F-1 1 df1.htm FORM F-1 Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on January 12, 2005

Registration No. 333-          


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form F-1

REGISTRATION STATEMENT UNDER

THE SECURITIES ACT OF 1933


Hurray! Holding Co., Ltd.

(Exact Name of Registrant as Specified in its Charter)


Cayman Islands   7374   Not Applicable

(State or Other Jurisdiction

of Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Room 305-306, China Resources Building

8 Jian Guo Men Bei Street

Dongcheng District, Beijing, People’s Republic of China 100005

(86-10) 6518-8989

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)


CT Corporation System

111 Eighth Avenue

New York, NY 10011

(212) 894 8940

(Name, address, including zip code, and telephone number, including area code, of agent for service)


Copies to:

Steven L. Toronto, Esq.

Charles Comey, Esq.

Paul Boltz, Esq.

Morrison & Foerster LLP

Suite 3408, China World Tower 2

1 Jian Guo Men Wai Avenue

Beijing, People’s Republic of China 100004

(86-10) 6505-9090

 

Chris K.H. Lin, Esq.

Simpson Thacher & Bartlett LLP

ICBC Tower, 7th Floor

3 Garden Road

Hong Kong

(852) 2514-7600


Approximate date of commencement of proposed sale to the public:    As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨


CALCULATION OF REGISTRATION FEE


Title of Each Class of

Securities to be Registered

 

Amount to
be
Registered(1)

  Proposed
Maximum
Offering
Price Per
Unit(2)
 

Proposed Maximum

Aggregate Offering

Price(1)(2)

 

Amount of

Registration Fee

Ordinary Shares, par value $0.00005 per share (3)

  791,200,000   0.1160   $91,779,200   $10,803(4)

(1)   Includes an aggregate of 103,200,000 ordinary shares that the underwriters have the option to purchase to cover over-allotments, if any. Also includes shares initially offered and sold outside of the United States that may be resold from time to time in the United States. These ordinary shares are not being registered for the purpose of sales outside the United States. See “Underwriting.”
(2)   Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933.
(3)   American depositary shares issuable upon deposit of the ordinary shares registered hereby have been registered under a separate registration statement on Form F-6. Each American depositary share represents 100 ordinary shares.
(4)   Registrant paid the registration fee in full on January 12, 2005.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.



Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION. DATED JANUARY 12, 2005

 

PROSPECTUS

 

LOGO

 

6,880,000 American Depositary Shares

 

Hurray! Holding Co., Ltd.

 

Representing 688,000,000 Ordinary Shares

 

$             per ADS

 


 

We are selling 662,433,900 of our ordinary shares in the form of American Depositary Shares and the selling shareholders named in this prospectus are selling 25,566,100 shares in the form of American Depositary Shares. Each ADS represents the right to receive 100 of our ordinary shares. We will not receive any proceeds from the sale of the ADSs by the selling shareholders. The initial public offering price per ADS is expected to be between $9.60 and $11.60.

 

We and some of our shareholders have granted the underwriters an option to purchase up to 1,032,000 additional ADSs to cover over-allotments.

 

We have applied to have the ADSs included for quotation on the Nasdaq National Market under the symbol “HRAY.”

 


 

Investing in the ADSs involves risks. See “ Risk Factors” beginning on page 12.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

     Per share

   Per ADS

   Total

Public Offering Price

   $         $         $     

Underwriting Discount

   $      $      $  

Proceeds to Hurray! Holding Co., Ltd. (before expenses)

   $      $      $  

Proceeds to the selling shareholders (before expenses)

   $      $      $  

 

The underwriters expect to deliver shares and the ADSs to purchasers on or about                     , 2005.

 


 

Citigroup

 

Piper Jaffray    ThinkEquity Partners LLC


Table of Contents

LOGO


Table of Contents

You should rely only on the information contained in this prospectus. Neither we nor the selling shareholders have authorized anyone to provide you with different information. We are not making an offer of these securities in any jurisdiction where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus.

 

TABLE OF CONTENTS

 

     Page

Summary

   1

Risk Factors

   12

Forward-Looking Statements

   39

Our Corporate Structure

   40

Use of Proceeds

   44

Dividend Policy

   44

Capitalization

   45

Exchange Rate Information

   46

Dilution

   47

Selected Historical and Unaudited Pro Forma Condensed Consolidated Financial and Operating Data

   49

Selected Financial Data of Beijing Enterprise

   52

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   53

Industry Overview

   78

Business

   81

Our Recent Acquisition of Beijing Enterprise

   111

Management

   114

Principal and Selling Shareholders

   123

Related Party Transactions

   126

Description of Share Capital

   129

Shares Eligible for Future Sale

   135

Description of American Depositary Shares

   137

Taxation

   147

Enforceability of Civil Liabilities

   153

Underwriting

   154

Legal Matters

   158

Experts

   159

Where You Can Find More Information

   160

Expenses Relating to this Offering

   161

Index to Financial Statements

   F-1

Index to Pro Forma Financial Statements

   P-1

 


 

Until                     , 2005 (25 days after the date of this prospectus), all dealers that buy, sell or trade our ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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SUMMARY

 

You should read the following summary together with the more detailed information and our consolidated financial statements and the notes to those statements appearing elsewhere in this prospectus. Unless otherwise indicated, information contained in this prospectus assumes that the underwriters will not exercise their option to purchase additional ADSs in this offering.

 

Our Business

 

We provide wireless value-added services such as ringtones, picture downloads, community and entertainment services to mobile phone users in China. We are one of the market leaders, in terms of revenue, in providing these services using wireless application protocol, commonly referred to as WAP, in China. We are the leading provider of WAP services through the mobile network of China Unicom, one of the two principal mobile operators in China, in terms of revenue. WAP services are offered through the advanced second generation, or 2.5G, mobile networks in China. We also offer these services to mobile phone users through second-generation, or 2G, mobile networks in China.

 

Substantially all of our 2.5G services are offered using WAP, which enables users to directly access, browse, search and download content through their mobile phones using menu-based interfaces called portals. These portals are operated by China’s two principal mobile operators, China Unicom and China Mobile. In June 2004, we acquired a provider of WAP services through China Mobile’s portals that has consistently ranked in the top five on these portals in terms of revenue. Our WAP services allow users to download pictures and ringtones, interact with other users by using our community services such as chatting, dating, and message boards, play mobile games and receive content on a variety of topics such as pop culture, news, finance and sports. As of September 30, 2004, we had approximately 3.9 million subscriptions for our WAP services, and picture downloads, ringtone downloads and pop culture related services accounted for approximately 26%, 29% and 25%, respectively, of our total 2.5G revenues in that month.

 

Our 2G services include short messaging services that allow users to send and receive simple text messages from their mobile phones, and interactive voice response services, which allow users to store, send and access voice content from their mobile phones. Community services and games accounted for approximately 53% and 47%, respectively, of our total 2G revenues in September 2004. As of September 30, 2004, we had approximately 1.7 million subscriptions for our short messaging services.

 

We also design, develop, sell and support a service provisioning and management software called VASPro that is used by mobile telecommunication network operators to support 2.5G services. We are the sole provider of this type of software to China Unicom for its nation-wide portal for the provision of WAP services.

 

Our revenues and net income have increased significantly in recent periods. For the year 2003, we had revenues of $23.1 million and net income of $4.5 million. In the first nine months of 2004, we had revenues of $39.4 million, an increase of 157.8% over revenues of $15.3 million for the first nine months of 2003. Our net income for the first nine months of 2004 was $12.0 million, a significant increase over net income of $2.5 million for the first nine months of 2003. On a pro forma basis after taking into account the acquisition referred to above, our revenues were $40.4 million and our net income was $12.7 million for the first nine months of 2004. Our revenues from 2.5G services have grown significantly during 2003 and the first nine months of 2004 and represent 62.7% of our combined 2G and 2.5G services revenues in the first nine months of 2004.

 

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Market Opportunity

 

China is experiencing significant growth in wireless value-added services. Short messaging services are currently the most widely used form of wireless value-added services in China. However, short messaging services do not offer the sophisticated content and applications available through WAP. WAP operates at a significantly higher bandwidth than short messaging services and allows a menu-based user interface which offers a user experience similar to how Internet content and applications can be accessed on a personal computer using an Internet browser such as Netscape and Explorer. Furthermore, we believe that a significant percentage of the newly sold mobile handsets in China are enabled to use WAP.

 

As a result of the superior user experience and increasing availability of WAP-enabled handsets, we believe that the market for WAP services in China is in the early stages of significant growth, similar to the market for short messaging services in early 2001, when short messaging services were first introduced. We believe that as one of the leading providers of WAP services, we will benefit from this anticipated high growth in the market for these services in China.

 

Our Strengths and Challenges

 

We believe we are well positioned to capture future growth opportunities because of our following principal strengths:

 

    Market leadership in 2.5G content and applications in China.

 

    Unique understanding of the core technologies needed to provide advanced wireless value-added services.

 

    Comprehensive services portfolio and innovative marketing.

 

    Strong relationships with mobile operators and a nation-wide network of sales and marketing professionals to support our activities at the provincial level.

 

    Proven and highly experienced management team.

 

Notwithstanding these strengths, we expect to face significant challenges in our business, including:

 

    Dependence on mobile operators in China for delivery of our services, maintenance of accurate records, and billing of, and collection from, mobile phone users of fees for our services.

 

    Maintaining our competitive position in the market for wireless value-added services in China, which is intensely competitive and fragmented.

 

    Dependence on contractual arrangements with our Chinese affiliates to provide our services through agreements with the mobile operators.

 

    Lack of direct access to operator information about our services, which means that we are not currently able to definitely calculate and monitor service-by-service revenue, and also as a result cannot definitely determine which of our services are or may be profitable.

 

    Our significant net losses and accumulated stockholders’ deficiency in the past, which could arise again in the future.

 

    Significant share ownership in our company by our management team even after completion of this offering (representing approximately 29.7% of our total outstanding ordinary shares at such time), which will give them significant influence over our company.

 

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Our Operating History and Corporate Structure

 

We became an independent company in September 1999 when we were spun-off from UT Starcom Inc., or UT Starcom, a Nasdaq-listed company that manufactures telecommunication equipment in China. In June 2001, our current management team purchased a substantial equity interest in our company, or described herein as our management buy-in.

 

We currently conduct our business in China through our wholly owned subsidiary, Hurray! Times. To comply with ownership requirements under Chinese law which impose certain restrictions on foreign companies such as us from investing in certain industries, such as value-added telecommunication and Internet services, we have entered into a series of agreements with a Chinese company, Hurray! Solutions, four other affiliated Chinese entities and their respective shareholders. We currently hold no ownership interest in Hurray! Solutions or any of our other affiliated Chinese entities. Hurray! Solutions is 85% and 15% owned by our president and chief executive officer, Qindai Wang, and one of our shareholders, Songzuo Xiang, respectively. In turn, Hurray! Solutions has one subsidiary, Beijing Cool Young. We also have three other affiliated companies, Beijing Network, WVAS Solutions and Beijing Palmsky. Beijing Cool Young is 95% owned by Hurray! Solutions and 5% owned by our president and chief executive officer, Qindai Wang. Beijing Network is 50% and 50% owned by two individuals in China, Sun Hao and Wang Xiaoping, both of whom serve as vice presidents of Hurray! Solutions. WVAS Solutions is 99% owned by Beijing Network, with the remaining 1% equally owned by Messrs. Sun and Wang. Beijing Palmsky is 50% and 50% owned by two individuals in China, Wang Jianhua and Yang Haoyu, both of whom are our shareholders and vice presidents. Through our agreements with these Chinese affiliates, we have:

 

    the power to vote all shares of all the shareholders of those companies on all their matters through Hurray! Times’ general manager, who is currently Qindai Wang, our president and chief executive officer,

 

    the rights and obligations with respect to the economic consequences of those companies, from which we are entitled to receive up to all of their revenue through service fees (which are determined by us) and over which we have a security interest over all of their assets under our contracts with them,

 

    the exclusive right to purchase at any time part or all of the equity interests from the shareholders of those companies at book value to the extent permitted by Chinese law, and

 

    the control of the major intellectual properties used by those companies.

 

The general managers of our Chinese affiliates, acting under the guidance of Hurray! Times pursuant to their contractual arrangements, are responsible for these entities’ day-to-day activities.

 

For a description of these agreements, see “Our Corporate Structure.”

 

In June 2004, we acquired the business operated by Beijing Enterprise Mobile Technology Co., Ltd. and Beijing Enterprise Network Technology Co., Ltd. (referred to as Beijing Network and together with Beijing Enterprise Mobile Technology Co., Ltd., as Beijing Enterprise), which offer 2.5G services through China Mobile. See “Our Recent Acquisition of Beijing Enterprise.”

 

Our Offices and Other Corporate Information

 

Our principal executive offices are located at Room 305-306, China Resources Building, 8 Jian Guo Men Bei Street, Dongcheng District, Beijing, 100005, the People’s Republic of China, and our telephone number is (86-10) 6518-8989. Our principal Internet addresses are www.hawa.cn, www.hurray.com, www.hurray.com.cn and www.hurray.net.cn. The information on our websites is not a part of this prospectus.

 

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This Offering

 

American Depositary Shares offered:

    

By us

   6,624,339 ADSs

By the selling shareholders

   255,661 ADSs
    

Total

   6,880,000 ADSs
    

The ADSs

   Each ADS represents 100 ordinary shares, par value $0.00005 per share. The ADSs will be evidenced by American Depositary Receipts, or ADRs. As an ADR holder, we will not treat you as one of our shareholders. The depositary, Citibank, N.A., will be the holder of the shares underlying your ADRs. You will have ADR holder rights as provided in the deposit agreement. Under the deposit agreement, you may instruct the depositary to vote the shares underlying your ADRs but only if we ask the depositary to ask for your instructions. The depositary will pay you the cash dividends or other distributions it receives on shares after deducting its fees and expenses. You must pay a fee for each issuance or cancellation of an ADS, distribution of securities by the depositary or some other depositary service. You may turn in your ADRs at the depositary’s office and after payment of some fees and expenses, the depositary will deliver the deliverable shares underlying your ADRs to you. To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.

Over-allotment Option

   Up to 1,032,000 ADSs, representing 103,200,000 ordinary shares, offered by us and some of our shareholders, and exercisable, in whole or in part, by the underwriters within 30 days from the date of commencement of trading of our ordinary shares on the Nasdaq National Market to cover over-allotments.

Ordinary shares outstanding after the offering

   2,187,595,840 ordinary shares (or 2,262,022,140 ordinary shares if the underwriters exercise the over-allotment option in full).

Nasdaq National Market symbol

   “HRAY”

Use of proceeds

   We expect to use the net proceeds from this offering for acquisitions in businesses that we believe are complementary to our existing business, repayment of our outstanding short-term loans, capital expenditures for the acquisition or licensing of key Internet and wireless data application technologies and adding

 

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supporting server software and hardware systems, product development and general corporate purposes. See “Use of Proceeds.”

 

We will not receive any of the proceeds from the sale of the ADSs by the selling shareholders.

Dividend policy

   We do not anticipate paying any cash dividends in the foreseeable future.

Risk factors

   You should carefully read and consider the information set forth under “Risk Factors” and all other information set forth in this prospectus before investing in our ADSs.

 

Certain Conventions

 

Unless specifically indicated otherwise or unless the context otherwise requires, all references to our ordinary shares have been adjusted to give effect to the automatic conversion of all outstanding Series A preference shares into an aggregate of 338,489,940 ordinary shares, which conversion will occur concurrently with the consummation of this offering, and the 20-for-1 stock split which became effective on July 9, 2004. As a result of the stock split, the par value of our ordinary shares decreased from $0.001 per share to $0.00005 per share.

 

The number of ordinary shares outstanding after this offering is based on the number of shares outstanding as of January 10, 2005 and does not include: (i) 151,374,220 ordinary shares subject to options outstanding as of January 10, 2005 at a weighted average exercise price of $0.08 per ordinary share and (ii) 80,000,000 additional ordinary shares that are reserved for issuance under our 2004 Share Incentive Plan, or the 2004 Plan. See “Management — Summary of Share Plans.”

 

References to “China” are to the People’s Republic of China, and references to “provinces” of China are to the provinces and municipalities under direct administration of the central government and the autonomous regions of China. All references to “RMB” or “Renminbi” are to the legal currency of China and all references to “U.S. dollars” or “$” are to the legal currency of the United States.

 

References to “WAP”, “SMS” and “IVR” are to wireless application protocol, short messaging services and interactive voice response services, respectively. Our services offered over the 2.5G mobile networks, including WAP, Java and BREW, are referred to in this prospectus as “2.5G services.” Our services offered over the 2G mobile networks, including SMS and IVR, are referred to in this prospectus as “2G services.”

 

Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi were made at the noon buying rate in the City of New York for cable transfers in Renminbi per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York on September 30, 2004, which was RMB8.2766 to $1.00. We make no representation that the RMB or U.S. dollar amounts referred to herein could have been or could be converted to U.S. dollars or RMB, as the case may be, at any particular rate.

 

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SUMMARY HISTORICAL CONDENSED CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following summary historical condensed consolidated financial and operating data should be read in conjunction with our audited historical consolidated financial statements, the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The summary historical consolidated statement of operations data for the years ended December 31, 2001 (predecessor), 2002 (predecessor), 2003 and for the nine months ended September 30, 2004, and the summary historical consolidated balance sheet data as of December 31, 2001 (predecessor), 2002 (predecessor) and 2003 and as of September 30, 2004 set forth below are derived from our audited historical consolidated financial statements included elsewhere in this prospectus. Our summary condensed consolidated financial statements as of September 30, 2003 and for the nine-month period then ended have been derived from our unaudited consolidated financial statements which are included in this prospectus and which have been prepared on substantially the same basis as our audited consolidated financial statements and contain normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for such unaudited period. Our results of operations in any period may not necessarily be indicative of the results that may be expected for any future period. Our audited historical consolidated financial statements have been prepared and presented in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, and audited by Deloitte Touche Tohmatsu CPA Ltd. For a description of the basis of presentation of these financial statements, see note 3 to our audited historical consolidated financial statements.

 

Hurray! Holding was formed on April 23, 2002. For our 1999, 2000 and 2001 financial statements, our existing affiliate, Hurray! Solutions, is treated as a predecessor entity. For our 2003 financial statements, Hurray! Holding is treated as a successor entity. Because Hurray! Holding had not yet entered into definitive agreements with Hurray! Solutions in 2002 and it had limited operations in that year, our 2002 financial statements are also presented with Hurray! Solutions as a predecessor entity. In accordance with applicable accounting standards, the assets and liabilities of Hurray! Solutions have been recorded at fair market value in our successor financial statements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

    As of and for the Year Ended
December 31,


    As of and for the
Nine Months Ended
September 30,


 
    2001
(Predecessor)


    2002
(Predecessor)


    2003

   

2003

(unaudited)


    2004

 
    (in thousands of U.S. dollars, except percentages and
subscription data)
 

Historical Condensed Consolidated Statement of Operations Data

                                       

Revenues:

                                       

2G services

  $ 1,414     $ 5,948     $ 13,471     $ 9,079     $ 11,421  

2.5G services

                4,289       1,968       19,209  

Software and system integration services

          4,565       5,363       4,233       8,770  
   


 


 


 


 


Total revenues

    1,414       10,513       23,123       15,280       39,400  
   


 


 


 


 


Cost of revenues:

                                       

2G services

    646       3,363       4,586       3,052       5,374  

2.5G services

                2,106       964       7,559  

Software and system integration services

          4,478       4,151       3,470       6,123  
   


 


 


 


 


Total cost of revenues

    646       7,841       10,843       7,486       19,056  
   


 


 


 


 


Gross profit

    768       2,672       12,280       7,794       20,344  

Operating expenses

    4,548       5,156       7,348       5,032       8,147  
   


 


 


 


 


Income (loss) from operations

    (3,780 )     (2.484 )     4,932       2,762       12,197  

Interest expense, net

    91       357       387       294       213  
   


 


 


 


 


Net income (loss)

    (3,871 )     (2,841 )     4,545       2,468       11,984  

Deemed dividends on Series A convertible preference shares

                (113 )     (73 )     (40 )
   


 


 


 


 


Income (loss) attributable to holders of ordinary shares

  $ (3,871 )   $ (2,841 )   $ 4,432     $ 2,395     $ 11,944  
   


 


 


 


 


 

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     As of and for the Year Ended
December 31,


    As of and for the
Nine Months Ended
September 30,


 
    

2001

(Predecessor)


   

2002

(Predecessor)


    2003

   

2003

(unaudited)


    2004

 
     (in thousands of U.S. dollars, except percentages and subscription
data)
 

Historical Condensed Consolidated Balance Sheet Data

                                        

Cash and cash equivalents

   $ 1,736     $ 3,493     $ 11,151     $ 9,936     $ 8,590  

Restricted cash

     1,466       1,510       1,510       1,510        

Accounts receivable, net

     802       2,937       7,892       7,962       15,376  

Other current assets

     1,470       329       228       518       1,415  

Property and equipment, net

     1,666       1,028       1,897       1,506       2,283  

Other assets

     404       473       231       277       887  

Goodwill

                 3,950       3,950       20,411  
    


 


 


 


 


Total assets

   $ 7,544     $ 9,770     $ 26,859     $ 25,659     $ 48,962  
    


 


 


 


 


Current liabilities

   $ 7,877     $ 12,404     $ 12,165     $ 13,070     $ 16,498  

Shareholders’ equity (deficiency)

     (333 )     (2,634 )     14,694       12,589       32,464  
    


 


 


 


 


Total liabilities and shareholders’ equity

   $ 7,544     $ 9,770     $ 26,859     $ 25,659     $ 48,962  
    


 


 


 


 


Other Historical Condensed Consolidated Financial Data

                                        

Gross profit margin:

                                        

2G services

     54.3 %     43.5 %     66.0 %     66.4 %     52.9 %

2.5G services

                 50.9       51.0       60.6  

Software and system integration services

           1.9       22.6       18.0       30.2  

Total gross profit margin

     54.3       25.4       53.1       51.0       51.6  

Income (loss) from operations

     (267.4 )     (23.6 )     21.3       18.1       31.0  

Net profit (loss) margin

     (273.9 )     (27.0 )     19.7       16.2       30.4  

Depreciation

   $ 338     $ 652     $ 858     $ 638     $ 968  

Amortization

     71       142       276       207       464  

Capital expenditure

     1,445       441       1,388       751       1,163  

Unaudited Operating Data (in millions)

                                        
Number of SMS subscriptions(1)            0.9       2.0       2.0       1.7  
Number of WAP subscriptions(2)                  1.6       0.8       3.9  

(1)   Approximate combined number of our SMS subscriptions on China Unicom’s and China Mobile’s 2G mobile networks as of the indicated date.
(2)   Approximate number of our subscriptions on China Unicom’s (and China Mobile’s, in the case of the unaudited operating data as of September 30, 2004) nation-wide WAP portal as of the indicated date.

