customers complete
access to message transmission and retrieval. AIUM gives the user freedom to
choose among various media, such as e-mail, telephone, facsimile and mobile
telephone, to send and retrieve messages.
AsiaInfo Internet Short Messaging Gateway (AIISMG). AIISMG is a business
support platform for value-added short messaging services. AIISMG improves
connectivity between the mobile user and the short message content provider to
boost short messaging services. AIISMG is the only one-layer short messaging
gateway used by China Mobile (which facilitated more than 80 billion short
messages in 2002) to achieve single-point access and provincial roaming.
Furthermore, AIISMG supports multi-protocols to enable short messages
transported between different carriers and different mobile networks, including
digital mobile (global system for mobile communications, or GSM), code division
multiple access, or CDMA, personal handy phone system, or PHS, and third
generation, or 3G networks.
NETWORK SECURITY SOLUTIONS--We provide high-end network security solutions to
telecommunications carriers, Internet data centers, Internet content providers
and Internet service providers using third party software applications. We
previously offered network security solutions through a majority-owned
subsidiary, 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. Our network security solutions
include the following services:
.. assessing, designing and deploying network security systems;
.. managing network security systems; and
.. providing technical training and support.
NETWORK MONITORING SOLUTIONS--Some of our Communications Solutions projects
involve the provision of base station network monitoring services for wireless
telecommunications carriers. We acquired this business through our acquisition
of Bonson in February of 2002. Software products in our network monitoring
business include AI-BS-ViewFocus, which is embedded in the hardware equipment
we design and use in providing network monitoring solutions. AI-BS-ViewFocus is
a web-based product that monitors transmission and power stations for mobile
communications.
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Operation Support System, or OSS, Solutions
Currently, our Operation Support System Solutions include three primary types
of products:
.. customer care and billing, or CC&B;
.. customer relationship management, or CRM; and
.. order fulfilment management.
Our Operation Support System Solutions allow our customers to manage their
network infrastructure utilizing our proprietary and third-party software tools
and applications. In addition to software, OSS Solutions projects generally
involve one or more of the following services:
.. software customization and installation;
.. design and implementation of network management centers; and
.. technical training and support.
CUSTOMER CARE AND BILLING PRODUCTS. We offer complex customer care and billing
solutions to support our clients' businesses. With the integration of Bonson's
wireless billing software into our OSS Solutions business unit, we are able to
provide a broader range of solutions to our clients. Our main CC&B product
offerings include wireless solutions, Internet protocol (IP) solutions,
clearance and settlement solutions, and convergent billing solutions. Software
products within these offerings include:
AsiaInfo Online Billing System (AIOBS). AIOBS is the software product used in
our wireless solutions. It is a real time, scalable software that enables
service providers to address mission critical needs such as customer care,
services support, and accurate and timely billing. AIOBS enables
telecommunications service providers to:
.. manage, authenticate and register users, create user accounts, check
account status and activate services;
.. monitor and analyze user activity, "map" individual user consumer behavior
and perform audit trials on user accounts;
.. price and rate a broad array of services, discount services and promotions
using multiple bases and resources, such as time of usage, bytes
transferred, size of server storage and number of page views; and
.. perform billing operations based on flexible billing cycles and manage user
accounts receivable.
In addition, AIOBS provides many features tailored to the China market,
including:
.. caller ID usage-based and restricted line services that allow telephone
customers to log on to the Internet without first registering with Internet
service providers, with usage-based fees charged to their regular monthly
telephone bills, and to log on only from certain, specified phone numbers;
.. a roaming service that allows registered customers from different Internet
service providers to log on to the Internet from each other's territories
(an important feature since most Chinese Internet service providers operate
and recruit users locally); and
.. a restricted credit (pre-paid card) service that allows customers to use
the Internet with monthly monetary or usage-based limits, with real time
cut-off the instant the credit limit is reached.
AsiaInfo Convergent Billing System (AICBS). Our convergent billing solutions
software, AICBS, offers real time, scalable solutions for customer care and
billing operations of wireless and long-distance telephony service providers,
including:
.. customer care, together with customer service, hierarchies and rapid report
management;
.. call center support, including usage processing;
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.. fraud detection and management;
.. billing and revenue management features, including accounts receivable and
collection; and
.. inter-carrier settlement.
With AICBS, we pioneered the fraud management software market in China, which
has seen increasing customer demand. We believe AICBS is the first and most
widely used customer care and billing software used by Chinese operators that
supports wireless services based on the CDMA standard in addition to the
digital mobile (GSM) standard.
AI-BS Mobile Business Operating Support System (AI-BS-BOSS). AI-BS-BOSS is an
integrated customer care and billing system used in our wireless solutions,
supporting all second generation, or 2G, 2.5 generation, or 2.5G, voice and
data services. It provides rating, provisioning and billing functions, as well
as powerful customer care, business and service management capabilities.