 

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SUMMARY UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA

 

The following summary unaudited pro forma condensed consolidated financial data should be read in conjunction with our unaudited pro forma condensed consolidated financial information and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The summary unaudited pro forma condensed consolidated financial data for the year ended December 31, 2003 and for the nine months ended September 30, 2004 set forth below are derived from our unaudited pro forma condensed consolidated financial information.

 

Our summary unaudited pro forma condensed consolidated financial data for the year ended December 31, 2003 is presented in order to give pro forma effect to the acquisition of Beijing Enterprise, which provides 2.5G services, as if the acquisition occurred on January 1, 2003. Our summary unaudited pro forma condensed consolidated statement of operations data for the nine months ended September 30, 2004 is presented to include (1) the historical consolidated financial data of our company for the three months ended March 31, 2004, (2) the historical financial data of Beijing Enterprise for the three months ended March 31, 2004 after giving pro forma effect to our acquisition of Beijing Enterprise as if the acquisition occurred on January 1, 2003 and (3) the historical consolidated financial data of our company for the six months from April 1, 2004 (acquisition of Beijing Enterprise) to September 30, 2004, in which the operating results of Beijing Enterprise for that period were consolidated.

 

Our summary unaudited pro forma condensed consolidated financial data for the year ended December 31, 2003 have been derived from our audited historical consolidated financial statements and the audited historical financial statements of Beijing Enterprise. Our summary unaudited pro forma condensed consolidated financial data for the nine months ended September 30, 2004 have been derived from our audited historical consolidated financial statements and, for the historical financial data of Beijing Enterprise for the three months ended March 31, 2004, from the unaudited quarterly financial information of Beijing Enterprise for that period, which were prepared on substantially the same basis as our audited historical consolidated financial statements and the audited historical financial statements of Beijing Enterprise and include all adjustments necessary for a fair statement of the financial results for the period presented. For a description of the basis of presentation and the adjustments made in preparation of these unaudited pro forma condensed consolidated financial information, see our unaudited pro forma condensed consolidated financial information included elsewhere in this prospectus.

 

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For the
Year Ended
December 31,
2003

(unaudited)


   

For the Nine
Months Ended
September 30,

2004

(unaudited)


 
    (in thousands of U.S. dollars,
except percentages)
 

Pro Forma Condensed Consolidated Statement of Operations Data

               

Revenues:

               

2G services

  $ 13,471     $ 11,421  

2.5G services

    5,532       20,208  

Software and system integration services

    5,364       8,770  
   


 


Total revenues

    24,367       40,399  
   


 


Cost of revenues:

               

2G services

    4,586       5,374  

2.5G services

    2,503       7,825  

Software and system integration services

    4,151       6,123  
   


 


Total cost of revenues

    11,240       19,322  
   


 


Gross profit

    13,127       21,077  

Operating expenses

    8,447       8,194  
   


 


Income from operations

    4,680       12,883  

Interest expense, net

    (385 )     (212 )
   


 


Net income

    4,295       12,671  

Deemed dividends on Series A convertible preference shares

    (113 )     (40 )
   


 


Income attributable to holders of ordinary shares

  $ 4,182     $ 12,631  
   


 


Other Pro Forma Condensed Consolidated Financial Data

               

Gross profit margin:

               

2G services

    66.0 %     52.9 %

2.5G services

    54.8       61.3  

Software and system integration services

    22.6       30.2  

Total gross profit margin

    53.9       52.2  

Income from operations

    19.2       31.9  

Net profit margin

    17.6       31.4  

Depreciation

  $ 878     $ 980  

Amortization

    963       471  

 

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SUMMARY UNAUDITED HISTORICAL CONSOLIDATED QUARTERLY FINANCIAL AND OPERATING DATA

 

The following summary unaudited historical consolidated quarterly financial and operating data should be read in conjunction with our audited historical consolidated financial statements, the notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The summary unaudited historical consolidated quarterly financial and operating data for the three months ended March 31, 2003, June 30, 2003, September 30, 2003, December 31, 2003, March 31, 2004, June 30, 2004 and September 30, 2004 were derived from our management financial information, which was prepared on substantially the same basis as our audited historical consolidated financial statements and include all adjustments necessary for a fair statement of the financial results for the periods presented. For a description of the basis of presentation of our audited historical consolidated financial statements, see note 3 to our audited historical consolidated financial statements.

 

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As of or for the Three Months Ended

(unaudited)


 
   

March 31,

2003


   

June 30,

2003


   

September 30,

2003


   

December 31,

2003


   

March 31,

2004


    June 30,
2004


    September 30,
2004


 
   

(in thousands of U.S. dollars,

except percentages and subscription data)

 

Historical Consolidated Statement of Operations Data

                                                       

Revenues:

                                                       

2G services

  $ 2,770     $ 2,901     $ 3,408     $ 4,392     $ 4,505     $ 3,556     $ 3,360  

2.5G services

    147       285       1,536       2,321       3,916       7,231       8,062  

Software and system integration services

    1,344       2,160       729       1,130       6,399       1,202       1,169  
   


 


 


 


 


 


 


Total revenues

    4.261       5,346       5,673       7,843       14,820       11,989       12,591  
   


 


 


 


 


 


 


Cost of revenues:

                                                       

2G services

    887       1,030       1,135       1,534       1,875       1,838       1,661  

2.5G services

    77       200       687       1,142       1,703       2,792       3,064  

Software and system integration services

    1,193       2,060       217       681       5,778       169       176  
   


 


 


 


 


 


 


Total cost of revenues

    2,157       3,290       2,039       3,357       9,356       4,799       4,901  
   


 


 


 


 


 


 


Gross profit

    2,104       2,056       3,634       4,486       5,464       7,190       7,690  

Operating expenses

    1,230       1,903       1,899       2,316       2,449       2,804       2,894  
   


 


 


 


 


 


 


Income from operations

    874       153       1,735       2,170       3,015       4,386       4,796  

Interest expense, net

    91       98       105       93       87       66       60  
   


 


 


 


 


 


 


Net income

    783       55       1,630       2,077       2,928       4,320       4,736  

Deemed dividends on Series A convertible preference shares

    (3 )     (30 )     (40 )     (40 )     (40 )            
   


 


 


 


 


 


 


Income attributable to holders of ordinary shares

  $ 780     $ 25     $ 1,590     $ 2,037     $ 2,888     $ 4,320     $ 4,736  
   


 


 


 


 


 


 


Historical Consolidated Balance Sheet Data

                                                       

Cash and cash equivalents

  $ 5,143     $ 9,324     $ 9,936     $ 11,151     $ 16,326     $ 7,367     $ 8,590  

Restricted cash

    1,510       1,510       1,510       1,510                    

Accounts receivable, net

    5,480       6,755       7,962       7,892       11,896       12,617       15,376  

Other current assets

    556       605       518       228       261       952       1,415  

Property and equipment, net

    1,222       1,291       1,506       1,897       1,891       2,307       2,283  

Other assets

    311       273       277       231       502       1,077       887  

Goodwill

    3,950       3,950       3,950       3,950       5,271       21,911       20,411  
   


 


 


 


 


 


 


Total assets

  $ 18,172     $ 23,708     $ 25,659     $ 26,859     $ 36,147     $ 46,231     $ 48,962  
   


 


 


 


 


 


 


Current liabilities

  $ 11,083     $ 12,646     $ 13,070     $ 12,165     $ 16,739     $ 12,502     $ 16,498  

Shareholders’ equity

    7,089       11,062       12,589       14,694       19,408       33,729       32,464  
   


 


 


 


 


 


 


Total liabilities and shareholders’ equity

  $ 18,172     $ 23,708     $ 25,659     $ 26,859     $ 36,147     $ 46,231     $ 48,962  
   


 


 


 


 


 


 


Other Historical Consolidated Financial Data

                                                       

Gross profit margin:

                                                       

2G services

    68.0 %     64.5 %     66.7 %     65.1 %     58.4 %     48.3 %     50.6 %

2.5G services

    47.3       29.8       55.3       50.8       56.5       62.5       62.0  

Software and system integration services

    11.2       4.6       70.2       39.8       9.7       85.9       84.9  

Total gross profit margin

    49.4       38.5       64.1       57.2       36.9       60.6       61.1  

Income (loss) from operations

    20.5       2.9       30.6       27.7       20.3       36.6       38.1  

Net profit margin

    18.4       1.0       28.7       26.5       19.8       36.0       37.6  

Depreciation

  $ 200     $ 203     $ 228     $ 227     $ 285     $ 326     $ 357  

Amortization

    68       69       69       70       35       242       187  

Unaudited Operating Data (in millions)

                                                       

Number of SMS subscriptions(1)

    1.2       1.6       2.0       2.0       2.4       2.2       1.7  

Number of WAP subscriptions(2)

          0.1       0.8       1.6       2.2       2.8       3.9  

(1)   Approximate combined number of our SMS subscriptions on China Unicom’s and China Mobile’s 2G mobile networks as of the indicated date.
(2)   Approximate number of subscriptions on China Unicom’s (and China Mobile’s, in the case of the unaudited operating data as of June 30, 2004 and September 30, 2004) nation-wide WAP portal as of the indicated date.

 

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RISK FACTORS

 

This offering involves a high degree of risk. You should carefully consider the risks described below before you decide to buy our ADSs. In particular, as we are a non-U.S. company, there are risks associated with investing in our ADSs that are not typical with investments in shares of U.S. companies. If any of the following risks actually occurs, our business, overall financial condition and results of operations would likely suffer. In such case, the market price of our ADSs could decline, and you could lose all or part of your investment.

 

Risks Related to Our Company

 

Risks Related to Our 2G and 2.5G Services

 

We depend on China United Telecommunications Corporation, or China Unicom, and, to a lesser extent, China Mobile Communications Corporation, or China Mobile, the two principal mobile operators in China, for substantially all of our revenue, and any loss or deterioration of our relationship with China Unicom and China Mobile may result in severe disruptions to our business operations and the loss of some or a major portion of our revenue.

 

We offer our 2G and 2.5G services to consumers through the two principal mobile operators in China, China Unicom and China Mobile, which service nearly all of China’s approximately 330 million mobile phone subscribers as of November 30, 2004. China Unicom and China Mobile are owned by the Chinese government and have publicly listed subsidiaries. Our agreements with those mobile operators and their provincial affiliates are non-exclusive, and have a limited term (generally two to three years for China Unicom and one year for China Mobile). We usually renew these agreements or enter into new ones when the prior agreements expire, but on occasion the renewal or new agreements can be delayed by periods of one month or more.

 

If either China Unicom or China Mobile ceases to continue to cooperate with us, it would be impossible to find appropriate replacement mobile operators with the requisite licenses and permits, infrastructure and customer base to offer our 2G and 2.5G services. For the first nine months of 2004, we derived approximately 83% of our combined 2G and 2.5G services revenue and 83% of our 2.5G services revenue from China Unicom. On a pro forma basis, we derived approximately 77% of our combined 2G and 2.5G services revenue from China Unicom in the first nine months of 2004. Accordingly, we are particularly dependent on China Unicom.

 

In addition, the Chinese government has extensive involvement in determining the structure of the telecommunications industry in China. During the development of this industry, changes in government policy have resulted in major restructurings of the telecommunications operators, including the establishment of new operators and the combination of all or part of existing operators. Any significant restructuring of any segment of the telecommunications industry in China, including in particular China Unicom, China Mobile or any other mobile operators in China and the potential combination of the mobile operations of various mobile operators in China, could significantly affect these relationships, our operations and our revenues.

 

Due to our reliance on China Unicom and, to a lesser extent, China Mobile for our wireless value-added services, any loss or deterioration of our relationship with them, due to their own business decisions or government-imposed restructurings, may result in severe disruptions to our business operations and the loss of some (in the case of China Mobile) or a major portion (in the case of China Unicom) of our revenue.

 

The termination or alteration of our various agreements with China Unicom, China Mobile and their provincial affiliates would materially and adversely impact our revenue and profitability.

 

Given the dominant market position of China Unicom and China Mobile, our leverage with these mobile operators is limited in terms of negotiating agreements, resolving disputes or otherwise. In particular, our

 

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agreements with them can be terminated in advance, penalties may be imposed or other parts of our services may be suspended or terminated, and approval for our new services may be delayed for a variety of reasons which vary among the individual agreements with the mobile operators, including, for example, where we breach our obligations under the agreements, a high number of customer complaints are made about our services or we cannot satisfy the operational or financial performance criteria established by the applicable mobile operator.

 

We may also be compelled to alter our agreements with these mobile operators in ways which adversely affect our business, such as by limiting the services we can offer or imposing other changes that limit the revenue we can derive from such agreements. We may not be able to adequately respond to any such changes because we are not able to predict if the mobile operators will unilaterally amend our contracts with them.

 

Unilateral changes in the policies of China Mobile and China Unicom and in their enforcement of their policies have resulted in our having to pay additional charges to the mobile operators, and further changes could materially and adversely impact our revenue and profitability in the future.

 

China Mobile and China Unicom have a wide range of policies and procedures regarding customer service, quality control and other aspects of the wireless value-added services industry. As the industry has evolved over the last several years, the mobile operators have refined these policies to improve overall service quality. In addition, in the last several months, acting under the guidance of China’s Ministry of Information Industry, the mobile operators have begun enforcing their customer service policies more rigorously than in the past and have initiated steps to improve customer service. This rigorous enforcement has resulted in a number of severe penalties being imposed on other participants in the market. Penalties have included precluding such participants from offering certain services over a mobile operator’s network or from offering new services for a fixed period.

 

We may not be able to adequately respond to these or other developments in mobile operator policies, or changes in the manner in which such policies are enforced. Furthermore, because the mobile operators’ policies are in a state of flux at this time and they are highly sensitive to customer complaints (even if the complaints may not have a bona fide basis), we cannot be certain that our business activities will always be deemed in compliance with those policies despite our efforts to so comply. Accordingly, we may be subject to monetary penalties or service suspensions or both, even for conduct which we believed to be permissible. For the nine months ended September 30, 2004, we were required to pay charges totaling $0.2 million due to the occasional inadvertent contravention of certain of these policies by us. Any future noncompliance with the mobile operators’ policies by us, whether inadvertent or not, could result in a material and adverse effect on our revenue and profitability.

 

In addition to enhanced enforcement of their policies, the mobile operators have been adopting new billing systems which have adversely affected our SMS revenue.

 

China Mobile and China Unicom are adopting new billing systems for 2G services on a province-by-province basis, which require users to make two confirmations to order services via the Internet or mobile phone, enable users to more easily cancel services and prevent service providers from billing inactive users for subscription-based services. As of October 31, 2004, these new billing systems were wholly or partially operational in 11 provinces for China Mobile and 7 provinces for China Unicom. Although the approximately 13% decline of our SMS revenue between the second and third quarters of 2004 was mainly driven by the overall market shift from 2G to 2.5G services, we believe that these new billing systems, in combination with the recent focus on compliance discussed in the prior risk factor, was also a contributing factor to the decline, though we have no basis to quantify the exact impact of such factors. We expect this trend in the decline in SMS revenue will continue for the next several quarters.

 

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The Chinese government, China Unicom or China Mobile may prevent us from distributing, and we may be subject to liability for, content that any of them believe is inappropriate.

 

China has enacted regulations governing telecommunication service providers, Internet access and the distribution of news and other information. In the past, the Chinese government has stopped the distribution of information over the Internet that it believes to violate Chinese law, including content that is pornographic or obscene, incites violence, endangers national security, is contrary to the national interest or is defamatory.

 

China Unicom and China Mobile also have their own policies regarding the distribution of inappropriate content by wireless value-added service providers and have recently punished certain providers for distributing inappropriate content, including the imposition of fines and service suspensions. Some of those providers indicated that the mobile operators informed them that certain of their content was construed as too adult-oriented or sexually suggestive. In addition, in June 2004, along with other participants in our industry, we received information and guidance from China Mobile and China Unicom regarding what they consider to be inappropriate content for wireless value-added services. In response, we reviewed our services and removed certain IVR and picture downloads in order to comply with such information and guidance. There can be no assurance that we will not receive future guidance that could compel us to further alter our services.

 

The appropriateness or inappropriateness of WAP and IVR content is a new and emerging concept in China: the industry is less than two years old and the first publicly announced application of penalties for inappropriate content occurred in the third quarter of this year. Most importantly, the determination that content is deemed to be inappropriate is inherently subjective, and is subject to the interpretation of the governmental authorities and mobile operators in China. Their standards are generally more restrictive than those applied in other countries like the United States. Accordingly, while we intend to comply with all applicable rules regarding wireless content, it is very difficult for us to assess whether we offer particular content that could be construed by the mobile operators as inappropriate under current regulations in China. Any penalties imposed on us by the mobile operators for the content of our services could result in a material and adverse effect on our revenue, profitability and reputation.

 

China Unicom and China Mobile may impose higher service or network fees on us for their own business purposes or if we are unable to satisfy customer usage and other performance criteria, which could reduce our gross margins.

 

Fees for our 2G and 2.5G services are charged on a monthly subscription or per-use basis. As provided in our network service agreements, we rely on China Unicom and China Mobile for both billing of, and collection from, mobile phone users of fees for our services. As noted above under “— The termination or alteration of our various agreements with China Unicom, China Mobile and their provincial affiliates would materially and adversely impact our revenue and profitability,” our negotiating leverage with the mobile operators is limited. As a result, the mobile operators could unilaterally for their own business purposes amend our agreements with them to increase the service or network fees that they retain from the revenues generated by our 2G and 2.5G services.

 

In addition, under these agreements, these service fees in some cases rise if we fail to meet certain customer usage, revenues and other performance criteria. Moreover, for 2G services, to the extent that the number of messages sent by us over China Mobile’s and China Unicom’s network exceeds the number of messages our customers send to us, we must pay per message network fees, which decrease in several provinces as the volume of customer usage of our services increases. The number of messages sent by us will exceed those sent by our users, for example, if a user sends us a single message to order a game but we in turn must send that user several messages to confirm his or her order and deliver the game itself. We cannot be certain that we will be able to satisfy any performance criteria in the future or that the mobile operators will keep the criteria at their current levels.

 

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Any increase in China Unicom’s or China Mobile’s service or network fees could reduce our gross margins. For example, we have experienced a recent rise in service fees payable with respect to our 2G services which contributed slightly to a decline in our gross profit margins for 2G services in the first nine months of 2004 compared to the same period in 2003.

 

If either China Unicom or China Mobile change their practices with regard to how service selections appear on their WAP portals, the revenue from our services, and thus our overall financial condition, could be materially and adversely affected.

 

The current practice of both China Unicom and China Mobile is to place the most popular WAP services at the top of the menu on the first page of the list of services available in each service category on their WAP portals. Services at the top of the menu are more accessible to users than other services and, in our experience, are more frequently accessed than those services lower on the menu. This effectively reinforces the position of the most popular services. The placement of services on these menus creates significant competitive advantages for the top-ranked services and significant challenges for newer and less popular services. We believe that our prominent position on the WAP portals of the two principal mobile operators in China helps us maintain our leading position, and in the future will help us to capture opportunities presented by the expected high growth in the market for WAP services in China. If either China Mobile or China Unicom changes its current practices so that the most popular services are not those that are the most accessible to customers, restricts the number or type of services a service provider is permitted to place on service menus or adopts new interface technologies that eliminate the current service menus, our services could become more difficult for users to access and could, therefore, become less popular. This could materially and adversely affect the revenue from our services, and thus our overall financial condition.

 

Our revenue from wireless value-added services would likely be adversely affected if China Unicom or China Mobile or both begin providing their own full portfolio of 2G and 2.5G services that compete with our services.

 

China Unicom and China Mobile currently offer a limited number of niche applications such as instant messaging. While, to date, they are not offering their own full portfolios of 2G and 2.5G services, our business would likely be adversely affected if China Unicom or China Mobile or both decide to begin providing 2G and 2.5G services to mobile phone users which compete with our services. In that case, we would not only face enhanced competition, but could be partially or completely denied access to their networks which could adversely affect our revenue from wireless value-added services.