AI-BS-BOSS is a highly configurable, expandable and scalable system which
accommodates both pre-paid and post-paid subscribers. AI-BS-BOSS supports voice
services such as digital mobile (GSM), analog and voice over Internet protocol,
or VoIP, and data services such as WAP, and general packet radio service, or
GPRS.
AsiaInfo Integrated Settlement System (AIISS). AIISS is an integrated
settlement software we provide to telecommunications operators through our
clearance and settlement solutions. AIISS covers all aspects of settlement,
including inter-operator and intra-operator, roaming, and service provider
settlement. It also supports most business lines of a carrier such as domestic
direct dial, or DDD, international direct dial, or IDD, data, VoIP and
value-added services. AIISS uses advanced plug-and-play component architecture,
offering flexibility, security and scalability to the carriers. Services
supported by AIISS include digital mobile (GSM), analog systems, 2.5G, third
generation mobile system, or 3G, IP, access, VoIP, public switched telephone
network, or PSTN, leased-line, generic digital subscriber line, or xDSL, CDMA,
broadband access and leased-line access.
CUSTOMER RELATIONSHIP MANAGEMENT. Our suite of customer relationship
management solutions allows wireless and fixed-line telecommunications
operators to improve customer service and establish strong customer
relationships. Our main CRM product offerings include solutions for Decision
Support Systems and Business Integration. Software products in these offerings
include:
AIOmniVision. AIOmniVision is our analytical customer relationship management
software product used in our solutions for Decision Support Systems and
Business Integration. With embedded technology such as data warehousing, online
analytical process and data mining, AIOmniVision enables carriers to make
management decisions based on analysis of customer behavior, competitive
environment, business profitability and other parameters. The system is able to
proactively generate business operation reports, which serve as a basis for top
management decisions.
AIOmniVision allows service providers to:
.. understand and maximize business value from their existing customers;
.. identify and focus on profitable customer groups;
.. explore and attract potential customers;
.. improve service quality and ensure customer satisfaction and retention;
.. enhance return on investment of new service offerings;
.. increase service usage and network utilization; and
.. improve efficiency and reduce costs.
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AsiaInfo Customer Care and Relationship Management System (AICRM Suite). AICRM
Suite is our integrated marketing management software product for fixed-line
and wireless telecommunications service providers. It provides carriers a
complete marketing management solution which enables them to formulate and
execute marketing policies and conduct operation analyses. Carriers are thus
able to effectively manage their customer service and strengthen their partner
and alliance relationships. AICRM features a multi-level architecture,
independent customer interfaces and databases, and quick time-to-market
response capabilities.
ORDER FULFILMENT MANAGEMENT. Our order fulfilment management software,
AsiaInfo Order Management System, or AIOMS, assists fixed-line
telecommunications providers in managing their orders, business processes,
operations and resources. AIOMS is a comprehensive production and operation
management software product with fast and flexible order management
capabilities. We currently offer AIOMS to fixed-line carriers but AIOMS is also
capable of supporting the systems of wireless service providers. AIOMS features
a multi-level architecture, independent customer interfaces and databases, and
flexible control mechanisms.
STRATEGIC ACQUISITIONS AND ALLIANCES
From time to time, we enter into strategic acquisitions and alliances in order
to further our business objectives, including:
.. expanding our product and service offerings;
.. entering vertical markets and obtaining complementary technology; and
.. increasing our distribution channels and co-marketing opportunities.
Our strategic investments have included our acquisition of Bonson Information
Technology Holdings Limited, or Bonson, a leading provider of operation support
system solutions to China's wireless telecommunications carriers. We acquired
Bonson in February of 2002 for a combination of cash and shares of our common
stock valued at a total of approximately $51.4 million. The wireless operation
support system solutions market in China is fragmented, and we believe the
acquisition of Bonson has given us the largest share of any participant in that
market.
PRICING
We currently price our projects on the following basis:
.. Hardware procurement. We sell hardware as part of our total solutions and
price hardware together with the total contract price as a fixed-fee. To
minimize exposure to hardware risk, we source equipment from hardware
vendors against letters of credit from our customers.
.. Software sales. We price our software products (except for AIOmniVision
and AINetXpert) based on the number of user licenses which our customers
purchase from us. We price AIOmniVision based on modules, functions and
requirements for follow-on services, and price AINetXpert based on the
number of networks we monitor using the software. In addition to these
license fees, our customers purchase technology support services for which
they pay a service fee comprised of a fixed percentage of the total
contract amount. We charge our customers for software customization on a
time plus materials basis. The pricing of our messaging software, AIMC, is
based on the total number of mail boxes purchased by our customers.
However, the unit price for each mail box differs among free web-based
e-mail service, basic ISP-provided Internet e-mail and business secure
e-mail offerings.
.. Services. We price our services internally on an estimated time and
material basis. However, services are quoted to customers as a fixed fee.
Contracts for our projects are generally subject to competitive bidding
processes.