 

One of our principal strategies is focusing on 2.5G services in China, the market for which may not grow to the extent we anticipate for a variety of reasons that are beyond our control, which in turn would limit the growth potential of our business and adversely affect the market price of our ADSs.

 

Revenues from 2G services such as SMS represented 100.0%, 56.6% and 58.3% of our total revenues in 2001, 2002 and 2003, respectively. However, we expect that our 2.5G services delivered through WAP will comprise the largest portion of our total revenues in 2004. In the nine months ended September 30, 2004, 48.7% of our total revenues were from 2.5G services and 29.1% were from 2G services. As a relative percentage of our total revenues, we expect that our 2G revenues will decline in future years.

 

Currently, 2.5G technology is still evolving in China. We cannot be certain whether the popularity of 2.5G services will reach the levels currently enjoyed by 2G services in the near future or ever. Factors which could affect the expansion of the 2.5G market and, accordingly, for our 2.5G services in China include:

 

    the cost of 2.5G compatible handsets and services,

 

    the technical bugs or other problems which users experience while using 2.5G services,

 

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    the growth in the capacity of 2.5G mobile networks to accommodate new users of 2.5G services in China,

 

    whether there is a critical mass of attractive services which are compatible with the technology,

 

    consumer preferences within China, particularly in under-penetrated smaller-sized cities and towns, and

 

    delays in testing and deployment of the complex software necessary to support the expansion of the 2.5G mobile networks, including our own VASPro software which China Unicom uses at the national level and in nine provincial offices for 2.5G services.

 

Because the foregoing factors are beyond our control, we cannot accurately predict consumer acceptance and demand for various existing and potential new offerings and services, and the future size, composition and growth of this market. If 2.5G services, particularly WAP services, are not adopted on a widespread basis in China, our business may not grow to the extent we anticipate.

 

The popularity of our 2G and 2.5G services, and therefore revenues from these services and our profitability, would be adversely affected if our competitors offer more attractive and engaging services or our services are rendered obsolete by the introduction of newer technologies such as 3G.

 

The wireless value-added services market is highly competitive, and our competitors may offer new or different services which are more popular than our 2G and 2.5G services, including, for example, MMS, which we do not offer. Moreover, our services could be rendered obsolete by the introduction of newer technologies such as 3G mobile networks. Although we are planning to transition our 2.5G services to 3G services when 3G licenses are awarded to mobile operators in China and 3G mobile networks are launched, it is difficult to predict the development of new mobile technologies or the types of services that will be popular on any new mobile networks. Accordingly, we cannot be certain whether any services we offer which are compatible with such new technologies will be successful.

 

China Unicom and China Mobile allow us to offer our services over their networks only if we achieve minimum customer usage, revenues and other criteria, and our revenues from 2.5G services depend in particular on our ability to meet those criteria to keep our services among the most popular offered through the mobile operators.

 

If we fail to achieve minimum customer usage, revenues and other criteria imposed by China Unicom or China Mobile at its discretion from time to time, our services could be excluded from the applicable mobile operator’s entire network at a provincial or national level, or we could be prevented from introducing new services. In addition, we believe that the success of our 2.5G services depends significantly on whether our services appear at the top of the menu on the first page of the list of services available in each service category on the mobile operators’ WAP portals. The ranking of services on these WAP page menus depends on the satisfaction of performance criteria established by the mobile operators from time to time. If we are excluded from any mobile operator’s network or are not able to keep our 2.5G services at the top of the service lists on any mobile operator’s WAP pages due to performance problems, our wireless value-added services revenue could be substantially reduced, which would materially and adversely affect our overall financial condition and the market price of our ADSs.

 

We are particularly dependent on the success of China Unicom’s 2.5G mobile networks operating on the CDMA platform, and if the use of CDMA compatible handsets does not continue to grow as we expect, our ability to generate revenues from 2.5G services could be limited.

 

All of our 2.5G services revenues in 2003, and a major portion in 2004, were derived from China Unicom’s users, and we expect China Unicom to continue to contribute the major portion of our 2.5G services revenues for

 

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the foreseeable future. China Unicom’s 2.5G mobile network operates on the code division multiple access, or CDMA, platform in contrast to China Mobile, the dominant mobile operator in China, which operates its 2.5G mobile network on the general packet radio system, or GPRS, platform. Mobile phone users can access China Unicom’s WAP services only if they purchase handsets that are compatible with CDMA. Sales of CDMA handsets, which have historically been significantly more expensive than handsets using older technology such as global system for mobile communication, or GSM, have been growing in China since their introduction in 2002. Although the prices of CDMA-compatible handsets have dropped in recent quarters, we cannot be certain whether this trend will continue or of the extent to which new or existing users will be willing to use CDMA handsets to obtain the latest technology. The pricing, marketing and other factors which affect the sales of more sophisticated mobile handsets are all outside of our control, and weak sales of mobile handsets for which we have developed services could limit our ability to generate revenues from those services.

 

Even following our acquisition of Beijing Enterprise, we may not be able to enhance our relationship with China Mobile, which would limit our ability to increase our market share and our overall profitability.

 

Our revenues from 2G and 2.5G services are substantially dependent on our relationship with China Unicom. Through the acquisition of Beijing Enterprise, which primarily provides 2.5G services to China Mobile’s users, and also leveraging our existing sales and marketing and product development teams, we intend to enhance our relationships with the national and provincial offices of China Mobile to increase the number of services we are able to offer through its network, enhance the positioning of our services on China Mobile’s WAP portal services menus and increase the marketing cooperation between us and China Mobile. However, like China Unicom, China Mobile, through its provincial offices, has historically preferred to work only with a small group of the best performing wireless value-added service providers, based upon various performance criteria including uniqueness of the service offered by each provider, total number of users, usage and revenues generated in the applicable province or municipality, the rate of customer complaints, and marketing expenditures in the applicable province or municipality. If we cannot achieve these performance criteria or China Mobile has concerns about working with us for more subjective reasons (for example, due to our long-standing relationship with China Unicom), our services may be less actively promoted by China Mobile to its users or may be excluded from its network altogether. In either case, our ability to increase our market share and our overall profitability would be limited.

 

We must rely on China Unicom and China Mobile to maintain accurate records of fees paid by users of our services, deduct service and network fees due to them and pay us fees due to us. Errors in record-keeping by the mobile operators could adversely affect our profitability and the market price of our ADSs.

 

We must rely on China Unicom and China Mobile to maintain accurate records of the fees paid by users and deduct the service and network fees due to them under our network service agreements. Specifically, the mobile operators provide us with monthly statements for our 2G services that do not provide itemized information regarding amounts paid for each of our services or calculations of the service and network fees. As a result, monthly statements that we have received from the mobile operators for our 2G services cannot be reconciled to our own internal records for the reasons discussed under “— China Unicom and China Mobile do not supply us with detailed information on billing and transmission failures, revenues, service or network fees or other charges, particularly with respect to our 2G services, and accordingly, it is difficult to analyze the factors affecting our financial performance.” In addition, we have only limited means to independently verify the information provided to us with respect to such 2G services because we do not have access to the mobile operators’ internal records. Rather, we can only seek consultations with the mobile operators to discuss the reasons for any discrepancies.

 

With respect to our 2.5G services, the mobile operators allow us limited access to their transmission and billing system information to monitor if our services are actually delivered and paid for, which information we then reconcile to our own internal records. In addition, the mobile operators in general provide us with monthly

 

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statements within two to three weeks after month end. To date, discrepancies between our internal records and the mobile operators’ confirmations has been insignificant. Nonetheless, we are still ultimately dependent on the ability of the mobile operators’ systems to accurately collect and analyze the relevant transmission and payment data regarding our services.

 

Because of the dominant market position of these mobile operators, we have limited leverage in challenging any discrepancies between their monthly statements and 2.5G system information, on the one hand, and our own records, on the other hand. Our profitability and the market price of our ADSs could be adversely affected if these mobile operators miscalculate the revenues generated from our services and our portion of those revenues.

 

Our dependence on the billing records of China Unicom and China Mobile may adversely affect our ability to record, process, summarize and report revenue and other information regarding our wireless value-added services. Any inaccuracies in our records and public reports could adversely affect our ability to effectively manage our business and the market price of our ADSs.

 

We maintain controls and procedures to ensure that financial and non-financial information regarding our business is recorded, processed, summarized and reported in a timely and accurate manner. However, as noted in the prior risk factor, we depend on the billing records of China Unicom and China Mobile and have only limited means to independently verify information provided by them. If the information they provide us is incorrect or incomplete, then our own internal records will also be incorrect or incomplete. Our business could be adversely affected if our management and board of directors make decisions based on deficient internal information, such as strategic initiatives involving new wireless value-added services. Moreover, following this offering, it is possible that, if information provided to us by the mobile operators were not correct or complete, our public reports could also be deficient, which could adversely affect the market price of our ADSs.

 

We have started to recognize revenue for a portion of our 2G services on an accrual basis beginning with our financial statements for the nine months ended September 30, 2004, based on an internal estimation process which involves the use of estimates of monthly revenues to the extent we are unable to obtain actual figures from the mobile operators before we finalize our financial statements, which could in turn require us to make adjustments to our financial statements.

 

Our financial statements through December 31, 2003 reflect our actual revenues as they appear on the mobile operators’ statements. However, for the nine months ended September 30, 2004, we recognized revenue for a portion of our 2G services (as well as for an insignificant portion of our 2.5G services) on an accrual basis and plan to do so in future quarters as necessary in order to report our quarterly or annual earnings on a timely basis. This involves the use of estimates of monthly revenues based on our internal records for the month and prior monthly confirmation rates with the mobile operators in prior months if we are unable to obtain actual figures from the mobile operators before we finalize our financial statements. We expect the effect of these estimates on our financial results will be more significant on our quarterly results of operations than on our annual results, as we are less likely to receive confirmation on all of our 2G revenues before we disclose our quarterly results. For 2003 and the first nine months of 2004, respectively, 100.0% and approximately 94% of our 2G revenues were recognized based on confirmations received from the mobile operators. To the extent that our revenues have not been confirmed by the mobile operators for any reporting period, we will need to adjust our revenues in the subsequent periods in which these revenues are confirmed. Actual revenues may differ from prior estimates when unexpected variations in billing and transmission failures occur. Recognizing revenues on an accrual basis could potentially require us to later make adjustments to our financial statements if the mobile operators’ billing statements and cash payments are different from our estimates, which could adversely affect our reputation and the market price of our ADSs.

 

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Our revenues and cost of revenues for 2G services, and to a lesser degree 2.5G services, are affected by billing and transmission failures and other discrepancies which are often beyond our control.

 

We do not collect fees for our services from China Unicom and China Mobile in a number of circumstances, including if:

 

    the delivery of our service to a customer is prevented because his or her phone is turned off for an extended period of time, the customer’s prepaid phone card has run out of value or the customer has ceased to be a customer of the applicable mobile operator;

 

    China Unicom or China Mobile experiences technical problems with its network which prevent the delivery of our services to the customer;

 

    we experience technical problems with our technology platform that prevents delivery of our services; or

 

    the customer refuses to pay for our services due to quality or other problems.

 

These situations are known in the industry as billing and transmission failures, and we do not recognize any revenues for services which are characterized as billing and transmission failures. Billing and transmission failures therefore significantly lower the revenues we record. The failure rate for 2G services can vary among the mobile operators, and by province, and also has fluctuated significantly in the past, ranging on a monthly basis from 3.4% to 22.2% of the total billable messages which are reflected in our internal records during 2004.

 

Although we do not experience the same type of billing and transmission failures for our 2.5G services as we do for our 2G services, we do experience a discrepancy between the revenues recorded by our internal system and the revenues confirmed by the mobile operators. This difference has historically averaged approximately 2% per month and relates to services that are provided but are not billed to the user for a variety of reasons associated with the manner in which the mobile operators register new users and manage their internal billing reconciliation process.

 

We are also required to pay some of our content providers a percentage of the revenues received from or confirmed by the mobile operators with respect to services incorporating the content providers’ products. In calculating the fees payable to these providers, we make estimates to take into account billing and transmission failures, which may have been applicable to the services incorporating the providers’ products, and reduce the fees payable by us accordingly. Nonetheless, as estimates involve making assumptions which may prove inaccurate, we have in the past paid, and may continue to pay, such providers fees which are disproportionate to what we have been paid for the relevant service. Our costs of services, gross margins and profitability could be adversely affected if, due to problems in estimating billing and transmission failures, we overpay service providers on a consistent and continuous basis.

 

China Unicom and China Mobile do not supply us with detailed information on billing and transmission failures, revenues, service and network fees or other charges, particularly with respect to our 2G services, and accordingly it is difficult to analyze the factors affecting our financial performance.

 

China Unicom’s and China Mobile’s monthly statements to service providers, including our company, regarding the services provided through their networks currently do not contain information about billing and transmission failures, revenues, service and network fees or other charges or detailed information on a service- by-service basis, particularly with respect to our 2G services. While the mobile operators allow third party service providers such as our company to have access to their 2.5G transmission and billing systems, such access is limited and does not offer complete information on all fee calculations and other charges. Moreover, China Unicom and China Mobile have from time to time imposed penalty charges on us when they believe we have contravened their customer service policies. These charges, which have been imposed in relation to our 2G

 

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services, totaled approximately RMB1.4 million ($0.2 million) for the nine months ended September 30, 2004 and were negligible in previous periods. The information provided by the mobile operators does not, however, identify exactly which services caused the problem or the time period in which they occurred.

 

As a result of the foregoing, we are unable to effectively analyze the factors that affect our financial performance and can only estimate our revenues and cost of revenues by service type. We are also unable to confirm which of our 2G services were transmitted but resulted in billing and transmission failures. As a result, with respect to specific services, we are not able to definitively calculate and monitor revenues, margin and other financial information, such as average revenues per-user by service and total revenues per-user by service, and also cannot definitively determine which of these services are or may be profitable. Moreover, we do not know what adjustments, if any, should be made with respect to specific services to avoid inadvertent violations of the mobile operators’ customer service policies.

 

The services we offer and the prices we charge are subject to approval by China Unicom and China Mobile, and if requested approvals are not granted in a timely manner or approved services are suspended or terminated, our competitive position, revenue and profitability could be adversely affected.

 

We must obtain approval from China Unicom and China Mobile with respect to each 2G and 2.5G service that we propose to offer to their customers and the pricing for such service. In addition, any changes in the pricing of our existing services must be approved in advance by these operators. There can be no assurance that such approvals will be granted in a timely manner or at all. Failure to obtain, or a delay in, obtaining such approvals could place us at a competitive disadvantage in the market and adversely affect our revenue and profitability. In addition, the recent more rigorous enforcement of customer service policies by China Unicom and China Mobile could result in heightened scrutiny of our existing or proposed services and pricing by the mobile operators. This could, in turn, result in delays in their approving new services, our failure to obtain approval for new services or suspensions or termination of all or part of our existing services or reductions in approved pricing of our services. The occurrence of any of these actions could materially and adversely affect our revenues.

 

If either China Unicom or China Mobile adopts a policy that prohibits branding by service providers for services provided on their WAP portals, our revenues could be adversely affected.

 

We introduced our Hawa brand in the fourth quarter of 2003. The branding of our services is an important part of our marketing strategy to increase user awareness of our services and create enhanced customer loyalty. China Mobile currently does not permit the use of corporate names to brand services on their WAP portals. If China Mobile expands this policy to include non-corporate names such as Hawa or China Unicom adopts similar restrictions, we do not believe we could market our services as effectively, which could have an adverse effect on our revenues.

 

The Chinese government is expected to grant licenses to offer basic wireless telecommunications services in China to third parties with which we have not yet developed close relationships. If those parties receive licenses and are successful in the wireless value-added services market, but we are unable to develop cooperative relationships with them, our revenue and overall financial condition could be adversely affected.

 

It is anticipated that the Chinese government will grant licenses to offer basic wireless telecommunications services in China to China Telecommunications Corporation, or China Telecom, China Network Communications Group Corporation, or China Netcom, and possibly others, although the timing of such grants is unclear. We have not yet developed close business relationships with those parties as we have done with China Unicom and, to a lesser extent, China Mobile. As a result, if those parties receive basic wireless telecommunications licenses and are successful in the wireless value-added services market, but we are unable to develop cooperative relationships with them, our revenue and overall financial condition could be adversely

 

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affected if they take market share from China Unicom and China Mobile. It is also possible that China Telecom, China Netcom and any other parties receiving basic wireless telecommunications licenses may decide to offer wireless value-added services created by them, rather than by third party service providers such as our company. In that case, we would be in direct competition with those operators, and our revenue and overall financial condition could be adversely affected if we are not able to compete effectively against them.

 

Risks Related to our Software Products

 

The market for our VASPro software is relatively new, rapidly evolving and dependent on the growth of 2.5G and 3G services in China and elsewhere. We may not be able to generate significant sustainable revenues from this software if the market does not develop as we anticipate or we are unable to respond to new market developments promptly.

 

The market for our VASPro software is relatively new and rapidly evolving. The mobile operators in China have only recently begun to introduce 2.5G services and implement advanced 2.5G services provisioning and management software such as VASPro, which allows 2.5G services to be offered through the mobile operators’ networks. We may not be able to develop and introduce software, software enhancements or services that respond to market demands, technology developments, increased competition or industry standards on a timely basis, or at all. In addition, to date, our revenues from VASPro have been primarily derived from one-time licensing and maintenance fees paid by China Unicom based on the capacity of its platform in terms of number of users. Under our current agreements, we only generate additional software revenues if China Unicom adds capacity for additional users on its nation-wide WAP portal or we supply such software to additional China Unicom provincial offices. If this market does not grow and evolve in the manner or in the timeframe that we anticipate, or if we are unable to respond to new market developments promptly, we may not be able to generate significant sustainable revenues from our software.

 

Our software sales are currently entirely dependent on China Unicom, and the loss of our relationship with China Unicom would materially and adversely affect the revenue from our software business.

 

The only customer for our VASPro software currently is China Unicom. While VASPro is highly complex and customized software and, therefore, difficult to replace, it is possible that China Unicom could purchase similar software from third parties, or develop such software itself, and cease using VASPro. Moreover, several provincial offices of China Unicom that operate their own local WAP portals have purchased services provisioning and management software from other parties, and other provincial offices may do so in the future. In this case, not only would we lose future revenues from sales of additional software to China Unicom at the national or provincial level, but we could also lose what we view to be an important selling point when marketing our software to other mobile operators, the fact that the software is being used successfully by a major mobile operator. This would materially and adversely affect the revenue from our software business.

 

The market for our VASPro software in China is limited, and we may not be able to sell our software outside of China, in which case the potential growth of our software business would be limited.

 

The other principal mobile operator in China besides China Unicom, China Mobile, purchases its services provisioning and management software from a subsidiary company of China Mobile specifically established for this purpose, and we believe it is unlikely that China Mobile will purchase our software for the foreseeable future. While, as noted above, it is expected that China Telecom, China Netcom and possibly others will be granted additional mobile licenses, we cannot be certain that any such companies will receive licenses or, if they do, that they will purchase our software. Accordingly, the market for VASPro is limited in China, and we may have to market our software in other countries to increase sales, which we may not be able to do successfully. This strategy contains risks, including difficulty in managing international operations due to distance, language and cultural differences and an inability to successfully market and operate services in foreign markets. There are also risks inherent in doing business on an international level, including unexpected changes in regulatory

 

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requirements, trade barriers, difficulties in staffing and managing foreign operations, fluctuations in currency exchange rates, and potentially adverse tax consequences.

 

Our provision of both 2G and 2.5G services and services provisioning and management software and related services to China Unicom or other mobile operators could be perceived as a conflict of interest and unfair competitive advantage. As a result, we could be prohibited from providing certain of those types of services, which could materially and adversely affect our competitive position, revenue and overall financial condition.

 

In addition to providing VASPro software, we provide China Unicom, at its request, operations support, data gathering, testing, consulting and maintenance services for its WAP portal. Third party wireless value-added service providers may complain to China Unicom or any other mobile operator that purchases our software that the simultaneous provision of wireless value-added services, VASPro software and technical consulting services for the software by us, which gives us access to China Unicom’s wireless value-added system, presents a conflict of interest and gives us an unfair competitive advantage. Actions arising from any such complaints could impair our ability to provide services to China Unicom or other mobile operators, which could materially and adversely affect our competitive position in the wireless value-added services market, the services provisioning and management software market, or both, as well as our revenue and overall financial condition.

 

Our VASPro software is highly complex, and any defects in it could result in a refusal by China Unicom or other mobile operators to use it, as well as errors or failures in the networks in which it operates. Accordingly, any such defects could not only adversely affect our revenue from VASPro, but could also subject us to claims from users, mobile operators or other parties and damage our credibility.

 

Our VASPro software enables mobile operators to manage a wide range of functions, including managing billing and multiple third party service providers. Given the breadth of this software, it is extremely complex for us to design, develop, install and support the operations of VASPro. Accordingly, despite our testing, current or enhanced versions of VASPro may contain software defects. Any such defects could cause China Unicom to stop licensing VASPro and cause other mobile operators to select services provisioning and management software from our competitors. Moreover, VASPro is a key component of the 2.5G mobile networks in which it operates, and defects could cause errors in such activities as billing or provisioning of services or even cause the whole network to crash. In that case, we could be subject to claims from mobile users, mobile operators which use VASPro or third party service providers for incorrect billing or delivery of services or other damages caused by network problems. Our credibility among mobile operators and users could also be adversely affected, which could adversely affect the long-term growth and profitability of our business as a whole.

 

Additional Risks Related to Our Company

 

The acquisition of Beijing Enterprise and any future acquisitions may have an adverse effect on our ability to manage our business and may subject us to unforeseen liabilities.

 

Selective acquisitions, such as the recent acquisition of Beijing Enterprise, form part of our strategy to further expand our business. If we are presented with appropriate opportunities, we may acquire additional businesses, technologies, services or products that are complementary to our core 2G services, 2.5G services or software and system integration business or help us develop next generation technologies, such as 3G. Beijing Enterprise may not be as successful as it has been in the past, and may also not perform as well as we expect. In particular, China Mobile could stop promoting services offered by Beijing Network, or could prohibit the operation of Beijing Network’s services on China Mobile’s network altogether, if, for example, Beijing Network failed to meet certain performance criteria set by China Mobile. This would significantly affect the expected benefits of this acquisition. Moreover, the integration of Beijing Enterprise into our operations has required significant attention from our management, in particular to ensure that Beijing Network’s relationship with China Mobile is not disrupted and that the quality of our 2G and 2.5G services is maintained. Future acquisitions will also likely present similar challenges.

 

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The diversion of our management’s attention and any difficulties encountered in any integration process could have an adverse effect on our ability to manage our business. Acquisitions, including that of Beijing Enterprise, expose us to potential risks, including risks associated with the assimilation of new operations, services and personnel, unforeseen or hidden liabilities, the diversion of resources from our existing businesses and technologies, the inability to generate sufficient revenues to offset the costs and expenses of acquisitions and potential loss of, or harm to, relationships with employees and content providers as a result of integration of new businesses. Given the sophisticated technologies used in the wireless value-added services industry, the successful, cost-effective integration of other businesses’ technology platforms and services into our own is critical in any acquisition we do.

 

The acquisition of Beijing Enterprise or any other company could also subject us to unforeseen liabilities arising from the acquisition itself or the operations of the company or both.

 

We face intense competition, which could cause us to lose market share and materially adversely affect our business and results of operations.

 

The Chinese market for wireless value-added services is changing rapidly and is intensely competitive, with more than 1,000 service providers of 2G services and approximately 150 providers of 2.5G services, according to Norson Telecom Consulting, an independent research firm. We compete principally with three groups of 2G and 2.5G service providers in China, which include companies that focus primarily or entirely on these markets, major Internet portal operators in China and niche service providers.

 

We have faced competition from all three groups since our entry into this market. Moreover, there are low barriers to entry for new competitors in the 2G and 2.5G services market. Many of our competitors have longer operating histories in China, greater name and brand recognition, larger customer bases and databases, significantly greater financial, technological and marketing resources and superior access to original content than we have. As a result, our existing or potential competitors may in the future achieve greater market acceptance and gain additional market share, which in turn could reduce our revenues. In addition, it is possible that China Mobile or China Unicom or both could decide to provide a portfolio of wireless value-added services to their users themselves and deny network access to third party service providers such as us.

 

With respect to our software products, we face significant competition from major international software companies such as Microsoft, traditional telecommunications companies such as Motorola and NEC, and major software and professional services companies such as Hewlett-Packard and IBM, all of which have greater market share worldwide and financial resources than we do. These established software and telecommunications companies are better positioned to finance research and development activities relating to 2.5G and 3G technologies. They are also able to provide a wider range of products and services for a greater spectrum of media and have greater resources with which to purchase additional technologies or acquire other companies. We also compete against local software developers and telecommunications companies such as Aspire, Huawei and ZTE.

 

We operate in a rapidly evolving industry, which may make it difficult for investors to evaluate our business.

 

We began commercially offering wireless value-added services and developing our VASPro software business in China in 2001, and since that time, the technologies and services used in the wireless value-added services industry in China have developed rapidly. As a result of this rapid and continual change in the industry, you should consider our prospects in light of the risks and difficulties frequently encountered by companies in an early stage of development. These risks include our ability to:

 

    attract and retain users for our 2G and 2.5G services, in particular 2.5G services,

 

    expand the services that we offer,

 

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    respond effectively to rapidly evolving competitive and market dynamics and address the effects of mergers and acquisitions among our competitors,

 

    provide our services to users on mobile networks in addition to China Unicom’s network,

 

    continue to develop reliable, state-of-the-art mobile service provisioning and management software for mobile operators,

 

    maintain, expand and enhance our relationships with mobile operators so that they will allow us to offer our 2G and 2.5G services over their networks and will buy our service provisioning and management software, and

 

    increase awareness of our brand and user loyalty.

 

Due to these factors, there can be no certainty that we will maintain or increase our current share of the highly competitive market in which we operate.

 

Our historical and pro forma financial information may not be representative of our current or future results of operations.

 

The historical and pro forma financial information that we have included in this prospectus may not reflect what our results of operations, overall financial condition and cash flow would have been if we had been a separate, stand-alone entity during the periods presented, or what our results of operations, financial condition or cash flow will be in the future. This is because we have experienced tremendous growth in our business in recent periods in part due to the growth in China’s 2G and 2.5G services industry, which may not be representative of future growth. In particular, we experienced rapid growth in sales of our 2.5G services in the second half of 2003 and the first nine months of 2004 as the market for such services has expanded.

 

For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We cannot assure you that our historical or pro forma financial information is indicative of our future operating or financial performance.

 

A substantial portion of our revenues are derived from the relatively wealthier coastal and southern provinces in China, and the termination or alteration of our contracts with the mobile operators, or a general economic downturn, in those areas could have a particularly adverse effect on our revenue and overall financial condition.

 

Per capita income levels and mobile phone penetration rates in China, i.e. the number of mobile subscribers divided by the population of China, are generally higher in the coastal and southern provinces, and we generate a substantial portion of our revenues from those areas. In particular, we derived 8% and 4% of our 2G services revenues for the first nine months of 2004 from China Unicom users in Zhejiang and Guangdong Provinces, respectively, and between 5% to 8% of our revenues in each of Jiangsu, Shaanxi and Sichuan Provinces. There are numerous, often highly subjective bases on which the mobile operators have the right to terminate our 2G and 2.5G service contracts with them. Moreover, all sales of our VASPro software have been to the China Unicom national office in Beijing and its provincial offices in nine coastal and southern provinces. If these 2G or 2.5G services or software license contracts are terminated or adversely altered or there is a general economic downturn in those areas, our revenue could be substantially reduced, which would adversely affect our overall financial condition.

 

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We depend on key personnel for the success of our business. Our business may be severely disrupted if we lose the services of our key executives and employees or fail to add new senior and middle managers to our management.

 

Our future success is heavily dependent upon the continued service of our key executives, particularly the team which conducted the management buy-in of our company in June 2001, namely, Qindai Wang, our president and chief executive officer, Jesse Liu, our senior vice president and chief financial officer, Ping Ji, our senior vice president in charge of software products, Fan Yang, our senior vice president in charge of content products, Jieqiang Li, our senior vice president in charge of content sales and operations, Haoyu Yang, our senior vice president in charge of research and development, and Shijie Wu, our chief technology officer in charge of software products. Our future success is also dependent upon our ability to attract and retain qualified senior and middle managers to our management team. If one or more of our current or future key executives or employees are unable or unwilling to continue in their present positions, we may not be able to easily replace them, and our business may be severely disrupted. In addition, if any of these key executives or employees joins a competitor or forms a competing company, we could lose customers and suppliers and incur additional expenses to recruit and train personnel. Each of our executive officers has entered into an employment agreement and a confidentiality, non-competition and non-solicitation agreement with us. As we believe is customary in our industry in China, we do not maintain key-man life insurance for any of our key executives.

 

We also rely on a number of key technology staff for the development and operations of our various businesses. Given the competitive nature of our industry, the risk of key technology staff departing our company is high and any such departure could disrupt our operations.

 

We have incurred net losses for a significant portion of our history which could occur again, thereby potentially causing the market price of our ADSs to decline.

 

We incurred significant net losses in 1999 through 2002 and the first quarter of 2003. We could incur significant net losses in the future due to unfavorable changes in the market, operating environment and competitive dynamics and our inability to respond to those changes. If we do not sustain profitability, the market price of our ADSs may decline.

 

Rapid growth and a rapidly changing operating environment strain our limited resources. Our future growth could be adversely affected if we cannot manage our expansion effectively.

 

We have limited operational, administrative and financial resources, which may be inadequate to sustain the growth we want to achieve. If the user base of our 2G and 2.5G services increases, we will need to increase our investment in our technology infrastructure, facilities and other areas of operations, in particular our product development, customer service and sales and marketing, which are important to our future success. If we are unable to manage our growth and expansion effectively, the quality of our services and our customer support could deteriorate and our business may suffer. For example, any such performance issue could prompt China Unicom, China Mobile or both to cease offering our services over their networks. Our future success will depend on, among other things, our ability to:

 

    develop and quickly introduce new 2G and 2.5G services, adapt our existing services and maintain and improve the quality of all of our services, particularly as the market for 2.5G services evolves and matures,

 

    effectively maintain our relationship with China Unicom, enhance our relationship with China Mobile and establish new relationships with any other recipients of mobile licenses in China so that we are able to offer 2G and 2.5G services over their networks and induce them to purchase our VASPro software,

 

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    continue training, motivating and retaining our existing employees and attract and integrate new employees, including our senior management,

 

    develop and improve our operational, financial, accounting and other internal systems and controls, and

 

    maintain adequate controls and procedures to ensure that our periodic public disclosure under applicable laws, including U.S. securities laws, is complete and accurate.

 

Any failures of the mobile telecommunications network, the Internet or our technology platform may reduce use of our services and our revenues.

 

Our wireless value-added services are offered only through the networks of China Unicom and China Mobile. In addition, we use our website to promote our services and enable users to order them. Thus, both the continual accessibility of China Unicom’s and China Mobile’s mobile networks and the performance and reliability of China’s Internet infrastructure are critical to our ability to attract and retain users. Moreover, our business depends on our ability to maintain the satisfactory performance, reliability and availability of our technology platform and the VASPro software we license. Any server interruptions, break-downs or system failures, including failures caused by computer viruses, hacking or sustained power shutdowns, floods or fire causing loss or corruption of data or malfunctions of software or hardware equipment, or other events outside our control that could result in a sustained shutdown of all or a material portion of the mobile networks, the Internet or our technology platform, could adversely impact our ability to provide our services to users and decrease our revenues.

 

Our corporate structure could be deemed to be in violation of current or future Chinese laws and regulations, which could adversely affect our ability to operate our business effectively or at all.

 

In connection with China’s entry into the World Trade Organization, or WTO, foreign investment in telecommunications and Internet services in China has been liberalized to allow for a maximum of 50% foreign ownership in value-added telecommunications and Internet services in China. To comply with these ownership requirements, we have implemented a structure which is similar to those used by several of our competitors such as SINA, Sohu, NetEase, Linktone and TOM Online by entering into various agreements with affiliated companies incorporated in China, Hurray! Solutions, Beijing Cool Young, WVAS Solutions, Beijing Network and Beijing Palmsky, and their shareholders. Hurray! Solutions is owned by our president and chief executive officer, Qindai Wang, and one of our shareholders, Songzuo Xiang. In turn, Hurray! Solutions has one subsidiary, Beijing Cool Young. We also have three other affiliated companies, Beijing Network, WVAS Solutions and Beijing Palmsky. Beijing Cool Young is 95% owned by Hurray! Solutions and 5% owned by our president and chief executive officer, Qindai Wang. Beijing Network is 50% and 50% owned by two individuals in China, Sun Hao and Wang Xiaoping, both of whom serve as vice presidents of Hurray! Solutions. WVAS Solutions is 99% owned by Beijing Network, with the remaining 1% equally owned by Messrs. Sun and Wang. Beijing Palmsky is 50% and 50% owned by two individuals in China, Wang Jianhua and Yang Haoyu, both of whom are our shareholders and vice presidents.

 

We do not have any direct ownership interest in our affiliated Chinese entities but have entered into a series of agreements with these entities through which we intend to be able to assert a degree of control and management. It is possible that the relevant Chinese authorities could, at any time, assert that any portion or all of our, Hurray! Times’ or our affiliated Chinese entities’ existing or future ownership structure and businesses, or our agreements with our affiliated Chinese entities, violate existing or future Chinese laws, regulations or policies. It is also possible that the new laws or regulations governing the telecommunication or Internet sectors in China that have been adopted or may be adopted in the future will prohibit or restrict foreign investment in, or other aspects of, any of our, Hurray! Times’ or our affiliated Chinese entities’ current or proposed businesses and operations. In addition, these new laws and regulations may be retroactively applied. If any of our company,

 

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Hurray! Times and our affiliated Chinese entities was found to be in violation of any existing or future Chinese laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violation, including, without limitation, the following:

 

    levying fines,

 

    confiscating the incomes of any of our company, Hurray! Times or our affiliated Chinese entities,

 

    revoking the business licenses of any of our company, Hurray! Times or our affiliated Chinese entities,

 

    shutting down servers or blocking websites maintained by any of our company, Hurray! Times or our affiliated Chinese entities,

 

    restricting or prohibiting our use of the proceeds from this global offering to finance our business and operations in China,

 

    requiring any of us, Hurray! Times or our affiliated Chinese entities to restructure our ownership structure or operations, and/or

 

    requiring any of us, Hurray! Times or our affiliated Chinese entities to discontinue any portion of or all of their wireless value-added services.

 

In any such case, we could be required to restructure our operations, which could adversely affect our ability to operate our business effectively or at all.

 

We may be required to pay amounts under our guarantees for bank credit facilities which have been extended to Hurray! Solutions and may be unable to recover any such amounts paid by us under these guarantees.

 

We have, through Hurray! Times, our wholly owned subsidiary, provided guarantees for Hurray! Solutions for the repayment of any loans it borrows from Hua Xia Bank between December 31, 2004 and December 31, 2005 in an amount up to RMB100.0 million ($12.0 million). As described in the following risk factor, we operate our business through agreements with Hurray! Solutions and our affiliated Chinese entities. As of December 31, 2004, Hurray! Solutions had outstanding loans of RMB22.0 million ($2.7 million) from Hua Xia Bank. If it defaults in the repayment of any borrowed amounts, we could be required to pay the lending bank pursuant to our guarantees. We expect that we will continue to be involved in and provide additional guarantees and financial support to Hurray! Solutions in the future to the extent allowed by the Sarbanes-Oxley Act of 2002 and any other applicable laws.

 

Our ability to ultimately collect payments made under these guarantees or any future guarantees, if any, will depend on the profitability of our affiliated Chinese entities and their operational needs, which are uncertain. If our affiliated Chinese entities fail to perform their obligations under these agreements, we may have to rely on legal remedies under Chinese law, which we cannot assure you would be effective or sufficient.

 

We depend upon agreements with our affiliated Chinese entities for the success of our business. These agreements may not be as effective in providing operational control as direct ownership of these businesses and may be difficult to enforce.

 

Because we conduct substantially all our business in China, and because we are restricted to a certain extent by the Chinese government from owning telecommunications or Internet operations in China, we depend on our affiliated Chinese entities, in which we have no direct ownership interest, to provide those services through agreements. These agreements may not be as effective in providing control over our telecommunications or Internet operations as direct ownership of these businesses. For example, our affiliated Chinese entities could fail

 

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to take actions required to operate our business, such as renewing their business licenses or services permits or entering into service contracts with China Unicom and China Mobile. Moreover, the fees for our services are paid by the mobile operators directly to our affiliated Chinese entities, which are then obligated at our request to transfer substantially all of such fees to our wholly owned subsidiary, Hurray! Times. If our affiliated Chinese entities fail to perform their obligations under these agreements, we may have to rely on legal remedies under Chinese law, which we cannot assure you would be effective or sufficient. In particular, the legal environment in China is not as developed as in other jurisdictions, such as the United States. Thus, Chinese courts are often inexperienced in handling corporate disputes, and different courts may apply laws and procedures in different ways.

 

In addition, there are substantial uncertainties regarding the interpretation and application of current and future Chinese laws and regulations, as discussed in this section under the heading “—Additional Risks Related to Our Company.” For example, each of Hurray! Solutions and Beijing Network has been granted an inter-provincial value-added telecommunication services license by the Ministry of Information Industry, but we cannot be certain whether any local or national value-added telecommunication services license requirements will conflict with one another or that any given license will be deemed sufficient by the relevant governmental authorities for the provision of our value-added telecommunications services. Accordingly, we cannot assure you that Chinese authorities will not ultimately take a view contrary to our own.

 

We do not believe that we have a reasonable basis to predict the likelihood of the occurrence of the foregoing risks. However, if there is such an occurrence, it could potentially have a significant adverse effect on our ability to operate our business and on our financial condition.

 

We generate our internal funds almost exclusively from Hurray! Times. If that company is restricted from paying dividends to us, we may lose almost all of our internal source of funds.

 

We are a holding company with no significant assets other than our equity interest in Hurray! Times. Our internal source of funds has been derived almost exclusively from dividend payments from that company after it receives payments from our affiliated Chinese entities. We are likely to lose all of our source of funds if Hurray! Times is restricted from paying dividends to us, except for interest we earn on our investments, which totaled $587 in 2003 and $24,662 in the first nine months of 2004. Under current Chinese tax regulations, dividends paid to us are not subject to Chinese income tax. However, Chinese legal restrictions permit payment of dividends only out of net income as determined in accordance with Chinese accounting standards and regulations, which in turn restricts our ability to receive these revenues.

 

The principal differences between net income under Chinese accounting standards and U.S. GAAP relate to pre-operating costs, stock-based compensation and deferred taxes. Pre-operating costs are expensed when incurred under U.S. GAAP, while they are amortized over five years under Chinese accounting standards. Stock-based compensation and deferred taxes are not recognized under Chinese accounting standards. Under Chinese law, Hurray! Times is also required to set aside a portion of its after-tax profit for which the legal minimum requirement is 10%, as determined by its boards of directors, to fund certain reserve funds beginning in its first profitable year after offsetting prior year’s cumulative losses. The amount of reserves was RMB1,623,732 ($196,340) as of September 30, 2004. These reserves are established for enterprise expansion, staff welfare and other general purposes under Chinese law and they are not distributable as cash dividends. If further restrictions on payments of dividends by our subsidiary are implemented under Chinese law, we may not be able to access our internal source of funds.

 

Our revenues may fluctuate significantly and may adversely affect the market price of our ADSs.

 

Our revenues and results of operations have varied in the past and may continue to fluctuate in the future. Many of the factors that cause such fluctuation are outside our control. Steady revenues and results of operations will depend largely on our ability to:

 

    attract and retain users in the increasingly competitive 2G and 2.5G services market in China,

 

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    capture a portion of the emerging market for 2.5G services, and when launched, of the market for 3G services,

 

    successfully implement our business strategies, and

 

    update and develop our services, technologies and content, including our VASPro software, which is highly complex.

 

Because the 2G and 2.5G services industry in China is new and rapidly evolving and our business is also relatively new and has experienced significant volatility in terms of financial results as a result of the factors stated above, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. It is possible that future fluctuations may cause our results of operations to be below the expectations of market analysts and investors. This could cause the market price of our ADSs to decline.

 

We may not be able to adequately protect our intellectual property, and we may be exposed to infringement claims by third parties.

 

We believe the copyrights, service marks, trademarks, trade secrets and other intellectual property we use are important components of our wireless value-added services. In addition, our software products are highly complex and involve proprietary software source code and know-how. Any unauthorized use of such intellectual property by third parties may adversely affect our current and future revenue from such services and software, as well as our reputation. We rely primarily on the intellectual property laws and contractual arrangements with our employees, clients, business partners and others to protect such intellectual property rights. Third parties may be able to obtain and use such intellectual property without authorization. Furthermore, the validity, enforceability and scope of protection of intellectual property in the Internet and wireless value-added related industries in China is uncertain and still evolving, and these laws may not protect intellectual property rights to the same extent as the laws of some other jurisdictions. In particular, the intellectual property law in China is less developed than in the United States and, historically, China has often not protected private parties’ intellectual property rights to the same extent as such parties might enjoy in the United States. Moreover, litigation may be necessary in the future to enforce our intellectual property rights, which could result in substantial costs and diversion of our resources, and have a material adverse effect on our business, overall financial condition and results of operations.

 

Due to the fact that we aggregate content and applications for our wireless value-added services, and because our services may be used for the distribution of information through, for example, our wireless community services, claims may be filed against us for defamation, negligence, copyright or trademark infringement or other violations. In addition, third parties could assert claims against us for losses in reliance on information distributed by us. For example, if we are found to have infringed any intellectual property rights of others, we may be enjoined from using such intellectual property, and we may incur licensing fees or be forced to develop alternative intellectual property. We may also incur significant costs in investigating and defending the claims, even if they do not result in liability. We have not purchased liability insurance for these risks.

 

We have limited business insurance coverage which could expose us to significant costs and business disruption.

 

The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products, and do not, to our knowledge, offer business liability insurance. As a result, we do not have any business liability insurance coverage for our operations. Moreover, while business disruption insurance is available, we have determined that the risks of disruption and cost of the insurance are such that we do not require it at this time. Any business disruption, litigation or natural disaster might result in substantial costs and diversion of resources, particularly if it affects our technology platform which we depend on for delivery of our wireless value-added services.

 

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We may be or become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors.