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TECHNOLOGY
Customer care and billing software. Our on-line customer care and billing
software, AIOBS, is designed to allow maximum flexibility, scalability and
performance. It has state-of-the-art, four-tier client/server architecture.
This multi-tier architecture, coupled with the other technologies, gives our
software the following advantages:
.. Flexibility. Because we use a data dictionary-based data model to collect
data from databases and other resources, data definitions, such as new
entries of demographic information, can be customized without any code
modification.
.. Minimum interruption of existing services. The system is built on dynamic
component modules which can be modified separately when a new product is
introduced and updated without system downtime.
.. Ease of customization. Our software offers fully documented application
programming interfaces that support standard scripts. As a result, our
customers can build client applications without compilation and can
customize and write new user interface applications with minimum training.
CONVERGENT BILLING SOFTWARE. Our convergent billing software, AICBS, also
utilizes state-of-the-art multi-tier architecture to achieve flexibility,
scalability and real-time performance. We are designing new architecture to
support convergent customer care and billing solutions for combined Internet,
Internet protocol telephony and traditional voice services. The technologies we
employ have given our wireless and long-distance telephony software advantages
such as well-designed applications for high performance under high capacity
subscribers and have enabled the software to ensure transaction integrity.
MESSAGING SOFTWARE. Our carrier-scale messaging software supports service
providers with a large number of subscribers and large volumes of messages. We
use the following technologies to achieve scalability and optimize performance:
.. advanced software technology that allows AIMC to scale both horizontally,
by adding more servers, and vertically, by using higher speed or multiple
central processing units, to handle subscriber growth without compromising
system performance and hardware investment;
.. switching technology that distributes workloads in a manageable and
flexible fashion and allows customers to easily add, remove or reconfigure
running systems without downtime in a live production environment; and
.. storage area network, or SAN, technology that offers speedy, reliable and
secure access to the data storage subsystem with ultra-high capacity
databases.
CUSTOMER RELATIONSHIP MANAGEMENT SOFTWARE. Our analytical customer
relationship management software, AIOmniVision, uses data-warehousing
technology, offering integrated systems and information for decision support
and execution. The advantages of AIOmniVision include:
.. the flexibility and universal design of the data-warehousing model;
.. dynamic component modules that can be modified separately when a new
product is introduced and updated without any system down times; and
.. fully documented application programming interfaces that support standard
scripts, allowing our customers to build client applications without
compilation and customize and write new interface applications with minimum
training.
Our marketing management software product, AICRM, for fixed-line and wireless
telecommunications service also uses a multi-level architecture to provide
carriers complete marketing management solutions with independent customer
interfaces and databases, and quick time-to-market response capabilities.
ORDER MANAGEMENT SOFTWARE. Our order management software, AIOMS, uses a
multi-tier architecture to provide flexibility in managing order distribution
and business processes. It also has fast and flexible order mechanisms by
providing a separate database for business processes and customer interfaces.
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We closely monitor world-wide technological developments in our service and
product areas. In developing these and other technologies, we sometimes source
knowledge, software and other products from major international technology
companies. Cooperation with global technology leaders improves our access to
the most sophisticated technologies, which enables us to provide the latest and
best services and software products to our customers.
RESEARCH AND DEVELOPMENT
We are committed to researching, designing and developing information
technology solutions and software products that will meet the future needs of
our customers. We develop upgrades of our existing software products to enhance
scalability and performance and provide added features and functions. In
addition, we are designing a wide array of new software products to address our
customers' growing need for OSS solutions, such as fixed-line operation support
systems and settlement systems.
The focus of our network services research is on new network technology
development and the evaluation of solutions based on multi-vendor products. The
focus of our software research is on architecture study, software development
platforms, commonly used libraries and other software management tools. We plan
to expand our research and development efforts further by adding more personnel
and financial resources, particularly in the area of operation support system
solutions.
CUSTOMERS
Our customers currently consist primarily of Chinese telecommunications service
providers, including China Telecom, China Netcom Group, China Mobile, China
Unicom and China Railcom. For the year ended December 31, 2002, China Telecom
(including contracts signed with all China Telecom entities merged into China
Netcom Group in May, 2002) accounted for 22% of our revenues net of hardware
costs, while China Unicom accounted for 22%, China Mobile accounted for 42%,
China Netcom Group (excluding contracts signed with the China Telecom entities
merged into China Netcom Group in May, 2002) accounted for 5%, China Railcom
accounted for 4% and other customers accounted for 5%. Our customer base is
changing and diversifying as the overall China telecommunications market
deregulates. For more information on recent restructurings and regulatory
changes affecting our customers, please see the discussion above under the
heading "Industry Background" and the discussion below under the heading
"Government Regulation."
CHINA TELECOM. China Telecom is the oldest voice and data communications
provider in China and is the leading provider of fixed-line telephone, data and
Internet and leased line services in four of the most economically developed
regions in China. Before the recent restructurings of the telecommunications
industry in China that began in 1999, China Telecom, together with its various
provincial subsidiaries, constituted our largest customer, accounting for
almost all of our revenues in 1997 and 1998. As part of the industry
reorganization completed in May 2002, the northern division of China Telecom
(comprising ten provinces) merged with China Netcom and Jitong Communication to
form China Netcom Group. The southern division (comprising twenty-one
provinces) continues to operate under the China Telecom name.
CHINA NETCOM GROUP. China Netcom was originally formed in 1999 to provide
nationwide Internet broadband access and integrated telecommunications
services. As part of the recent industry reorganization, China Netcom merged
with the northern division of China Telecom and Jitong Communication, and the
combined business now operates under the China Netcom Group name. As a result
of the reorganization, China Netcom Group is permitted to operate nationwide
fixed-line telecommunications networks and provide nationwide services.
CHINA MOBILE. China Mobile was established in July 1999 to operate mobile
telecommunications networks nationwide that had previously been operated by
China Telecom. China Mobile is the largest telephony service provider in China
with over 101 million wireless voice service subscribers and has various
provincial subsidiaries throughout China which are responsible for local
networks. China Mobile's digital mobile (GSM)
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network covers all of China's cities and 96% of its rural areas. In addition to
mobile services, the company operates an Internet Protocol telephony service
and is an Internet service provider.
CHINA UNICOM. China Unicom was established in 1994 and is China's second
largest mobile operator, providing services to over 39 million mobile customers
through its digital mobile (GSM) network and since January 2002, its second
generation, or 2G, CDMA network. In 2002, the first year of operation of China
Unicom's CDMA network, China Unicom had seven million subscribers and is
targeting to achieve 20 million subscribers by the end of 2003 with the launch
of its new CDMA 1X data services. China Unicom also provides a wide array of
services, including long distance telephone services, local telephone services,
Internet and data communications services, paging services, communications
value-added services and other communications services.
CHINA RAILCOM. China Railcom was established in December 2000 and is the
newest of the six licensed telecommunications service providers in China. With
the second largest fixed communications network in China, it is a multi-service
vendor, providing long distance and local fixed-line services, as well as data
communications services. China Railcom is 51% owned by China's Ministry of
Railway and 49% owned by 14 railway bureaus.
SALES AND MARKETING
Sales
We market and sell our services and products primarily through our direct sales
force. Our direct sales professionals provide business consulting, promote
pre-sale activity and manage our relations with our customers. We employ direct
sales personnel in regional offices in Beijing, Shanghai, Wuhan, Chengdu and
Guangzhou. In connection with our recent reorganization, our sales teams from
network solutions, service application solutions and network security solutions
have been combined into one team under the Communications Solutions business
unit. The Bonson sales team has been integrated into the OSS Solutions business
unit. For more detailed information on our recent reorganization, please see
the discussion above under "Item 1. Business--Recent Developments."
We classify market segments and target opportunities on national and regional
levels. This classification helps us determine our primary sales targets and
prepare monthly and quarterly sales forecasts. Sales quotas are assigned to all
sales personnel according to annual sales plans. We approve target projects,
develop detailed sales promotion strategies and prepare reports on order
forecast, technical evaluation, sales budgeting expense, schedules and
competition analysis. After a report has been approved, a sales team is
appointed consisting of sales personnel, system design engineers and a senior
system architect.
Marketing
Our marketing strategy focuses on building long-term relationships with our
customers, educating them about technological developments and generating their
interest in our services and products. Historically, our marketing and sales
efforts were combined. As our businesses expanded and the marketplace became
increasingly sophisticated, we established dedicated marketing teams for each
of our two strategic business units. These departments continuously analyze the
needs of our customers, our competitive environment, the market potential of
our products and services, and the effectiveness of our pricing and
distribution strategies. They also assist in the planning of the roll-out of
our solutions and products in anticipation of customers' needs.
In addition to our marketing departments, we have a market communications, or
marcom, department, which engages in a number of activities aimed at increasing
awareness of our products and services. These activities include:
.. managing and maintaining our web site;
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.. producing corporate and product brochures and monthly customer newsletters;
.. conducting seminars and media conferences;
.. conducting ongoing public relations programs; and
.. creating and placing advertisements.
COMPETITION
Communications Solutions
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 this sector is Openwave Systems Inc. (formerly Software.com and
Phone.com). In the network security solutions market, we mainly compete with
Information Security One Limited, Nsfocus Information Technology Co., Ltd., and
21ViaNet China Inc. An increasing number of companies are devoting their
resources to this sector in developing network security products. In the
network monitoring solutions market, our principal competitor is Emerson
Electric Co. (through its acquisition of Avansys Power Co., Ltd. from Huawei
Technologies).
Operation Support System Solutions
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. 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 World Trade
Organization, or WTO, we anticipate the entrance of new competitors into the
operation support system market.