 

We may be classified as a passive foreign investment company by the United States Internal Revenue Service for U.S. federal income tax purposes. Such characterization could result in adverse U.S. tax consequences to you if you are a U.S. investor. For example, if we are a passive foreign investment company, our U.S. investors will become subject to increased tax liabilities under U.S. tax laws and regulations and will become subject to U.S. tax reporting requirements. The determination of whether or not we are a passive foreign investment company will be made on an annual basis and will depend on the composition of our income and assets, including goodwill, from time to time. Specifically, we will be classified as a passive foreign investment company for U.S. tax purposes if 50.0% or more of our assets, based on an annual quarterly average, are passive assets, or 75.0% or more of our annual gross income is derived from passive assets. We have determined that virtually all of our income for 2001, 2002 and 2003 was active income under the gross income test. However, as cash and cash equivalents (which the United States Internal Revenue Service has stated constitute passive assets for passive foreign investment company testing purposes) have comprised a significant percentage of our assets (based on U.S. GAAP) in the past and are likely to do so following completion of this offering, the determination whether we were a passive foreign investment company in prior years or will be a passive foreign investment company in the future will depend on the valuation of our intangible assets (including goodwill and going concern value) which are not reflected in our financial statements. We did not obtain an appraisal of our intangible assets for passive foreign investment company testing purposes for prior periods, but we believe that the value of these intangibles exceeds the amount of our cash and cash equivalents. Our judgment is not binding on the Internal Revenue Service. In the future, the valuation of our intangible assets will be based, in part, on the then market value of our ADSs, which is subject to change. In addition, the composition of our income and assets will be affected by how we spend the cash we raise in this offering. We cannot assure you that we will not be a passive foreign investment company for the current or any future taxable year. See “Taxation — United States Federal Income Taxation — U.S. Holders — Passive Foreign Investment Company.”

 

Anti-takeover provisions in our charter documents could make an acquisition of us, which may be beneficial to our shareholders, more difficult and may prevent attempts by our shareholders to replace or remove our current management.

 

Our amended and restated articles of association, which will become effective upon the closing of this offering, include two provisions which could make an acquisition of us more difficult and may prevent attempts by our shareholders to replace or remove our current management. First, our amended and restated articles of association provide for a classified board of directors. Second, our board of directors has the right to issue preference shares without shareholder approval, which could be used to institute a “poison pill” that would work to dilute a potential hostile acquirer’s ownership interest in our company, effectively preventing acquisitions that have not been approved by our board of directors.

 

Our executive officers will own 29.7% of our ordinary shares after completion of this offering, which will give them significant influence over our company.

 

Our executive officers will own 29.7% of our ordinary shares after completion of this offering. Accordingly, they will be able to exercise significant influence in determining the outcome of any corporate transaction or other matter submitted to the shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. They will also have significant influence in preventing or facilitating a change in control. In addition, without the consent of these shareholders, we could be prevented from entering into transactions that could be beneficial to us. The interests of these shareholders may differ from the interests of the other shareholders.

 

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Shareholder rights under Cayman Islands law may differ materially from shareholder rights in the United States, which could adversely affect the ability of us and our shareholders to protect our and their interests.

 

Our corporate affairs are governed by our amended and restated memorandum and articles of association, by the Companies Law (2004 Revision) and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders, and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law in the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, the decisions of whose courts are of persuasive authority but are not binding on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law in this area may not be as clearly established as they would be under statutes or judicial precedent in existence in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and some states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate laws. Moreover, our company could be involved in a corporate combination in which dissenting shareholders would have no rights comparable to appraisal rights which would otherwise ordinarily be available to dissenting shareholders of United States corporations. Also, our Cayman Islands counsel is not aware of any reported class action or derivative action having been brought in a Cayman Islands court. Such actions are ordinarily available in respect of United States corporations in U.S. courts. Finally, Cayman Islands companies may not have standing to initiate shareholder derivative action before the federal courts of the United States. As a result, our public shareholders may face different considerations in protecting their interests in actions against the management, directors or our controlling shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States, and our ability to protect our interests may be limited if we are harmed in a manner that would otherwise enable us to sue in a United States federal court. See “Description of Share Capital—Differences in Corporate Law.”

 

Risks Related to our Industry

 

The telecommunication laws and regulations in China are evolving and subject to interpretation and will likely change in the near future. If we are found to be in violation of current or future Chinese laws or regulations, we could be subject to severe penalties.

 

Although our 2G and 2.5G services are subject to general regulations regarding telecommunication services, specific laws at the national level governing wireless value-added services, such as our services related to SMS and WAP, have only been issued recently. The interpretation and application of newly issued Chinese laws and regulations and the possibility of new laws or regulations being adopted have created significant uncertainty regarding the legality of existing and future foreign investments in, and the businesses and activities of, Chinese companies providing 2G and 2.5G services, including our Chinese affiliated entities. Many providers of 2G and 2.5G services have obtained various value-added telecommunication services licenses.

 

Each of Hurray! Solutions and Beijing Network has been granted an inter-provincial value-added telecommunication license by the Ministry of Information Industry that permits it to conduct inter-provincial operations. Our affiliate, WVAS Solutions, has been granted a value-added telecommunication service license issued by the local Beijing Municipal Telecommunications Administration Bureau. This license may not be sufficient to authorize WVAS Solutions to provide value-added telecommunication services on an inter-provincial basis. We cannot be certain that any local or national value-added telecommunication license requirements will not conflict with one another or that any given license will be deemed sufficient by the relevant governmental authorities for the provision of this category of service, due to the lack of a comprehensive body of laws and regulations governing our 2G and 2.5G services. It is also possible that new national legislation might be adopted to regulate such services.

 

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If we or our subsidiary or affiliates are found to be in violation of any existing or future Chinese laws or regulations regarding our 2G and 2.5G services or Internet access which is discussed in the following risk factor, the relevant Chinese authorities have the power to, among other things:

 

    levy fines,

 

    confiscate our income or the income of our affiliates,

 

    revoke our business license or the business license of our affiliates,

 

    shut down our servers or the servers of our affiliates and/or blocking any Web or WAP sites that we operate, and

 

    require us to discontinue any portion or all of our 2G and 2.5G services business.

 

The regulation of Internet website operators is also new and subject to interpretation in China, and our business could be adversely affected if we are deemed to have violated applicable laws and regulations.

 

Our affiliate, Hurray! Solutions, and some of our other affiliated Chinese entities operate Internet websites in China, which are one of the channels through which our services are offered. The interpretation and application of existing Chinese laws and regulations, the stated positions of the main governing authority, the Ministry of Information Industry, and the possibility of new laws or regulations being adopted have created significant uncertainty regarding the legality of existing and future foreign investments in, and the businesses and activities of, Chinese companies with Internet operations, including ours. In particular, the Ministry of Information Industry has stated that the activities of Internet content providers are subject to regulation by various Chinese government authorities, depending on the specific activities conducted by the Internet content provider. We cannot be certain that the commercial Internet content provider license issued by the relevant government agencies overseeing the telecommunications industry or any value-added telecommunication license held by Hurray! Solutions or our other affiliated Chinese entities will satisfy these requirements. We have learned that the Ministry of Information Industry is in the process of preparing new laws and regulations that will govern these activities, which could be applicable to the services we offer. Our failure to comply with applicable Chinese Internet regulations could subject us to severe penalties as noted in the prior risk factor.

 

Risks Related to Doing Business in China

 

A slowdown in the Chinese economy may slow down our growth and profitability.

 

The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any slowdown will not have a negative effect on our business. Several years ago, the Chinese economy experienced deflation, which may recur in the foreseeable future. More recently, the Chinese government announced its intention to use macroeconomic tools and regulations to slow the rate of growth of the Chinese economy, the results of which are difficult to predict. The Chinese economy overall affects our profitability as expenditures for wireless value-added services may decrease due to slowing domestic demand. More specifically, increased penetration of wireless value-added services in the less economically developed central and western provinces of China will depend on their achieving certain income levels so that mobile handsets and related services become affordable to a significant portion of the population.

 

The Chinese legal system embodies uncertainties which could limit the legal protections available to you and could also adversely affect our ability to operate our business.

 

The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. Although legislation in China over the past 20

 

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years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you. In addition, the Chinese government may enact new laws or amend current laws that may be detrimental to our current contractual arrangements with our Chinese affiliates, which may in turn have a material adverse effect on our ability to operate our business.

 

Any recurrence of severe acute respiratory syndrome, or SARS, pandemic avian influenza or another widespread public health problem, could adversely affect our business and results of operations.

 

A renewed outbreak of SARS, pandemic avian influenza or another widespread public health problem in China, where all of our revenues are derived, and in Beijing, where our operations are headquartered, could have a negative effect on our operations. Our operations may be affected by a number of health-related factors, including the following:

 

    quarantines or closures of some of our offices which would severely disrupt our operations,

 

    the sickness or death of our key officers and employees, and

 

    a general slowdown in the Chinese economy.

 

Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations.

 

Changes in China’s political and economic policies could harm our business.

 

The economy of China has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the Chinese government have had a positive effect on the economic development of China, we cannot predict the future direction of these economic reforms or the effects these measures may have on our business, financial position or results of operations. In addition, the Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD. These differences include:

 

    economic structure,

 

    level of government involvement in the economy,

 

    level of development,

 

    level of capital reinvestment,

 

    control of foreign exchange,

 

    methods of allocating resources, and

 

    balance of payments position.

 

As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries.

 

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Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

 

Because almost all of our future revenues may be in the form of Renminbi, any future restrictions on currency exchanges may limit our ability to use revenues generated in Renminbi to fund our business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi, especially with respect to foreign exchange transactions.

 

The value of our ordinary shares and ADSs will be affected by the foreign exchange rate between U.S. dollars and Renminbi.

 

The value of our ordinary shares and ADSs will be affected by the foreign exchange rate between U.S. dollars and Renminbi. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position and the price of our ordinary shares and ADSs may be adversely affected. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our ordinary shares or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiary in China would be reduced.

 

Risks Related to this Offering

 

If an active trading market for our ADSs does not develop, the market price of our ADSs may suffer and may decline below the initial offering price.

 

Prior to this offering, there has been no public market for our ordinary shares or ADSs. The initial price to the public for our ADSs will be determined by negotiations between us and our underwriters and may not be indicative of the price at which ADSs will trade following the completion of this offering. We cannot assure you that an active trading market will develop or be sustained following the completion of this offering, or that the market price of our ADSs will not decline below the initial offering price.

 

The sale by our existing shareholders of a substantial number of our ADSs in the public market could adversely affect the market price of our ADSs.

 

Immediately after the completion of this offering, we will have 2,187,595,840 ordinary shares outstanding, including ordinary shares represented by ADSs sold in this offering (assuming the over-allotment option is not exercised). Our ADSs sold in this offering (other than those held by our affiliates) will be eligible for immediate resale in the public market without restrictions and 1,499,595,840 ordinary shares held by our existing shareholders and any ADSs held by our affiliates may also be sold in the public market in the future pursuant to, and subject to the restrictions contained in, Rule 144 under the U.S. Securities Act of 1933, as amended, or the Securities Act, and applicable lock-up agreements. All of our ordinary shares outstanding immediately after this offering, except for ordinary shares evidenced by ADSs sold in this offering and ordinary shares held by our officers and directors, will be subject to a lock-up agreement. Once that lock-up agreement expires, such ordinary shares will become tradeable subject to the requirements of applicable securities laws. If any existing shareholder or shareholders sell a substantial amount of ADSs, the prevailing market price for our ADSs could be adversely affected.

 

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You will experience immediate and substantial dilution in the book value of the ADSs that you purchase because the initial public offering price per ADS is higher than the value of our net assets per ADS.

 

You will experience an immediate dilution of $7.28 per ADS when you purchase ADSs from this offering at an assumed initial public offering price of $10.60. This dilution results from the fact that the initial public offering price per ADS substantially exceeds the per ADS value of our assets, less our liabilities (i.e., our net tangible book value per ADS). Thus, purchasers of our ADSs in this offering will be contributing approximately 128% of our total assets as of September 30, 2004, but will only own approximately 31.5% of our outstanding share capital immediately after completion of this offering.

 

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

 

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. We cannot offer you those rights unless the securities to which the rights relate are either registered under the Securities Act or exempt from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings. The depositary may allow rights that are not distributed or sold to lapse. In that case, you will receive no value for them.

 

The market price for our ADSs may be volatile, which could result in substantial losses to investors.

 

The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to factors including the following:

 

    actual or anticipated fluctuations in our quarterly operating results,

 

    announcements of new services by us or our competitors,

 

    changes in financial estimates by securities analysts,

 

    conditions in the 2G and 2.5G services market,

 

    changes in the economic performance or market valuations of other companies involved in 2G and 2.5G services,

 

    announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments,

 

    additions or departures of key personnel, or

 

    potential litigation.

 

In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

 

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Your ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, will be limited because we are incorporated in the Cayman Islands, because we conduct all of our operations in China and because the majority of our directors and officers reside outside of the U.S.

 

We are a company incorporated under the laws of the Cayman Islands, and substantially all of our assets and all our subsidiaries and affiliates are located outside the United States. In addition, most of our directors and officers and their assets are located outside the United States. As a result, it may not be possible to effect service of process within the United States upon our directors or officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws.

 

Our Chinese legal counsel, Jingtian & Gongcheng, has advised us that China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States, the United Kingdom or most other western countries. As a result, recognition and enforcement in China of judgments of a court obtained in those jurisdictions in relation to any matter not subject to a binding arbitration provision may be difficult or impossible. See “Enforceability of Civil Liabilities.”

 

We have been advised by Conyers Dill & Pearman, Cayman, our Cayman Islands legal advisers, that the courts of the Cayman Islands are unlikely:

 

    to recognize or enforce against us judgments of courts of the United States based on certain civil liability provisions of the securities laws of the United States or any State thereof, and

 

    in original actions brought in the Cayman Islands, to impose liabilities against us based on certain of the civil liability provisions of the securities laws of the United States or any State thereof, if and to the extent that such provisions are penal in nature.

 

However, in the case of laws that are not penal in nature, although there is no statutory enforcement in the Cayman Islands of judgments obtained in the United States, the courts of the Cayman Islands will generally give a judgment based upon a judgment of a foreign court of competent jurisdiction under which a sum of money is payable without retrial on the merits provided that:

 

    such courts had proper jurisdiction over the parties subject to such judgment;

 

    such courts did not contravene the rules of natural justice of the Cayman Islands;

 

    such judgment was not obtained by fraud;

 

    the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands;

 

    no new admissible evidence relevant to the action is submitted prior to the rendering of the judgment by the courts of the Cayman Islands; and

 

    there is due compliance with the correct procedures under the laws of the Cayman Islands. Cayman Islands court may stay proceedings if concurrent proceedings are being brought elsewhere.

 

We have not determined any specific use for a significant portion of the proceeds from this offering and we may use the proceeds in ways with which you may not agree.

 

We have not allocated the net proceeds of this offering to any specific use. Rather, our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately.

 

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You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to achieve profitability or increase our stock price. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.

 

You may not be able to exercise your right to vote.

 

As a holder of our ADSs, you may instruct the depositary of our ADSs to vote the ordinary shares underlying your ADSs but only if we ask the depositary to ask for your instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw our ordinary shares underlying the ADSs you hold. However, you may not know about the meeting enough in advance to withdraw those ordinary shares. If we ask for your instructions, the depositary will notify you of the upcoming vote and arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your ordinary shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. This means that you may not be able to exercise your right to vote, and there may be nothing you can do if the ordinary shares underlying your ADSs are not voted as you requested.

 

The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

 

Under the deposit agreement for the ADSs, the depositary will give us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings if you do not vote, unless:

 

    we notify the depositary that:

 

    we do not wish to receive a discretionary proxy;

 

    we think there is substantial shareholder opposition to the particular question;

 

    the depositary has knowledge of any solicitation of proxies in opposition to any recommendation by our company as to an action to be taken at the meeting; or

 

    the proposal relates to a merger or consolidation or other matter which may affect substantially the rights of shareholders.

 

The effect of this discretionary proxy is that you cannot prevent our ordinary shares underlying your ADSs from being voted, absent the situations described above, and it may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

 

You may not receive distributions on our ordinary shares or any value for them if it is illegal or impractical to make them available to you.

 

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian for our ADSs receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of our ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. We have no obligation to take any other action to permit the distribution of our ADSs, ordinary shares, rights or anything else to holders of our ADSs. This means that you

 

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may not receive the distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may have a material adverse effect on the value of your ADSs.

 

You may be subject to limitations on transfer of your ADSs.

 

Your ADSs represented by American Depositary Receipts are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

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FORWARD-LOOKING STATEMENTS

 

Many statements made in this prospectus under the captions “Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere are forward-looking statements that reflect our current expectations and views of future events. You can identify these forward-looking statements by terminology such as “will,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar statements. The accuracy of these statements may be affected by a number of business risks and uncertainties that could cause actual results to differ materially from those projected or anticipated, including those related to:

 

    the risk that our various contractual relationships with China Unicom or China Mobile will terminate or be altered in a way that adversely affects our business;

 

    changes in the mobile operators’ policies or the way in which such policies are enforced;

 

    our reliance on our agreements with our affiliated Chinese entities;

 

    intensifying competition in the market in which we operate;

 

    the risk that the current popularity in China of 2G and 2.5G services that we offer, including ringtone and picture downloads, chat services, wireless games and other 2G and 2.5G services, will not continue for whatever reason, including SMS and WAP being superseded by other technologies for which we are unable to offer attractive services;

 

    the risk that the recent and projected growth in the usage of 2G and 2.5G services, in particular 2.5G services, will slow or cease, or that such usage will decrease for whatever reason;

 

    the risk that we may not be able to continuously develop new and creative 2G and 2.5G services;

 

    the risk that China Unicom will stop using our VASPro software or that we will not be able to sell such software to other mobile operators;

 

    the risk that we will not be able to control our expenses in future periods;

 

    the risk that we will not be able to develop and implement additional operational and financial systems to manage our operations as they expand;

 

    governmental uncertainties; and

 

    uncertainty as to future profitability and the risk that security, reliability, cost and quality of service concerns may impede broad use of 2G and 2.5G services.

 

We do not undertake any obligation to update this forward-looking information, except as required under applicable law.

 

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OUR CORPORATE STRUCTURE

 

We became an independent company in September 1999 when we were spun-off from UT Starcom, a Nasdaq-listed company that manufactures telecommunication equipment in China. In June 2001, our current management team conducted a management buy-in by purchasing a substantial equity interest in our company.

 

We currently conduct our business in China through our wholly owned subsidiary, Hurray! Times. To comply with ownership requirements under Chinese law which impose certain restrictions on foreign companies from investing in certain industries such as value-added telecommunication and Internet services, we have entered into a series of agreements with five affiliated Chinese entities, Hurray! Solutions, Beijing Cool Young, WVAS Solutions, Beijing Network and Beijing Palmsky, and their respective shareholders. We hold no ownership interest in our affiliated Chinese entities. Hurray! Solutions is 85% and 15% owned by our president and chief executive officer, Qindai Wang, and one of our shareholders, Songzuo Xiang, respectively. In turn, Hurray! Solutions has one subsidiary, Beijing Cool Young. We also have three other affiliated companies, Beijing Network, WVAS Solutions and Beijing Palmsky. Beijing Cool Young is 95% owned by Hurray! Solutions and 5% owned by our president and chief executive officer, Qindai Wang. Beijing Network is 50% and 50% owned by two individuals in China, Sun Hao and Wang Xiaoping, both of whom serve as vice presidents of Hurray! Solutions. WVAS Solutions is 99% owned by Beijing Network, with the remaining 1% equally owned by Messrs. Sun and Wang. Beijing Palmsky is 50% and 50% owned by two individuals in China, Wang Jianhua and Yang Haoyu, both of whom are our shareholders and vice presidents.

 

In June 2004, we acquired Beijing Enterprise, which offers 2.5G services through China Mobile. We have entered into agreements with Beijing Network similar to the ones we have entered into with our other affiliated Chinese entities as described above. See “Our Recent Acquisition of Beijing Enterprise.”

 

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The following diagram shows the group structure of our subsidiaries and affiliated companies:

 

LOGO


(1)   Mr. Qindai Wang owns the remaining 1% equity interest.
(2)   Each of Mr. Qindai Wang and Mr. Songzuo Xiang owns 85% and 15% of Hurray! Solutions’ equity interest, respectively.
(3)   Mr. Qindai Wang owns the remaining 5% of the equity interest in Beijing Cool Young.
(4)   Beijing Network was previously 95% and 5% owned by Hurray! Solutions and Mr. Qindai Wang, respectively. To be eligible to receive an inter-provincial value-added telecommunication services license, in July 2004, we conducted a restructuring of the shareholdings of Beijing Network, under which Hurray! Solutions and Mr. Qindai Wang transferred their collective shareholdings to individuals in China, Mr. Sun Hao and Mr. Wang Xiaoping, each of whom owned 50% of Beijing Network after the restructuring.
(5)   WVAS Solutions was previously 95% and 5% owned by Hurray! Solutions and Mr. Qindai Wang, respectively. In October 2004, we conducted a restructuring of the shareholdings of WVAS Solutions, under which Hurray! Solutions and Mr. Qindai Wang transferred 99% of their collective shareholdings to Beijing Network and 0.5% and 0.5% to each of Mr. Sun Hao and Mr. Wang Xiaoping. Both Messrs. Sun and Wang currently serve as vice presidents of Hurray! Solutions.
(6)   Beijing Palmsky was previously 99% and 1% owned by Hurray! Solutions and Mr. Qindai Wang, respectively. In October 2004, we conducted a restructuring of the shareholdings of Beijing Palmsky, under which Hurray! Solutions and Mr. Qindai Wang transferred their collective shareholdings to Mr. Wang Jianhua and Mr. Yang Haoyu, each of whom owned 50% of Beijing Palmsky after the restructuring. Both Messrs. Wang and Yang are currently our shareholders and also serve as vice presidents of our company.
(7)   We do not have any ownership interest in Hurray! Solutions, WVAS Solutions, Beijing Cool Young, Beijing Network, and Beijing Palmsky. We have entered into a series of agreements with these entities and their respective shareholders through Hurray! Times.
(8)   We have agreements granting us the exclusive right to purchase the equity interests in each of Hurray! Solutions, WVAS Solutions, Beijing Cool Young, Beijing Network and Beijing Palmsky from their respective shareholders.

 

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The principal terms of the agreements with our Chinese affiliates are described below.

 

Powers of Attorney.    Except for Qindai Wang, each of the shareholders of our affiliated Chinese entities has irrevocably designated Qindai Wang, in his capacity as General Manager of Hurray! Times, as attorney-in-fact, to vote on their behalf at shareholders meetings on matters on which they are entitled to vote with respect to Hurray! Solutions, Beijing Cool Young, WVAS Solutions, Beijing Network and Beijing Palmsky, as the case may be, including matters relating to the transfer of any or all of their respective equity interests in our affiliated Chinese entities and the appointment of the directors of our affiliated Chinese entities. The term of each of the powers of attorney is ten years. These powers of attorney do not extend to votes by the shareholders of our company or subsidiaries.

 

Each such power of attorney by its terms is valid only for so long as the designated attorney-in-fact remains the general manager of Hurray! Times. If the attorney-in-fact ceases to be the general manager, the power of attorney will terminate automatically and the succeeding general manager shall be designated.

 

Operating Agreements.    Through Hurray! Times, we may provide guarantees to our affiliated Chinese entities of their contracts, agreements or transactions with third parties, to the extent permitted under Chinese law. In return, our affiliated Chinese entities have granted us a security interest over all of their assets, including all of their accounts receivable, which have not previously been encumbered by security interests. We also have the right of first refusal with respect to future loan guarantees. In addition, our affiliated Chinese entities and their shareholders have each agreed that they will not enter into any transaction, or fail to take any action, that would substantially affect their assets, rights and obligations, or business without our prior written consent. They will also appoint persons designated by Hurray! Times as the directors, officers and other senior management personnel of our affiliated Chinese entities, as well as accept the guidance of Hurray! Times regarding their day-to-day operations, financial management and the hiring and dismissal of their employees. While Hurray! Times has the right to terminate all of its agreements with our affiliated Chinese entities if any of our agreements with them expires or is terminated, our affiliated Chinese entities may not terminate the operating agreements during the term of the agreements, which is ten years.

 

Exclusive Technical Consulting and Services Agreements.    Through Hurray! Times, we provide our affiliated Chinese entities with exclusive technical support and related consulting and information services. We are the exclusive provider of these services. The initial term of these agreements is ten years. The service fees are subject to adjustment from time to time based on the services provided to our affiliated Chinese entities, up to amounts equaling all of these entities’ revenues.

 

Trademark, Domain Name and Software Transfer Agreements.    Hurray! Solutions has entered into agreements to transfer to Hurray! Times its ownership rights in its domain names, some of which Hurray! Times has licensed back for Hurray! Solutions’ use in its operations on a non-exclusive basis. Each of WVAS Solutions, Beijing Cool Young, Beijing Palmsky and Beijing Network has entered into agreements to transfer to Hurray! Times its ownership rights in its domain names and Hurray! Times has licensed back to each of them their respective domain names for use in their operations on a non-exclusive basis. Hurray! Solutions has transferred to Hurray! Times its ownership rights in its registered trademark of our corporate logo, which Hurray! Times has licensed back for Hurray! Solutions’ use in its operations on a non-exclusive basis. Beijing Palmsky also has entered into agreements to transfer to Hurray! Times its ownership rights in its games software, which Hurray! Times has licensed back for Beijing Palmsky’s use in its operations on a non-exclusive basis.

 

Trademark, Domain Name and Software License Agreements.    Hurray! Times has granted to each of Hurray! Solutions, Beijing Cool Young, WVAS Solutions, Beijing Palmsky and Beijing Network a license to use certain of its domain names. Hurray! Times has also granted Hurray! Solutions a license to use its registered trademark of our corporate logo. The licensee of each of the licenses described above pays us a nominal annual license fee. In addition, Hurray! Times has granted Beijing Palmsky a license to use several games software for a nominal annual license fee. Each of these license agreements will terminate upon the earlier of ten years or the

 

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expiration of Hurray! Times’ right to use the relevant domain names and trademarks. Our affiliated Chinese entities cannot assign or transfer their rights under the licenses to any third party, and cannot promote or advertise the licensed trademarks in television, newspapers, magazines, the Internet or other public media without our prior written consent.

 

Contracts Relating to the Exclusive Purchase Right of Equity Interest.    Under the Contracts Relating to the Exclusive Purchase Right of Equity Interest among us, our affiliated Chinese entities and each of their shareholders, we or our designee has an exclusive option to purchase from each of their shareholders all or part of each such shareholder’s equity interest in our affiliated Chinese entities at book value, to the extent permitted by Chinese law. The term of these agreements is 10 years, renewable by us for an additional 10-year term at our sole discretion.

 

Equity Interests Pledge Agreements.    Each of the shareholders of our affiliated Chinese entities pledged their respective equity interests in such entities to guarantee the payment of the service fee by our affiliated Chinese entities under the Exclusive Technical Consulting and Services Agreements described above. If any of our affiliated Chinese entities breach any of their obligations under the Equity Interests Pledge Agreements, Hurray! Times is entitled to sell the equity interests held by such shareholders and retain the proceeds of such sale or require any of them to transfer to us their equity interest in the applicable affiliated entity.

 

We believe that the terms of these agreements are no less favorable to us than we could obtain from disinterested parties. The material terms of the agreements among us, our respective affiliated Chinese entities and their shareholders are substantially identical except for the amount of license fees paid by each entity. We believe that the individual shareholders of each entity will not receive any personal benefits from these agreements, except as shareholders of our company. As a result of the foregoing contractual arrangements, we effectively have financial control over our affiliated Chinese entities through our security interests over their assets, our ability to receive up to all of their revenue and our other rights described above. In turn, the general manager of Hurray! Times (currently Qindai Wang), who, as a matter of Chinese laws, is subject to the direction of Hurray! Times’ board of directors, maintains control over all voting matters involving our affiliated Chinese entities. According to our Chinese counsel, Jingtian & Gongcheng, these agreements are valid, binding and enforceable under the current Chinese laws and regulations. However, these agreements may not be as effective in providing control over our operations as direct ownership of these businesses. See “Risk Factors — Additional Risks Related to Our Company — Our corporate structure could be deemed to be in violation of current or future Chinese laws and regulations, which could adversely affect our ability to operate our business effectively or at all” and “Risk Factors — Additional Risks Related to Our Company — We depend upon agreements with our affiliated Chinese entities for the success of our business. These agreements may not be as effective in providing operational control as direct ownership of these businesses and may be difficult to enforce.”

 

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USE OF PROCEEDS

 

We expect to receive net proceeds of approximately $62.6 million from this offering, after deducting the estimated underwriting discount and offering expenses payable by us. If the underwriters’ over-allotment option is exercised in full, the net proceeds we will receive will be approximately $69.9 million. We will not receive any of the proceeds from the sale of the ADSs by the selling shareholders.

 

We intend to use the net proceeds of this offering as follows, though the allocation of the use of proceeds may change along with evolving business conditions and other management considerations:

 

    up to 50% for potential acquisitions in businesses that we believe are complementary to our existing business, although no acquisitions are pending;

 

    up to 5% for repayment of our outstanding short-term loans;

 

    up to 10% for our capital expenditures for acquisition or licensing of key Internet and wireless data application technologies and adding supporting server software and hardware systems;

 

    up to 10% for product development; and

 

    any remaining balance for general corporate purposes.

 

Pending use of the net proceeds, we intend to invest our net proceeds in short-term, interest-bearing, investment-grade obligations. These investments may have a material adverse effect on the U.S. federal income tax consequences of an investment in our ADSs. It is possible that we may become a passive foreign investment company for United States federal income taxpayers, which could result in negative tax consequences for you. These consequences are described in more detail in “Risk Factors — Additional Risks Related to Our Company — We may be or become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors” and “Taxation — United States Federal Income Taxation — U.S. Holders — Passive Foreign Investment Company.”

 

DIVIDEND POLICY

 

We have never declared or paid any dividends on our ordinary shares. We do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and for the expansion of our business. Payments of dividends by our subsidiaries in China to our company are subject to restrictions including primarily the restriction that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. There are no such similar foreign exchange restrictions in the Cayman Islands.

 

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CAPITALIZATION

 

The following table shows our capitalization as of September 30, 2004:

 

    on an actual basis (as adjusted to give effect to the 20-for-1 stock split of our ordinary shares which became effective on July 9, 2004);

 

    on a pro forma basis assuming the conversion of our outstanding Series A convertible preference shares into ordinary shares at the closing of this offering; and

 

    on a pro forma as adjusted basis to reflect our sale of 6,624,339 ADSs in this offering at an assumed offering price of $9.48, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

Please read this information together with:

 

    the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and

 

    the consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of September 30, 2004

 
     Actual

    Pro forma

   

Pro forma

as adjusted


 

Shareholders’ equity:

                        

Series A convertible preference shares ($0.001 par value); 22,000,000 shares authorized; 16,924,497 shares issued and outstanding (actual); and no shares issued and outstanding (pro forma and pro forma as adjusted)

   $ 16,925     $     $  

Ordinary shares ($0.00005 par value); 4,560,000,000 shares authorized; 1,229,360,780 shares issued and outstanding (actual); 1,567,850,720 shares issued and outstanding (pro forma) and 2,230,284,620 shares issued and outstanding (pro forma as adjusted)(1)

     61,468       78,393       111,514  

Ordinary shares subject to repurchase

     (6,000,000 )     (6,000,000 )     (6,000,000 )

Subscription receivable

     (50,880 )     (50,880 )     (50,880 )

Additional paid-in capital

     22,414,063       22,414,063       84,964,495  

Retained earnings (accumulated deficiency)

     16,023,891       16,023,891       16,023,891  

Accumulated other comprehensive loss

     (1,108 )     (1,108 )     (1,108 )
    


 


 


Total shareholders’ equity

     32,464,359       32,464,359       95,047,912  
    


 


 


Total capitalization

   $ 32,464,359     $ 32,464,359     $ 95,047,912  
    


 


 



(1)   The number of our ordinary shares outstanding as of September 30, 2004 does not include: 153,119,720 ordinary shares subject to options outstanding as of September 30, 2004, at a weighted average exercise price of $0.076 per ordinary share.

 

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EXCHANGE RATE INFORMATION

 

We present our historical consolidated financial statements in U.S. dollars. In addition, certain pricing information is presented in U.S. dollars and certain contractual amounts that are in Renminbi include a U.S. dollar equivalent solely for the convenience of the reader. Except as otherwise specified, this pricing information and these contractual amounts are translated at RMB8.2766 = US$1.00, the prevailing rate on September 30, 2004. The translations are not a representation that the Renminbi amounts could actually be converted to U.S. dollars at this rate. For a discussion of the exchange rates used for the presentation of our financial statements, see note 3(k) to our audited historical consolidated financial statements.

 

The People’s Bank of China sets and publishes daily a base exchange rate with reference primarily to the supply and demand of Renminbi against the U.S. dollar in the market during the prior day. The People’s Bank of China also takes into account other factors such as the general conditions existing in the international foreign exchange markets. Although Chinese governmental policies were introduced in 1996 to reduce restrictions on the convertibility of Renminbi into foreign currency for current account items, conversion of Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or security, requires the approval of the State Administration for Foreign Exchange and other relevant authorities.

 

The noon buying rate in New York City for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York was RMB8.2765 = US$1.00 on January 10, 2005. The following table sets forth, for the period indicated, information concerning the number of Renminbi for which one U.S. dollar could be exchanged based on the noon buying rate for cable transfers in Renminbi as certified for customs purposes by the Federal Reserve Bank of New York.

 

     Noon Buying Rate

     RMB per US$1.00

     High

   Low

July 2004

   8.2769    8.2766

August 2004

   8.2770    8.2766

September 2004

   8.2768    8.2766

October 2004

   8.2768    8.2765

November 2004

   8.2765    8.2764

December 2004

   8.2767    8.2765

 

The following table sets forth the average noon buying rates between Renminbi and U.S. dollars for each of 2000, 2001, 2002, 2003 and 2004, calculated by averaging the noon buying rates on the last day of each month during the relevant year.

 

     Average Noon Buying Rate

     RMB per US$1.00

2000

   8.2784

2001

   8.2772

2002

   8.2772

2003

   8.2771

2004

   8.2768

 

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DILUTION

 

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and the pro forma net tangible book value per ADS after the offering. Dilution results from the fact that the per ordinary share offering price of our ADSs is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares. Our net tangible book value attributable to ordinary shareholders at September 30, 2004 was $11.4 million, or $0.01 per ordinary share and $1.00 per ADS. Net tangible book value per ordinary share as of September 30, 2004 represents the amount of total tangible assets less goodwill, acquired intangible assets net, and total liabilities, divided by the number of ordinary shares outstanding. Our pro forma net tangible book value at September 30, 2004 was $11.4 million, or $0.01 per ordinary share and $0.73 per ADS. Pro forma net tangible book value per ordinary share represents the amount of total tangible assets less goodwill, acquired intangible assets, net and total liabilities, divided by the number of ordinary shares outstanding after giving effect to the automatic conversion of all outstanding shares of our Series A preference shares into our ordinary shares.

 

After giving effect to our sale of 6,624,339 ADSs in this offering at the initial public offering price of $10.60 per ADS (the mid-point of the range set forth on the cover page of this prospectus) and after deducting the underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value as of September 30, 2004 would have been $74.0 million, or $0.03 per share and $3.32 per ADS. This represents an immediate increase in pro forma net tangible book value of $0.03 per ordinary share, or $2.59 per ADS, to existing shareholders and an immediate dilution of $0.07 per ordinary share, or $7.38 per ADS, to investors purchasing ADSs in this offering. The following table illustrates this per share dilution:

 

Assumed initial public offering price per ADS before deducting underwriter discounts and commissions and other estimated expenses of the offering

   $ 10.60

Net tangible book value per ADS at September 30, 2004

     1.00

Pro forma net tangible book value per ADS at September 30, 2004

     0.73

Increase in pro forma net tangible book value per ADS attributable to this offering

     2.59

Pro forma net tangible book value per ADS after this offering

     3.32
    

Dilution per ADS to new investors

   $ 7.38
    

Dilution per ordinary shares to new investors

   $ 0.07
    

 

The following table summarizes, on a pro forma basis as of September 30, 2004, the differences between existing shareholders and the new investors with respect to the number of ordinary shares purchased from us, the total consideration paid and the average price per share paid before deducting the underwriting discounts and commissions and our estimated offering expenses.

 

     ADSs purchased

    Total consideration

   

Average
price

per ADS


  

Average
price

per share


     Number

   Percent

    Amount

   Percent

      
     (in thousands of U.S. dollars, except percentages)

Existing holders of capital stock

   15,678,507    70 %   $ 12,548,601    15 %   $ 0.80    $ 0.008

Investors purchasing ADSs in this offering from our company

   6,624,339    30 %     62,583,553    85 %   $ 9.45    $ 0.09
    
  

 

  

            

Total

   22,302,846    100.0 %   $ 75,132,154    100.0 %             
    
  

 

  

            

 

The discussion and tables above assume no exercise of stock options outstanding as of September 30, 2004. As of the consummation of this offering, we expect to have options outstanding to purchase a total of

 

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170,374,220 ordinary shares, including options to purchase a total of 99,044,640 ordinary shares which are exercisable as of the consummation of this offering, with a weighted average exercise price of $0.06 per share. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

If the underwriters’ over-allotment option is exercised in full, investors purchasing ADSs in this offering from our company will hold 35.0% of the total number of our ordinary shares outstanding after this offering.

 

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SELECTED HISTORICAL AND UNAUDITED PRO FORMA CONDENSED

CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following selected historical and unaudited pro forma condensed consolidated financial and operating data should be read in conjunction with our audited historical and unaudited pro forma condensed consolidated financial statements, the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The selected historical consolidated statement of operations data for the years ended December 31, 2001 (predecessor), 2002 (predecessor) and 2003 and for the nine months ended September 30, 2004 and the selected historical consolidated balance sheet data as of December 31, 2001 (predecessor), 2002 (predecessor) and 2003 and as of September 30, 2004 set forth below are derived from our audited historical consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated financial data as of September 30, 2003 and for the nine-month period then ended set forth below are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated statement of operations data for the period from September 21, 1999 to December 31, 1999 (predecessor) and for the year ended December 31, 2000 (predecessor) and the selected historical consolidated balance sheet data as of December 31, 1999 (predecessor) and 2000 (predecessor) set forth below are derived from our unaudited historical consolidated financial statements that are not included in this prospectus. The selected unaudited pro forma condensed consolidated statement of operations data for the year ended December 31, 2003 and for the nine months ended September 30, 2004 are derived from our unaudited pro forma condensed consolidated financial information included elsewhere in this prospectus. Our audited historical consolidated financial statements have been prepared and presented in accordance with U.S. GAAP and audited by Deloitte Touche Tohmatsu CPA Ltd. Our unaudited historical consolidated financial statements and our pro forma consolidated financial statements have been prepared and presented in accordance with U.S. GAAP. For a description of the basis of presentation of these financial statements, see note 3 to our audited historical consolidated financial statements.

 

Hurray! Holding was formed on April 23, 2002. For our 1999, 2000 and 2001 financial statements, our existing affiliate, Hurray! Solutions, is treated as a predecessor entity. For our 2003 financial statements, Hurray! Holding is treated as a successor entity. Because Hurray! Holding had not yet entered into definitive agreements with Hurray! Solutions in 2002 and it had limited operations in that year, our 2002 financial statements are also presented with Hurray! Solutions as a predecessor entity. In accordance with the applicable accounting standards, the assets and liabilities of Hurray! Solutions have been recorded at fair market value in our successor financial statements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Hurray! Holding had total assets of $1,200,035 as of December 31, 2002 and no revenues and a loss from continuing operations of $352,764, or $0.00 per ordinary share, for the period from April 23, 2002 (date of incorporation) to December 31, 2002. Combining Hurray! Holding and Hurray! Solutions on a pro forma basis would increase total assets of Hurray! Solutions by $484,979 as of December 31, 2002 and increase operating expenses and the loss from continuing operations by $352,764 for the period from April 23, 2002 to December 31, 2002.

 

Our selected unaudited pro forma condensed consolidated financial data for the year ended December 31, 2003 is presented in order to give pro forma effect to the acquisition of Beijing Enterprise as if the acquisition occurred on January 1, 2003. Our selected unaudited pro forma condensed consolidated statement of operations data for the nine months ended September 30, 2004 is presented to include (1) the historical consolidated financial data of our company for the three months ended March 31, 2004, (2) the historical financial data of Beijing Enterprise for the three months ended March 31, 2004 after giving pro forma effect to our acquisition of Beijing Enterprise as if the acquisition occurred on January 1, 2003 and (3) the historical consolidated financial data of our company for the six months from April 1, 2004 (acquisition of Beijing Enterprise) to September 30, 2004, in which the operating results of Beijing Enterprise for that period were consolidated.