We believe that we have competitive advantages in all of our product and
service segments due to our network infrastructure technology leadership,
combined international and China expertise, high performance, scalable and
flexible software, customer-centric and cost effective project management
capability, and established customer relationships. 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.
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GOVERNMENT REGULATION
The Chinese government has generally encouraged the development of the
information technology industry, and the products and services we offer are not
currently subject to extensive government regulations. The telecommunications
industry in which our customers operate, however, is subject to extensive
government regulation and control. Currently, all the major telecommunications
and Internet service providers in China are primarily state owned or state
controlled and their business decisions and strategies are affected by the
government's budgeting and spending plans. In addition, they are required to
comply with regulations and rules promulgated from time to time by China's
Ministry of Information Industry, or MII, and other ministries and government
departments.
In September 2000, China published the Regulations of the People's Republic of
China on Telecommunications, also known as the Telecommunications Regulations.
The Telecommunications Regulations are the first comprehensive set of
regulations governing the conduct of telecommunications businesses in China.
The principles expressed by the Telecommunications Regulations reflected on
China's commitment to accede to the WTO. In particular, the Telecommunications
Regulations set out in clear terms the framework for operational licensing,
network interconnection, the setting of telecommunications charges and
standards of telecommunications services in China.
The Circular on the Structural Adjustment of Telecommunication Charges, issued
in December of 2000, reduced telecommunications service and Internet service
fees in China, such as Internet access fees and leased line renting fees,
permitting Internet protocol telephony operators, paging business operators,
web hosting service providers and certain other value added service providers
to set their prices based on their own cost structure and competitive strategy.
We believe this Circular has positively impacted our business because, with the
decline in telecommunications and Internet services fees, China's Internet
population and tele-density have grown, which in turn has generated more demand
for our products and services. For example, the number of Internet users in
China increased to 59.1 million in 2002 due in part to the decrease in Internet
access fees. In addition, with declining leased line tariffs, more and more
enterprises will be able to afford to use the Internet as a business tool.
Under regulations introduced in December of 2001, foreign investors are now
permitted to invest in China's telecommunications industry through Sino-foreign
joint ventures. The new regulations, known as the Provisions on the
Administration of Foreign-Invested Telecommunications Enterprises, or the
Provisions, were the result of China's accession to the WTO. Under the
Provisions, foreign investors will be ultimately permitted to own up to 49% of
basic telecommunications businesses (with the exception of wireless paging
businesses) in China, and up to 50% of value-added telecommunications
businesses (which include Internet service providers and Internet content
providers) and wireless paging businesses.
Notwithstanding the recent developments in China's telecommunications
regulations, many laws and regulations applicable to the telecommunications
industry in China are still evolving and unsettled. In September 2000, China's
State Council approved the Administrative Measures on Internet Information
Services. The Administrative Measures on Internet Information Services provide
for control and censoring of information on the Internet. A restrictive
regulatory environment for our customers could adversely affect our business.
For a further discussion of the changing regulatory environment in China,
please see the discussion below under "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operation--Factors Affecting Our
Operating Results and Our Common Stock--Laws and regulations applicable to the
Internet in China remain unsettled and could have a material adverse affect on
the Internet's growth and thereby have a material adverse affect on our
business."
INTELLECTUAL PROPERTY
Our success and ability to compete depends in part upon our intellectual
property rights, which we protect through a combination of confidentiality
arrangements and copyright and trademark registrations. We have filed
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five trademark applications with the United States Patent and Trademark Office,
three of which have been passed on to registration and two of which are
currently pending. Our trademark application covering AsiaInfo's logo and
design has been granted by the Trademark Bureau of the State Administration of
Industry and Commerce in China. In addition, we have filed three trademark
applications with the Hong Kong Trade Marks Registry for AsiaInfo's logo, which
are pending. We have also completed the registration of the copyrights for 67
versions of our software products with the State Copyright Bureau in China,
including the AIOBS series, the AISerBase series, the AIMC series and the
AIOmniVision series. However, although we may apply for such protection in the
future, we have not applied for copyright protection in other jurisdictions
(including the United States, which does not require registration for
protection of copyrights). 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. Since the
Chinese legal system in general, and the intellectual property regime in
particular, is 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. 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 in the future 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 and could have a material adverse effect on our
business, results of operations and financial condition.
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.
EMPLOYEES
We have over 900 employees. We devote significant resources to recruiting
professionals with relevant industry experience. Most of our senior management
and technical employees are western educated Chinese professionals with
substantial expertise in information technologies systems integration and
application software development. We believe that our success in attracting and
retaining highly skilled technical employees and sales and marketing personnel
is largely a product of our commitment to providing a motivating and
interactive work environment that features continuous and extensive
professional development opportunities, as well as frequent and open
communications at all levels of the organization. As an incentive, we have
created employee stock option plans that include vesting provisions designed to
encourage long term employment.
OUR CODE OF ETHICS
In 1999, we adopted a code of ethics, or the Code, which applies to all of our
employees. Recently, we conducted a thorough review and updating of the Code. A
copy of the Code and a brief description of any amendments to or waivers from
the Code relating to any of our principal executive officers or senior
financial officers will be posted on our website at www.asiainfo.com.
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SEC REPORTS AVAILABLE ON WEBSITE
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, are available on our
website at www.asiainfo.com, when such reports are available on the Securities
and Exchange Commission website.
ITEM 2. Properties
Our principal sales, marketing and development facilities and administrative
offices currently occupy approximately 7,300 square meters in a new building
located in the Beijing Zhongguancun Science Park. The lease has a term of five
years, which expires in February 2005, subject to termination in 2003 if an
agreement on the adjustment of rent cannot be reached at that time. In
addition, we have regional field support offices in various cities in China,
namely Shanghai, Guangzhou, Chengdu, Hangzhou, Nanjing and Wuhan, as well as a
regional office in Santa Clara, California.
ITEM 3. 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 (Louis Lau, our Chairman, James
Ding, our President and Chief Executive Officer and Ying Han, our Chief
Financial Officer). The dismissals were based on stipulations signed by those
defendants and the plaintiffs' representatives.
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.
21
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the fiscal year covered
by this report to a vote of our security holders.
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock has been quoted on the Nasdaq National Market under the symbol
"ASIA" since our initial public offering on March 2, 2000. The following table
sets forth, for the periods indicated, the high and low sales prices per share
of the common stock as reported on the Nasdaq National Market.
High Low
----- -----
2002:
Fourth Quarter.................................................... 8.90 2.04
Third Quarter..................................................... 13.78 3.22
Second Quarter.................................................... 13.88 9.80
First Quarter..................................................... 24.25 10.66
2001:
Fourth Quarter.................................................... 21.25 11.10
Third Quarter..................................................... 20.00 9.37
Second Quarter.................................................... 20.39 8.44
First Quarter..................................................... 19.94 6.94
As of February 28, 2003, we had approximately 164 holders of record of our
common stock.
We have never declared or paid any dividends on our capital stock, and do not
intend to pay dividends on our shares of common stock in the forseeable future.
Instead, we intend to retain all earnings for use in our business. Future cash
dividends, if any, will be at the discretion of our board of directors and will
depend upon our future operations and earnings, capital requirements and
surplus, general financial condition, contractual restrictions and other
factors as the board of directors may deem relevant. Any dividends we declare
will be paid in U.S. dollars.
As a holding company, our primary source of cash for the payment of dividends
are distributions, if any, from our subsidiaries. Our principal operating
subsidiaries were established in China and are able to make distributions of
profits to us only if they satisfy certain conditions under Chinese law,
including the satisfaction of tax liabilities, recovery of losses from previous
years and mandatory contributions to statutory reserves. In addition, loan
agreements and contractual arrangements we enter into in the future may also
restrict our ability to pay dividends.
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) were approximately $126,610,000. From the
effective date of the Registration Statement through December 31, 2002, the net
proceeds have been used for the following purposes:
Purchase and installation of machinery and equipment...... $ 7,120,000
Temporary investments, including cash and cash equivalents 36,690,000
Investments in subsidiaries............................... 50,900,000
Research and development and sales and marketing expenses. 31,900,000
------------
$126,610,000
============
22
The net proceeds will be used for general corporate purposes, including working
capital, and expenses such as research and development and sales and marketing.
A portion of the net proceeds may also be used to acquire or invest in
complementary businesses or products. None of the net proceeds of the offering
have been paid directly or indirectly to our directors, officers or their
associates, to persons owning ten percent or more of our common stock, or to
our affiliates.
ITEM 6. Selected Financial Data
The following table sets forth our selected consolidated financial data. You
should read this information together with our consolidated financial
statements and the notes to those statements included in this report, and "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operation" beginning on page 20 of this report. The selected consolidated
balance sheet data and statements of operations data in the table below have
been derived from our audited consolidated financial statements. Historical
results are not necessarily indicative of the results to be expected in the
future.