 

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As of and
for the

Period from
September 21,

1999 to

December 31,

1999

(Predecessor)


    As of and for the Year Ended December 31,

    As of and for the Nine Months Ended September 30,

 
      2000     2001     2002     2003     2003     2003     2004     2004  
      (Predecessor)

   
    (Pro forma
unaudited)


   
   
    (Pro forma
unaudited)


 
    (in thousands of U.S. dollars, except percentages and subscription data)                    

Historical and Unaudited Pro Forma Condensed Consolidated Statement of Operations Data

                                                                       

Revenues:

                                                                       

2G services

  $     $     $ 1,414     $ 5,948     $ 13,471     $ 13,471     $ 9,079     $ 11,421     $ 11,421  

2.5G services

                            4,289       5,532       1,968       19,209       20,208  

Software and system integration services

    2,848       4,941             4,565       5,363       5,364       4,233       8,770       8,770  
   


 


 


 


 


 


 


 


 


Total revenues

    2,848       4,941       1,414       10,513       23,123       24,367       15,280       39,400       40,399  
   


 


 


 


 


 


 


 


 


Cost of revenues:

                                                                       

2G services

                646       3,363       4,586       4,586       3,052       5,374       5,374  

2.5G services

                            2,106       2,503       964       7,559       7,825  

Software and system integration services

    2,175       2,663             4,478       4,151       4,151       3,470       6,123       6,123  
   


 


 


 


 


 


 


 


 


Total cost of revenues

    2,175       2,663       646       7,841       10,843       11,240       7,486       19,056       19,322  
   


 


 


 


 


 


 


 


 


Gross profit

    673       2,278       768       2,672       12,280       13,127       7,794       20,344       21,077  

Operating expenses

    1,059       4,759       4,548       5,156       7,348       8,447       5,032       8,147       8,194  
   


 


 


 


 


 


 


 


 


Income (loss) from operations

    (386 )     (2,481 )     (3,780 )     (2,484 )     4,932       4,680       2,762       12,197       12,883  

Interest income (expense), net

    1       17       (91 )     (357 )     (387 )     (385 )     (294 )     (213 )     (212 )
   


 


 


 


 


 


 


 


 


Income (loss) before tax

    (385 )     (2,464 )     (3,871 )     (2,841 )     4,545       4,295       2,468       11,984       12,671  

Income tax

    414                                                  
   


 


 


 


 


 


 


 


 


Net income (loss)

    (799 )     (2,464 )     (3,871 )     (2,841 )     4,545       4,295       2,468       11,984       12,671  

Deemed dividends on Series A convertible preference shares

                            (113 )     (113 )     (73 )     (40 )     (40 )
   


 


 


 


 


 


 


 


 


Income (loss) attributable to holders of ordinary shares

  $ (799 )   $ (2,464 )   $ (3,871 )   $ (2,841 )   $ 4,432     $ 4,182     $ 2,395     $ 11,944     $ 12,631  
   


 


 


 


 


 


 


 


 


Income per share, basic(1)

                                  $ 0.00     $ 0.00     $ 0.00     $ 0.01     $ 0.01  
                                   


 


 


 


 


Income per share, diluted(2)

                                  $ 0.00     $ 0.00     $ 0.00     $ 0.01     $ 0.01  
                                   


 


 


 


 


Shares used in calculating basic income per share

                                    1,088,810,959       1,131,499,739       1,059,428,571       1,210,392,381       1,225,816,430  
                                   


 


 


 


 


Shares used in calculating diluted income per share

                                    1,343,606,622       1,386,295,402       1,237,282,102       1,602,946,291       1,618,370,340  
                                   


 


 


 


 


Pro forma basic income per share (unaudited)(3)

                                  $ 0.00       0.00     $ 0.00     $ 0.01       0.01  
                                   


 


 


 


 


Pro forma diluted income per share (unaudited)(4)

                                  $ 0.00       0.00     $ 0.00     $ 0.01       0.01  
                                   


 


 


 


 


Shares used in calculating pro forma basic income per share (unaudited)

                                    1,252,210,071       1,294,898,851       1,194,688,199       1,518,029,659       1,533,453,707  
                                   


 


 


 


 


Shares used in calculating pro forma diluted income per share (unaudited)

                                    1,343,606,622       1,386,295,402       1,237,282,102       1,602,946,291       1,618,370,340  
                                   


 


 


 


 


 

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Table of Contents

(1)   Basic income per share is computed by dividing income attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period (as adjusted to give effect to the 20-for-1 stock split of our ordinary shares which became effective on July 9, 2004).
(2)   Diluted income per share reflects the potential dilution that could occur if securities or other contracts to issue ordinary shares were exercised or converted into ordinary shares.
(3)   Pro forma basic income per share is computed by dividing income attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period (as adjusted to give effect to the 20-for-1 stock split of our ordinary shares which became effective on July 9, 2004), plus the number of ordinary shares resulting from the assumed conversion upon the closing of this offering of all outstanding Series A convertible preference shares.
(4)   Pro forma diluted income per share reflects the potential dilution that could occur if securities or other contracts to issue ordinary shares were exercised or converted into ordinary shares.
   

As of and
for the Period from
September 21, 1999 to
December 31, 1999

(Predecessor)


    As of and for the Year Ended December 31,

   

As of and for the

Nine
Months Ended

September 30,


 
     

2000

(Predecessor)


   

2001

(Predecessor)


   

2002

(Predecessor)


   

2003


   

2003


   

2004


 
               
    (in thousands of U.S. dollars, except percentages and subscription data)              

Historical and Unaudited Pro Forma Condensed Consolidated Balance Sheet Data

                                                       

Cash and cash equivalents

  $ 2,834     $ 1,140     $ 1,736     $ 3,493     $ 11,151     $ 9,936     $ 8,590  

Restricted cash

                1,466       1,510       1,510       1,510        

Accounts receivable, net

    2,327       706       802       2,937       7,892       7,962       15,376  

Other current assets

    2,225       1,086       1,470       329       228       518       1,415  

Property and equipment, net

    700       688       1,666       1,028       1,897       1,506       2,283  

Other assets

    5,815             404       473       231       277       887  

Goodwill

                            3,950       3,950       20,411  
   


 


 


 


 


 


 


Total assets

  $ 13,901     $ 3,620     $ 7,544     $ 9,770     $ 26,859     $ 25,659     $ 48,962  
   


 


 


 


 


 


 


Current liabilities

  $ 11,077     $ 2,014     $ 7,877     $ 12,404     $ 12,165     $ 13,070     $ 16,498  

Shareholders’ equity (deficiency)

    2,824       1,606       (333 )     (2,634 )     14,694       12,589       32,464  
   


 


 


 


 


 


 


Total liabilities and shareholders’ equity

  $ 13,901     $ 3,620     $ 7,544     $ 9,770     $ 26,859     $ 25,659     $ 48,962  
   


 


 


 


 


 


 


Other Historical and Unaudited Pro Forma Condensed Consolidated Financial Data

                                                       

Gross profit margin

                                                       

2G services

    %     %     54.3 %     43.5 %     66.0 %     66.4 %     52.9 %

2.5G services

                            50.9       51.0       60.6  

Software and system integration services

    23.6       46.1             1.9       22.6       18.0       30.2  

Total gross profit margin

    23.6       46.1       54.3       25.4       53.1       51.0       51.6  

Income (loss) from operations

    (13.6 )     (50.2 )     (267.4 )     (23.6 )     21.3       18.1       31.0  

Net profit (loss) margin

    (28.1 )     (49.9 )     (273.9 )     (27.0 )     19.7       16.2       30.4  

Depreciation

  $ 73     $ 242     $ 338     $ 652     $ 858     $ 638     $ 968  

Amortization

                71       142       276       207       464  

Capital expenditure

    408       929       1,445       441       1,388       751       1,163  

Unaudited Operating Data (in millions)

                                                       

Number of SMS service subscriptions(1)

                      0.9       2.0       2.0       1.7  

Number of WAP service subscriptions(2)

                            1.6       0.8       3.9  

(1)   Approximate combined number of our SMS subscriptions on China Unicom’s and China Mobile’s 2G mobile networks as of the indicated date.
(2)   Approximate number of subscriptions on China Unicom’s (and China Mobile’s, in the case of the unaudited pro forma operating data as of December 31, 2003 and September 30, 2004) nation-wide WAP portal as of the indicated date.

 

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SELECTED FINANCIAL DATA OF BEIJING ENTERPRISE

 

The following selected historical financial data for Beijing Enterprise should be read in conjunction with Beijing Enterprise’s historical financial statements, the notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Our Recent Acquisition of Beijing Enterprise” included elsewhere in this prospectus. The selected Beijing Enterprise historical statement of operations data for the period from June 27, 2002, the date of incorporation, to December 31, 2002 and for the year ended December 31, 2003, and the selected historical balance sheet data as of December 31, 2002 and 2003 set forth below are derived from Beijing Enterprise’s audited combined financial statements, which have been prepared and presented in accordance with U.S. GAAP and audited by Deloitte Touche Tohmatsu CPA Ltd. The selected unaudited historical financial data as of and for the three months ended March 31, 2004 are derived from the management financial information of Beijing Enterprise, which was prepared on substantially the same basis as its audited historical financial statements and include all adjustments necessary for a fair statement of the financial results for the period presented. For a description of the basis of presentation of these financial statements, see note 2 to the financial statements of Beijing Enterprise.

 

No stand-alone financial data for Beijing Enterprise after March 31, 2004 is available as we commenced the consolidation of Beijing Enterprise into our consolidated financial data beginning in the second quarter of 2004.

 

     As of
December 31, 2002
and for the Period
From
July 27, 2002 to
December 31, 2002


    As of and for the
Year Ended
December 31, 2003


   

As of and for
the Three
Months Ended
March 31, 2004

(unaudited)


 
     (in thousands of U.S. dollars, except percentages)  

Historical Combined Statement of Operations Data

                        

Revenues

   $ 29     $ 1,244     $ 999  

Cost of revenues

     12       382       274  
    


 


 


Gross profit

     17       862       725  

Operating expenses

     101       427       369  
    


 


 


Operating profit (loss)

     (84 )     435       356  

Interest income

           2       1  
    


 


 


Net income (loss)

   $ (84 )   $ 437     $ 357  
    


 


 


Historical Combined Balance Sheet Data

                        

Cash and cash equivalents

   $ 358     $ 478     $ 633  

Accounts receivable

     6       190       490  

Other current assets

     83       220       306  

Property and equipment, net

     18       122       152  

Other assets

     1       33       34  
    


 


 


Total assets

   $ 466     $ 1,043     $ 1,615  
    


 


 


Current liabilities

   $ 42     $ 183     $ 398  

Owners’ equity

     424       860       1,217  
    


 


 


Total liabilities and owners’ equity

   $ 466     $ 1,043     $ 1,615  
    


 


 


Other Historical Combined Financial Data

                        

Gross profit margin

     58.1 %     69.3 %     72.6 %

Operating profit (loss) margin

     (293.4 )     35.0       35.7  

Net profit (loss) margin

     (292.7 )     35.1       35.7  

Depreciation

   $ 1     $ 20     $ 12  

Capital expenditure

     19       126       42  

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with our audited historical consolidated financial statements and our unaudited pro forma condensed consolidated financial statements, together with the respective notes thereto, included elsewhere in this prospectus.

 

Our audited historical consolidated financial statements and the audited historical financial statements of Beijing Enterprise have been prepared in accordance with U.S. GAAP.

 

Our unaudited pro forma financial information has been derived from our audited historical consolidated financial statements and the audited historical financial statements of Beijing Enterprise.

 

Overview

 

We provide wireless value-added services such as ringtones, picture downloads, community and entertainment services to mobile phone users in China. We are one of the market leaders in terms of revenue in providing WAP services over China’s 2.5G mobile networks, the most advanced broadly available mobile telecommunication networks deployed in China. We also offer a variety of SMS over China’s 2G mobile networks. In addition, we design, develop, sell and support service provisioning and management software, called VASPro, and are the sole provider of this type of software to China Unicom for its nation-wide WAP portal.

 

Substantially all of our 2.5G services revenues are derived from WAP services, the predominant 2.5G service available in China. Our 2G services consist of SMS and our recently introduced IVR services. Users pay for our services by monthly subscription and/or on a per-use basis. We receive payments for these services principally in the form of payments from the mobile operators after the users have paid for our services and the operators have deducted their service and network fees. We also earn revenues from our software and system integration services that enable mobile operators to manage and support wireless value-added services on the 2.5G and, in the future, 3G mobile networks.

 

In June 2004, we acquired Beijing Enterprise for an aggregate purchase price of $18.0 million, of which $12.0 million was paid in cash and $6.0 million was paid in the form of our ordinary shares at a price of $0.14055 per share. Such ordinary shares were cancelled in November 2004 in exchange for a reduced cash payment of $4.5 million, half of which has been paid already with the other half to be paid by May 2005. In addition, two of our affiliated companies have also provided a loan in the amount of such balance to the beneficiary owner of the seller, which shall be repaid in full by May 2005. Beijing Network provides WAP services on China Mobile’s WAP portals, and has consistently ranked in the top five on these portals in terms of revenue. For a description of our acquisition of Beijing Enterprise, see “Our Recent Acquisition of Beijing Enterprise.”

 

We achieved net income of $4.5 million for 2003, compared to a net loss of $2.8 million for 2002. For 2003, we generated $23.1 million in total revenues, compared to $10.5 million for 2002, representing an increase of 120.0%. For 2003, 2G, 2.5G and software and system integration services accounted for 58.3%, 18.5% and 23.2% of our gross revenues, respectively, compared to 56.6%, 0.0% and 43.4% in 2002. Our increase in total revenues during this period was due to increased sales of our services. These increased sales were driven by continued growth in demand for 2G services such as SMS in China and the commencement of significant growth in demand for 2.5G services in the third and fourth quarters of 2003. Our software and system integration services revenues also increased as we licensed additional service provisioning and management software to China Unicom, our sole customer and licensee of such software, in connection with actual and anticipated increases in the user base for WAP-based services offered through its network.

 

We had retained earnings of $4.1 million as of December 31, 2003, compared to an accumulated deficiency of $10.0 million as of December 31, 2002. Our prior accumulated losses were funded from our private placements of ordinary and preference shares to both our management and investors, capital contributions, and cash flow from our operations.

 

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Table of Contents

In the first nine months of 2004, our total revenues and net income were $39.4 million and $12.0 million, respectively, compared to total revenues of $15.3 million and net income of $2.5 million in the first nine months of 2003.

 

After giving pro forma effect to the acquisition of Beijing Enterprise as if the acquisition occurred on January 1, 2003, our total revenues and net income were $24.4 million and $4.3 million for 2003, respectively, with revenues derived from our 2G, 2.5G and software and system integration services representing 55.3%, 22.7% and 22.0% of total revenues, respectively. On a pro forma basis, our total revenues and net income were $40.4 million and $12.7 million for the first nine months of 2004, respectively, with revenues derived from our 2G, 2.5G and software and system integration services representing 28.3%, 50.0% and 21.7% of total revenues, respectively. Our unaudited pro forma condensed consolidated financial data for the nine months ended September 30, 2004 is presented to include (1) the historical consolidated financial data of our company for the three months ended March 31, 2004, (2) the historical financial data of Beijing Enterprise for the three months ended March 31, 2004 after giving pro forma effect to our acquisition of Beijing Enterprise as if the acquisition occurred on January 1, 2003 and (3) the historical consolidated financial data of our company for the six months ended September 30, 2004, in which the operating results of Beijing Enterprise for that period were consolidated.

 

We currently conduct our business in China through our wholly owned subsidiary, Hurray! Times. To comply with ownership requirements under Chinese law, which impose certain restrictions on foreign companies such as us, from investing in certain industries such as value-added telecommunication and Internet services, we have entered into a series of agreements with five affiliated Chinese entities and their respective shareholders. We hold no ownership interest in any such affiliated Chinese entities. Hurray! Solutions is 85% and 15% owned by our president and chief executive officer, Qindai Wang, and one of our shareholders, Songzuo Xiang, respectively. In turn, Hurray! Solutions has one subsidiary, Beijing Cool Young. We also have three other affiliated companies, Beijing Network, WVAS Solutions and Beijing Palmsky. Beijing Cool Young is 95% owned by Hurray! Solutions and 5% owned by our president and chief executive officer, Qindai Wang. Beijing Network is 50% and 50% owned by two individuals in China, Sun Hao and Wang Xiaoping, both of whom serve as vice presidents of Hurray! Solutions. WVAS Solutions is 99% owned by Beijing Network, with the remaining 1% equally owned by Messrs. Sun and Wang. Beijing Palmsky is 50% and 50% owned by two individuals in China, Wang Jianhua and Yang Haoyu, both of whom are our shareholders and vice presidents. However, through our agreements with these Chinese affiliates, we have the power to vote all shares of all the shareholders of those companies on all their matters, through the general manager of Hurray! Times, as well as the right to enjoy the economic benefits of those companies, the exclusive right to purchase equity interests from the shareholders of those companies to the extent permitted by Chinese laws and the control of the major intellectual properties used by those companies. See “Our Corporate Structure.”

 

Under FASB Interpretation No. 46, or FIN 46, we are the primary beneficiary of the economic benefits of our variable interest entities, Hurray! Solutions, WVAS Solutions, Beijing Cool Young, Beijing Palmsky and Beijing Network. Accordingly, these entities are consolidated into our financial statements. Transactions among these entities and our company and subsidiaries are eliminated in consolidation.

 

Hurray! Holding was formed on April 23, 2002. For our 1999, 2000 and 2001 financial statements, our existing affiliate, Hurray! Solutions, is treated as a predecessor entity. For our 2003 and first nine months of 2004 financial statements, Hurray! Holding is treated as a successor entity. Because Hurray! Holding had not yet entered into definitive agreements with Hurray! Solutions in 2002 and it had limited operations in that year, our 2002 financial statements are also presented with Hurray! Solutions as a predecessor entity and, unless otherwise indicated below, do not present the results of Hurray! Solutions and Hurray! Holding on a combined pro forma basis. In accordance with the applicable accounting standards, the assets and liabilities of Hurray! Solutions have been recorded at fair market value in our successor financial statements.

 

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The major factors affecting our results of operations and financial condition include:

 

    Growth of the Wireless Value-Added Services Market in China, in Particular for Our 2.5G Services.    Our financial results have been, and we expect them to continue to be, largely dependent on growth in the wireless value-added services market in China. Historically, 2G services, such as SMS, have represented the predominant portion of the wireless value-added services market in China and of our revenues. According to Norson, SMS represented 85% of the total wireless value-added services revenues generated by service providers in China in 2003. Our 2G services, all of which were SMS, represented 75.9% of our total wireless value-added services revenues in 2003. We commercially launched 2.5G services in September 2002 and began billing users for these services at the beginning of 2003. Since the launch of our 2.5G services, we have experienced much higher growth rates in revenues from these services than from our 2G services. Our 2.5G services, substantially all of which are WAP services, represented 62.7% of our total wireless value-added services revenue for the first nine months of 2004. We believe that our financial success in the near-term will depend on the growth of the market for our 2.5G services, especially WAP services, where we have a leading position and, in the longer-term, on our ability to offer popular services on any new wireless technologies that are introduced in China such as 3G. See “Risk Factors — Risks Related to Our Company — Risks Related to Our 2G and 2.5G Services — One of our principal strategies is focusing on 2.5G services in China, the market for which may not grow to the extent we anticipate for a variety of reasons that are beyond our control, which in turn would limit the growth potential of our business and adversely affect the market price of our ADSs” and “Risk Factors — Risks Related to Our Company — Risks Related to Our 2G and 2.5G Services — The popularity of our 2G and 2.5G services, and therefore revenues from these services and our profitability, would be adversely affected if our competitors offer more attractive and engaging services or our services are rendered obsolete by the introduction of newer technologies such as 3G.”

 

    Positioning of Our Services on the WAP Portals of China Unicom and China Mobile.    A key component of our revenue growth is our ability to not only maintain access to China Unicom’s and China Mobile’s networks, but also to secure prominent positioning for our services at the top of the menu of services for each major service category on the mobile operators’ WAP portals so that users see our services first when opening the service menus. See “Risk Factors — Risks Related to our Company — Risks Related to our 2G and 2.5G Services — China Unicom and China Mobile allow us to offer our services over their networks only if we achieve minimum customer usage, revenues and other criteria, and our revenues from 2.5G services depend in particular on our ability to meet those criteria to keep our services among the most popular offered through the mobile operators.” We do not enjoy the same leading position on China Mobile’s WAP portal as we do on China Unicom’s, and have not historically developed as strong a relationship with China Mobile as we have with China Unicom. We may not be successful in building on Beijing Network’s relationship with China Mobile to enhance the position of our services on China Mobile’s WAP portal.

 

   

Network Service Agreements with China Unicom and China Mobile.    Our results of operations are dependent on the terms of network service agreements with China Unicom and China Mobile and the manner in which the mobile operators implement these agreements and their related customer service policies. Each of these agreements is non-exclusive, and has a limited term, generally one or two years. Renewal of them on favorable terms depends on our relationship with these mobile operators at both the national and provincial level, the popularity of our services and our ability to maintain adequate levels of performance. Either mobile operator could alter any of these terms or terminate the contracts for a variety of reasons in the future, including, for example, to increase their own service or network fees in order to enhance their profitability at the expense of service providers. See “Risk Factors — Risks Related to our Company — Risks Related to our 2G and 2.5G Services — We depend on China United Telecommunications Corporation, or China Unicom and, to a lesser extent, China Mobile Communications Corporation, or China Mobile, the two principal mobile operators in China, for substantially all of our revenue, and any loss or deterioration of our relationship with China Unicom and China Mobile may result in severe disruptions to our business operations and the loss of some or a major

 

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portion of our revenue”, “ — The termination or alteration of our various agreements with China Unicom, China Mobile and their provincial affiliates would materially and adversely impact our revenue and profitability” and “ — Additional Risks Related to Our Company — A substantial portion of our revenues are derived from the relatively wealthier coastal and southern provinces in China, and the termination or alteration of our contracts with the mobile operators, or a general economic downturn, in those areas could have a particularly adverse effect on our revenue and overall financial condition.”

 

    Changes in Mobile Operator Policies or the Manner in Which They are Enforced.    The policies and procedures adopted by China Mobile and China Unicom regarding customer service, quality control and other aspects of the wireless value-added services industry significantly affect the revenue we receive, as discussed in “Risk Factors — Risks Related to Our Company — Risks Related to Our 2G and 2.5G Services — Unilateral changes in the policies of China Mobile and China Unicom and in their enforcement of their policies have resulted in our having to pay additional charges to the mobile operators, and further changes could materially and adversely impact our revenue and profitability in the future”; “— In addition to enhanced enforcement of their policies, the mobile operators have been adopting new billing systems which have adversely affected our SMS revenue”; “— The Chinese government, China Unicom or China Mobile may prevent us from distributing, and we may be subject to liability for, content that any of them believe is inappropriate”. Recent changes in the implementation of certain policies have reduced our revenues from SMS-based services by, for example, making it more difficult for customers to order our services, enabling customers to more easily cancel our services and requiring us to automatically terminate subscription services for our inactive users. Further changes in their policies or in their implementation by the mobile operators, including changes that could affect our 2.5G services, could adversely affect our business and financial condition.