Years Ended December 31,
-----------------------------------------------------------------------
2002 2001/(1)/ 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(Amounts in thousands of U.S. dollars except share and per share data)
Consolidated Statements of Operations Data:
Revenues:
Communications Solutions................... $ 68,018 $ 146,541 N/A/(2)/ N/A/(2)/ N/A/(2)/
Operation Support System Solutions......... 53,248 42,465 N/A/(2)/ N/A/(2)/ N/A/(2)/
----------- ----------- ----------- ----------- -----------
Total revenues........................... 121,266 189,006 $ 176,063 $ 60,280 $ 44,222
----------- ----------- ----------- ----------- -----------
Cost of revenues:
Communications Solutions................... 48,714 106,622 N/A/(2)/ N/A/(2)/ N/A/(2)/
Operation Support System Solutions......... 32,286 26,911 N/A/(2)/ N/A/(2)/ N/A/(2)/
----------- ----------- ----------- ----------- -----------
Total cost of revenues................... 81,000 133,533 144,698 41,963 32,189
----------- ----------- ----------- ----------- -----------
Gross profit................................. 40,266 55,473 31,365 18,317 12,033
----------- ----------- ----------- ----------- -----------
Operating expenses:
Sales and marketing........................ 14,680 21,768 19,734 8,768 2,408
General and administrative/(3)/............ 9,907 14,905 12,893 8,167 6,463
Research and development................... 8,503 7,304 5,974 2,838 1,436
In-process research and development........ 350 -- -- -- --
Amortization of deferred stock
compensation.............................. 407 1,144 2,209 3,508 1,045
Amortization of acquired intangible assets. 1,749 -- -- -- --
----------- ----------- ----------- ----------- -----------
Total operating expenses................. 35,596 45,121 40,810 23,281 11,352
----------- ----------- ----------- ----------- -----------
Operating income (loss)...................... 4,670 10,352 (9,445) (4,964) 681
Other income (expense), net................ 1,450 6,107 6,865 352 477
Income tax expense (benefit)............... 824 3,444 218 383 (256)
Minority interests in (income) loss of
consolidated subsidiaries................. 75 (396) 32 84 122
Equity in loss of affiliate................ (2,465) (885) -- (35) --
----------- ----------- ----------- ----------- -----------
Net income (loss)............................ $ 2,906 $ 11,734 $ (2,766) $ (4,946) $ 1,536
=========== =========== =========== =========== ===========
Net income (loss) per share:.................
Basic.................................... $ 0.07 $ 0.28 $ (0.07) $ (0.34) $ 0.11
=========== =========== =========== =========== ===========
Diluted/(4)/............................. $ 0.06 $ 0.26 $ (0.07) $ (0.34) $ 0.05
=========== =========== =========== =========== ===========
Shares used in computation:..................
Basic...................................... 43,583,420 41,525,159 37,239,649 14,630,145 13,616,412
=========== =========== =========== =========== ===========
Diluted/(4)/............................... 45,961,545 45,924,724 37,239,649 14,630,145 31,765,534
=========== =========== =========== =========== ===========
Additional Data:
Total revenues net of hardware costs......... $ 64,733 $ 71,391 $ 44,578 $ 25,221 $ 19,286
23
As of December 31,
------------------------------------------
2002 2001/(1)/ 2000 1999 1998
-------- -------- -------- ------- -------
Consolidated Balance Sheet Data:
Cash and cash equivalents....................... $115,153 $110,635 $ 48,834 $25,404 $ 9,749
Total current assets............................ 215,094 232,836 254,190 64,773 42,805
Total assets.................................... 263,430 245,860 264,003 71,427 45,359
Total liabilities (excluding minority interests) 52,955 60,460 95,206 31,639 26,048
Total stockholders' equity...................... 210,158 184,790 168,609 39,788 19,247
- --------
(1) Reclassified to conform with 2002 presentation.
(2) Prior to the restructuring of our operating units in the fourth quarter of
2002, we reported our operating results on the basis of our old reporting
segments (network solutions and software solutions). Although we have
reclassified our revenues for the year 2001 according to our new reporting
segments, reclassifying our revenues for 2000, 1999 and 1998 would be not
be reasonably practicable.
(3) In 2002, we adopted Statement of Financial Accounting Standards No.142,
"Goodwill and Other Intangible Assets," and as a result we discontinued
amortization of goodwill on January 1, 2002 (see note 3 of Note to
Consolidated Financial Statements).
(4) In 1999 and 2000 the diluted net loss per share computation excludes shares
of common stock issuable under stock option plans, upon the exercise of
warrants and upon the automatic conversion of our convertible preferred
stock which, if included, would have had an antidilutive effect on the net
loss reported in those periods. In 2002 and 2001, the Company had options
outstanding which could potentially dilute earnings per share in the
future, but were excluded from the computation of diluted earnings per
share in the year, as their exercise prices were above the average market
values in the year. See note 12 of Notes to Consolidated Financial
Statements for a detailed explanation of the determination of the shares
used in computing basic and diluted net income (loss) per share.
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation
OVERVIEW
We are a leading provider of telecommunications network integration services
and software solutions in China. Our software products and network services
enable our customers to build, maintain, operate, manage and continuously
improve their communications 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., or AsiaInfo
Management, which are both Chinese companies.
We develop, market and sell our products and services through our two strategic
business units: Communications Solutions and Operation Support System
Solutions. 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 and similar software 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. 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.
24
As a result of the recent restructuring in China's telecommunications industry,
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 the MII, overall capital
expenditure by telecommunications services 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 and that
spending will begin to return to pre-restructuring levels in the second half of
2003, continued delays in capital expenditure projects could continue to
negatively affect our growth in the near-term. Similar restructurings of this
nature could cause our operating results to vary unexpectedly from quarter to
quarter in the future.
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 include 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 telecom 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 both under our new and old reporting segments:
Year Ended December 31,
------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
New Reporting Segments
Communications Solutions net of hardware costs.......... 48% 73%/(1)/ N/A/(2)/ N/A/(2)/ N/A/(2)/
Operation Support System Solutions net of hardware costs 52% 27%/(1)/ N/A/(2)/ N/A/(2)/ N/A/(2)/
Old Reporting Segments
Network solutions net of hardware costs................. 51% 61% 61% 74% 88%
Software solutions...................................... 49% 39% 39% 26% 12%
- --------
(1) Reclassified to conform with 2002 presentation.
(2) Prior to the restructuring of our operating units in the fourth quarter of
2002, we reported our operating results on the basis of our old reporting
segments (network solutions and software solutions). Although we have
reclassified our revenues for the year 2001 according to our new reporting
segments, reclassifying our revenues for 2000, 1999 and 1998 would be not
be reasonably practicable.
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 procured by us on behalf of our customers from hardware vendors. 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 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
25
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, these 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 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 December 31, 2002, our revenue backlog net of hardware costs was
$40.3 million, an 8% 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 Telecom, causing the carriers to delay their orders
longer than previously expected. OSS Solutions backlog was $17.24 million, or
43% of net revenue backlog, a 4% increase over the period a year ago. Orders
under contracts generated by Bonson accounted for 18% of the total backlog net
of hardware costs and 43% of OSS Solutions backlog. 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.
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.
26
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 almost entirely 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 these costs through a 10% headcount reduction and a
10% salary cut for employees at the manager level and above.
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 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 17 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.
27
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, our principal operating
subsidiary for our Communications Solutions SBU, 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 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, our subsidiary that
sources hardware in China for our customers, 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 anticipated formal governmental
approval, it is likely that AsiaInfo Chengdu will operate free of Chinese state
and local corporate income tax for two years beginning from its first
profitable year of operation, which was 2002, and should be entitled to a 50%
tax reduction at the rate of 7.5% for the subsequent three years. As such, the
anticipated tax holiday for AsiaInfo Chengdu should expire on December 31, 2003
and the 50% tax reduction should expire on December 31, 2006.
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 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 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.
28
CONSOLIDATED RESULTS OF OPERATIONS
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
REVENUES. Total revenues, including hardware pass-through, decreased 36% to
$121.3 million in 2002, from $189 million in 2001. Revenues net of hardware
costs decreased approximately 9% to $64.7 million in 2002. OSS Solutions
revenue was $33.5 million in 2002, representing 52% of total revenues net of
hardware costs and a 75% increase over OSS Solutions revenue of $19.1 million
in 2001. This increase was primarily due to our acquisition of Bonson, which
has been consolidated since February 6, 2002 and contributed $13.3 million to
OSS Solutions revenue in 2002. Communications Solutions revenue was $31.2
million in 2002, compared to $52.3 million in 2001, representing a decrease of
40%. This decrease was partially attributable to our shift in focus to high-end
systems integration projects involving less hardware pass-through revenue.
Under our previous reporting structure, software solutions revenues were $31.7
million in 2002, representing 49% of total revenues net of hardware costs and a
14% increase over software solutions revenues from the previous year. Network
solutions revenues net of hardware costs were $33 million in 2002, a 24%
decrease from the previous year.
The decrease in total revenues 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, as well as
our shift in focus to high-end systems integration projects involving less
hardware pass-through revenue. The decrease in net revenues was attributable to
the prolonged telecommunications industry restructuring in China resulting in
an estimated 20% decrease of total capital expenditure in 2002 on the part of
telecommunications carriers in China. The decrease in net revenues was
partially offset by our acquisition of Bonson, which contributed 23% of total
net revenue and approximately 40% of net revenue in our OSS Solutions business
unit. For more information on the restructuring, please see the discussion
above under the heading "Item 1. Business--Industry Background."
Looking forward, we anticipate that our net revenues will increase 2 to 8% in
2003. We expect OSS Solutions revenue to account for 45 to 55% of total net
revenues in 2003.
COST OF REVENUES. Our cost of revenues decreased 39% to $81 million in 2002,
partially as a result of more customers purchasing hardware directly from
hardware vendors. Our cost of revenues net of hardware costs increased 54% to
$24.5 million in 2002 while our revenues net of hardware cost decreased 9%.
This was primarily due to the increased number of employees in our OSS
Solutions business unit and lower margins on hardware pass-through.
GROSS PROFIT. Gross profit decreased 27% in 2002 to $40.3 million. Gross
profit as a percentage of gross revenues, or gross margin, increased to 33% in
2002, as compared to 29% in 2001. The increase in gross margin is primarily
attributable to the smaller amount of low margin hardware pass-through revenue
recognized in 2002. Gross profit as a percentage of net revenues decreased to
62% in 2002, as compared to 78% in 2001, primarily due to the increased number
of employees in the OSS Solutions business unit and lower margins on hardwa