 

    Taxes.    Our subsidiary, Hurray! Times is subject to a 30.0% state enterprise income tax and a 3.0% local enterprise income tax and our affiliated Chinese entities are generally subject to a 33.0% enterprise income tax in China. However, Hurray! Times, as well as Hurray! Solutions, have obtained approval from the Chinese government authorities to be classified as “high technology” companies. This classification entitles Hurray! Times to a three-year exemption from enterprise income tax commencing in 2003, followed by a 7.5% preferential tax rate for the succeeding three years and 15% preferential tax rate thereafter. Hurray! Solutions had a three-year tax exemption from 2000 to 2002, followed by a 7.5% preferential tax rate for the succeeding three years and a 15% preferential tax rate thereafter. The earnings of our affiliated Chinese entities are passed on to Hurray! Times pursuant to various services agreements.

 

    Maintaining and Expanding the Customer Base for Our VASPro Services Provisioning and Management Software.    China Unicom and nine of its provincial offices that have their own local WAP portals use our VASPro services provisioning and management software. We believe it is unlikely that the other current principal mobile operator in China, China Mobile, will purchase this software in the foreseeable future because it purchases this category of software from a subsidiary which was established for that purpose. Accordingly, continued sales of our software depend on our ability to maintain our relationship with China Unicom and the expansion of China Unicom’s WAP user base so that it will need to license additional software from us to support additional users, acquiring new customers in China, such as China Telecom and China Netcom with which we have not yet developed close relationships, and expanding sales of our software to mobile operators overseas, with which we have almost no experience.

 

   

Billing and Transmission Failures.    We do not recognize any revenues for services that are characterized as billing and transmission failures. These failures occur when we do not collect fees for our 2G services from mobile operators in a number of circumstances, including when the delivery of our services to a customer is prevented because the customer’s phone is off, the customer’s prepaid phone card has run out of value or a mobile operator experiences technical problems with its network. These situations are known in the industry as billing and transmission failures. The level of billing and transmission failures significantly affects revenues we record. The failure rate for 2G services has fluctuated significantly in the

 

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past, ranging on a monthly basis from 3.4% to 22.2% of the total billable messages which are reflected in our internal records during 2004. Although we do not experience the same type of billing and transmission errors for our WAP services as we do for our SMS, we do experience a discrepancy between the revenues recorded by our internal system and the revenues that we receive from the mobile operators. This difference has historically averaged approximately 2% per month and relates to services that are provided but for a variety of reasons are not billed to the user due to the manner in which the mobile operators register new users or manage their internal billing reconciliation process.

 

Revenues

 

We derive our revenues from our primary operating segments: 2G services, 2.5G services and software and system integration services. Currently, our revenues are primarily derived from 2G and 2.5G services. Through these services, we provide downloads, information and community-oriented products, such as picture and ringtone downloads, chatting, games, enhanced text-based content services and IVR. Our revenues are primarily derived from Hurray! Times through agreements with our affiliated Chinese entities.

 

Our revenues represent our total revenues from operations, net of certain business and value-added taxes. Our revenues from wireless value-added services are subject to a 3.0% business tax and our revenues from software and system integration services are subject to a value-added tax at the rate of 17.0%. Furthermore, any service fees that Hurray! Times charges and subsequently collects pursuant to the exclusive technical and consulting service agreements with our affiliated Chinese entities are subject to a 5.0% business tax.

 

The following tables set forth certain historical consolidated revenues, by amount and as a percentage of our total revenues, for the periods indicated:

 

     For the Year Ended December 31,

 
    

2002

(Predecessor)


   

2003


 
     Amount

  

Percentage

of revenues


    Amount

  

Percentage

of revenues


 
     (in thousands of U.S. dollars, except percentages)  

Revenues:

                          

2G services

   $ 5,948    56.6 %   $ 13,471    58.3 %

2.5G services

              4,289    18.5  

Software and system integration services

     4,565    43.4       5,363    23.2  
    

  

 

  

Total revenues

   $ 10,513    100.0 %   $ 23,123    100.0 %
    

  

 

  

 

     For the Nine Months Ended

 
    

September 30, 2003

(unaudited)


   

September 30, 2004


 
     Amount

   Percentage
of revenues


    Amount

   Percentage
of revenues


 
    

(in thousands of U.S. dollars,

except percentages)

 

Revenues:

                          

2G services

   $ 9,079    59.4 %   $ 11,421    29.0 %

2.5G services

     1,968    12.9       19,209    48.7  

Software and system integration services

     4,233    27.7       8,770    22.3  
    

  

 

  

Total revenues

   $ 15,280    100.0 %   $ 39,400    100.0 %
    

  

 

  

 

2G and 2.5G services.    Our 2G and 2.5G services revenues are derived from services that we provide to our users through China Unicom’s and China Mobile’s networks. We recognize revenues derived from these services before deducting service and network fees paid to the mobile operators. For a description of our revenue

 

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recognition policies, see “— Critical Accounting Policies,” and for a description of our network service agreements with these mobile operators, see “Business — Network Service Agreements with China Unicom and China Mobile for 2G and 2.5G Services — Fee Arrangements and Other Payment Considerations for 2.5G Services”; “— Fee Arrangements and Other Payment Considerations for 2G Services.”

 

2G services have historically been our primary source of revenues, accounting for approximately 56.6% and 58.3% of our total revenues in 2002 and 2003, respectively. However, we expect that sales of our 2.5G services, particularly our WAP services, will continue to increase, and sales of our 2G services will continue to decline as 2.5G and 3G services gain in popularity. In the first nine months of 2004, our 2G and 2.5G services accounted for approximately 37.3% and 62.7%, respectively, of our combined 2G and 2.5G services revenues, compared with 82.2% and 17.8%, respectively, in the first nine months of 2003.

 

The following table sets forth subscriptions for 2G and 2.5G services as of the dates indicated:

 

     As of

    

September 30,

2003


  

December 31,

2003


  

September 30,

2004


     (in millions)

Service Subscriptions:

              

2G Subscriptions(1)

   2.0    2.0    1.7

2.5G Subscriptions(2)

   0.8    1.6    3.9

(1)   Approximate combined number of our SMS subscription on China Unicom’s and China Mobile’s 2G mobile networks.
(2)   Approximate number of subscriptions on China Unicom’s (and China Mobile’s, in the case of the unaudited operating data as of September 30, 2004) nation-wide WAP portal.

 

Most of our 2.5G services revenues from China Unicom and China Mobile are subscription-based. In September 2004, more than 74% and 85% of 2.5G services revenues provided through China Unicom and China Mobile, respectively, were subscription-based. Revenues from our subscription services, which are purchased for a fixed period of time, usually three to six months, are typically more predictable and more stable than per-use services which are often the result of impulse buying and tend to fluctuate from month-to-month. Because of the more stable recurring revenue generated by our subscription-based services, we have been focused on migrating Beijing Network’s user base, which had been historically mostly per-use, to subscription-based services by offering a wider range of subscription-based services to its users and increasing promotion of those services through online and offline methods as discussed under “Business—Sales and Marketing.” As these initiatives have only recently been launched, we cannot determine whether they will be successful on a long-term basis.

 

Software and system integration services.    Our revenues from these services have been derived from the design, development, licensing fees, hardware installation and after-sale support of our VASPro services provisioning and management software, which has been purchased by China Unicom and nine of its provincial offices. We deliver these services under a small number of relatively high value contracts. The revenues from these contracts are recognized based on the percentage of completed contractual obligations. Since a large part of certain projects often relates to third party hardware and software, the timing of their delivery can cause our quarterly gross revenues and cost of revenues to fluctuate significantly. However, those fluctuations do not significantly affect our gross profits because hardware-related revenues approximate the costs of such revenues. See “— Critical Accounting Policies.”

 

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Cost of Revenues

 

The following tables set forth certain historical consolidated cost of revenues data by amount for the periods indicated:

 

     For the Year Ended
December 31,


    

2002

(Predecessor)


  

2003


     (in thousands of U.S.
dollars)

Cost of Revenues:

             

2G services

   $ 3,363    $ 4,586

2.5G services

          2,106

Software and system integration services

     4,478      4,151
    

  

Total cost of revenues

   $ 7,841    $ 10,843
    

  

 

    For the
Nine Months Ended


   

September 30,
2003

(unaudited)


 

September 30,
2004


    (in thousands of U.S. dollars)

Cost of Revenues:

         

2G services

  $ 3,052   $5,374

2.5G services

    964   7,559

Software and system integration services

    3,470   6,123
   

 

Total cost of revenues

  $ 7,486   $19,056
   

 

 

2G and 2.5G services.    The principal cost of revenues for our 2G and 2.5G services is the service and network fees paid to the mobile operators under our network service agreements with them. The cost of revenues also includes fees paid to our content providers and marketing partners, maintenance costs related to equipment used to provide the services, bandwidth leasing charges and data center services, operator imposed penalty charges, and certain distribution costs.

 

Software and system integration services.    Our cost of revenues for our software and system integration services includes acquisition cost of third party hardware and software products provided to our customers and staffing and travel costs related to system integration services in connection with a given project.

 

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Gross Profit Margin

 

The following tables set forth the historical consolidated gross profits and gross profit margin of our business activities for the periods indicated:

 

    

For the Year Ended

December 31,


 
    

2002

(Predecessor)


   

2003


 
    

(in thousands of

U.S. dollars, except
percentages)

 

Gross Profits:

                

2G services

   $ 2,585     $ 8,885  

2.5G services

           2,183  

Software and system integration services

     87       1,212  
    


 


Total gross profits

   $ 2,672     $ 12,280  
    


 


Gross Profit Margin:

                

2G services

     43.5 %     66.0 %

2.5G services

           50.9  

Software and system integration services

     1.9       22.6  

Total gross profit margin

     25.4       53.1  

 

    For the Nine Months Ended

 
   

September 30,

2003

(unaudited)


   

September 30,

2004


 
    (in thousands of U.S. dollars,
except percentages)
 

Gross profit:

               

2G services

  $ 6,027     $ 6,047  

2.5G services

    1,004       11,650  

Software system and integration services

    763       2,647  
   


 


Total gross profits

  $ 7,794     $ 20,344  
   


 


Gross profit margin:

               

2G services

    66.4 %     52.9 %

2.5G services

    51.0       60.6  

Software system and integration services

    18.0       30.2  

Total gross profits

    51.0       51.6  

 

The increase in our 2G and 2.5G services gross profit margins in 2003 compared to 2002 is due to an increase in the revenues derived from this business at a more rapid rate than the increase in the cost of revenues associated with this business. This difference in the rate of increase is primarily because a significant component of the cost of revenues is the allocated portion of fixed common costs, which do not increase in proportion to increases in our 2G and 2.5G services revenues.

 

The gross profit margins for our 2G services declined in the first nine months of 2004 compared to the first nine months of 2003, due to increased costs related to those services, particularly a higher level of costs related to revenue sharing with promotional partners and third party content providers as well as an increase in promotional and other expenses related to our 2G services. We anticipate that gross profit margins for our 2G services will continue to decline in future periods, driven primarily by the increasingly competitive environment in the 2G

 

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market. On the other hand, our gross profit margins for our 2.5G services increased in the first nine months of 2004 compared to the first nine months of 2003 as we achieved economies of scale in this market, and we anticipate that such margins will remain stable or may even increase, if the market continues to expand and we are able to continue to achieve enhanced economies of scale.

 

The gross profit margins for software and system integration services have varied significantly between 2002 and 2003 as well as during the first nine months of 2003 and 2004. This variance is primarily attributable to our delivery of more third party hardware and software in certain periods, which has significantly lower margins, compared to the delivery of our own software and services. In the last three fiscal years combined, third party hardware and software accounted for an average of 68% of the total contract value of our software system and integration services, or 98%, 77% and 77% of our total revenues from software and systems integration services in 2002, 2003 and the first nine months of 2004, respectively. In the future, we intend to minimize the provision of third party hardware and software in connection with our software and system integration services, but we may still be required by our customers to provide those items from time to time. If we are successful in minimizing our provision of third party hardware and software, we expect that our gross profit margins in this segment will tend to stabilize at a higher level.

 

Operating Expenses

 

The following tables set forth certain historical consolidated operating expenses data, in terms of amount and as a percentage of our total revenues, for the periods indicated:

 

     For the Year Ended December 31,

 
    

2002

(Predecessor)


   

2003


 
     Amount

   Percentage
of revenues


    Amount

   Percentage
of revenues


 
    

(in thousands of U.S. dollars,

except percentages)

 

Operating Expenses:

                          

Product development expenses

   $ 878    8.4 %   $ 1,375    5.9 %

Selling and marketing expenses

     2,908    27.7       4,578    19.8  

General and administrative expenses

     1,370    13.0       1,241    5.4  

Stock-based compensation

              154    0.7  
    

  

 

  

Total operating expenses

   $ 5,156    49.1 %   $ 7,348    31.8 %
    

  

 

  

 

    For the Nine Months Ended

 
   

September 30, 2003

(unaudited)


   

September 30, 2004


 
    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


 
    (in thousands of U.S. dollars, except
percentages)
 

Operating Expenses:

                     

Product development expenses

  $ 961   6.3 %   $1,653   4.2 %

Selling and marketing expenses

    3,084   20.2     5,008   12.7  

General and administrative expenses

    858   5.6     1,168   3.0  

Stock-based compensation

    129   0.8     282   0.7  

In-process research and development

          36   0.1  
   

 

 
 

Total operating expenses

  $ 5,032   32.9 %   $8,147   20.7 %
   

 

 
 

 

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Product Development Expenses.    Product development expenses primarily consist of research and development staff costs. Most of our product development expenses relate to enhancing our portfolio of 2.5G services and improving and updating our services provisioning and management software. Product development expenses also include depreciation and amortization of computers and software related to the activities of our product development teams. We depreciate our computer equipment, software and other assets on a straight-line basis over their estimated useful lives, which is three to five years.

 

Selling and Marketing Expenses.    Selling and marketing expenses primarily consist of staff costs related to managing the development of our service offerings. These expenses also include advertising, sales and marketing expenses, such as expenses associated with sponsoring promotional events, salaries and benefits for our direct sales force, free trial services we offer through, for example, certain retailers of mobile phones in China and gifts we provide to Hawa Club members in exchange for points they accumulate for using our 2G and 2.5G services. In 2003, selling and marketing expenses also included amortization of customer lists of Hurray! Solutions. We expect that our selling and marketing expenses will increase in future periods as we promote the brand recognition of the Hawa brand, and also provide more gifts in exchange for Hawa Club points as more users join that club.

 

General and Administrative Expenses.    General and administrative expenses primarily consist of compensation and benefits for our management, salaries for our finance and administrative personnel, professional service fees, lease expenses, other office expenses and expenses related to depreciation of equipment for general corporate purposes.

 

We lease bandwidth from mobile operators’ provincial offices. Bandwidth and server custody fees, office rentals and depreciation charges allocated to our general management, finance and administrative personnel are also included in general and administrative expenses.

 

We depreciate leasehold improvements, which are recorded as general and administrative expenses on a straight-line basis over the relevant lease term.

 

We expect our general and administrative expenses to increase as we add personnel in response to the expansion of our business in future periods. We also expect general and administrative expenses to increase as we incur professional service fees, such as for legal and accounting services, for our listing on Nasdaq.

 

Stock-based Compensation.    We grant stock options to our employees and certain non-employees. Stock-based compensation expenses arise from options granted to employees to the extent that the exercise price of options granted exceeds the fair market value of the underlying stock on the measurement date. We have not recognized a compensation expense in our consolidated financial statements for employee option grants since the exercise prices were equal to or greater than the fair market values at the dates of grant. We account for stock-based awards to non-employees by recording a charge for the services rendered by the non-employees using their estimated fair values. In 2003, we incurred stock-based compensation cost of $0.2 million, which arose in connection with options granted in that year to non-employees, including external consultants and a member of our board of directors in exchange for their services. In addition, in 2002, Hurray! Holding incurred stock-based compensation cost of $0.4 million, which arose in connection with options granted in that year to non-employees. We may incur additional compensation expenses in connection with certain non-employee grants as the fair market value of the options will be re-determined at the end of each fiscal year until they fully vest.

 

Critical Accounting Policies

 

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We have summarized our accounting policies below that we believe are both important to an understanding of

 

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our financial results and involve the need to make estimates about the effect of matters that are inherently uncertain. We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting estimates because they do not generally require us to make estimates or judgments that are difficult or subjective.

 

Revenue Recognition

 

2G and 2.5G services.    Our revenues are primarily derived from the sale of 2G and 2.5G services to our customers delivered over China Unicom’s and China Mobile’s mobile telecommunications networks. 2G and 2.5G services revenues are derived from providing picture downloads, ringtone downloads, chat rooms, games, pop culture, news and financial information services to mobile phone customers of the mobile operators. Fees for these services are established by an agreement with the mobile operators and indicated in the message received on the mobile phone. These fees are charged on a per-use basis or on a monthly subscription basis, and vary according to the type of services delivered.

 

Our services are delivered to users through the mobile telecommunication networks of the mobile operators, and we rely upon them to provide us with billing and collection services. We have, however, developed an internal system that records the number of transactions and subscriptions of our services, which we then compare to the confirmations received from the mobile operators. Generally within 15 to 30 days after the end of each month, a statement from the mobile operators confirming the value of the 2G and 2.5G services they bill to users in that month will be delivered to us, and usually within 60 days after such delivery, we will be paid by the mobile operators for these services, net of their service fees, network fees and applicable business taxes.

 

We initially ascertain the value of the 2G services provided based upon statements sent to us by the mobile operators with respect to the amount of services we deliver to the end users. Because there has historically been a discrepancy between the value of our 2G services based on our internal system and the value of the services based on the statements received from the mobile operators due to technical issues with the transmission and billing systems, at the end of each month, we will, based on the historical data regarding such discrepancies and other factors, make an estimate of our revenues for such month. This estimate may be higher or lower than the actual revenues we have a right to receive based on the statements received from the mobile operators. As part of our estimation process, after the end of each month, our sales force contacts the provincial offices of the mobile operators to assess whether and to what extent there are any discrepancies between our billing system and the provincial operators’ records. Through this interaction with the mobile operators’ provincial offices, our sales force is able to monitor to a degree the accuracy of estimated revenues during the period prior to receipt of the confirmations. When there is significant uncertainty regarding the timing of receipt of a monthly statement or we are aware that a particular billing issue exists in a province, revenue is not recognized for that province until the statement is received.

 

By the time we report our financial results, we would generally have received well over a majority of the monthly statements from the mobile operators and would have recognized our revenues based on the monthly statements. In the event that a monthly statement is not received at the time such financial results are reported, we will report the fees payable to us based on our internal estimate. As a result, we may overstate or understate our revenues for the reporting period. Any difference between the statement received from the mobile operators and our estimate will result in a subsequent adjustment to our revenues reported in our financial statements in the following reporting period. However, such billing discrepancies have had no impact on our historical financial statements for 2001, 2002 and 2003, since we recorded our revenues in accordance with the monthly statements received from the mobile operators in those years. For the nine months ended September 30, 2004, we recognized approximately 6% of our 2G services on an estimated basis. In addition, if 2G services continue to represent a decreasing percentage of our total revenues (a trend which has been occurring for the last several quarters and we expect to continue for the foreseeable future), we anticipate that the portion of our revenues which will be subject to such estimations will decline in future periods.

 

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Although we do not experience the same type of billing and transmission failures for our 2.5G services as we do for our 2G services, we do experience a discrepancy between the revenues recorded by our internal system and the revenues confirmed by the mobile operators. This difference has historically averaged approximately 2% per month and relates to services that are provided but are not billed to the user for a variety of reasons associated with the manner in which the mobile operators register new users and manage their internal billing reconciliation process. However, the 2.5G transmission and billing systems of the mobile operators allow us (as well as other service providers) to monitor if services are actually delivered and paid for. We are then able to identify in a timely manner any discrepancies between our internal system and the systems of the mobile operators. In addition, we typically receive the monthly statements from the mobile operators for our 2.5G services within two or three weeks after the end of each month. Accordingly, the amount of revenue recognized on an accrual basis for our 2.5G services for the nine months ended September 30, 2004 was insignificant and is expected to remain insignificant in future periods for the foreseeable future.

 

We evaluate our network service agreements with the mobile operators to determine whether to recognize our revenues gross or net of the fees charged by the mobile operators. Pursuant to applicable accounting standards, our determination was based upon an assessment of whether we act as a principal or agent when providing the services to our mobile operators. We have concluded that we act as a principal. Factors that we believe support our conclusion are as follows:

 

    We have latitude in establishing prices within ranges prescribed by the mobile operators;

 

    We determine the specifications of the services we will be rendering;

 

    We have the ability to control the selection of our content suppliers; and

 

    We assume the risk of non-payment by customers.

 

Although the mobile operators must approve the prices of our services in advance, we have been able to adjust our prices from time to time to reflect or react to changes in the market. In addition, the mobile operators will usually not pay us if users of our services do not pay them and they will not pay us if users do not receive the services due to billing or transmission failures. As a result, we in fact bear the credit and delivery risk for our portion of the revenues generated with respect to our services.

 

Software and System Integration.    We generally charge a fixed price for all of our projects and recognize revenues based on the percentage of completion of the project. Software revenues from customer orders requiring design, development and support of the software are recognized over the installation period. We use labor costs and direct project expenses to determine the stage of completion, except for revenues associated with the procurement of hardware, which we recognize upon delivery of the hardware to the customer. Since a large part of the cost of certain projects often relates to third party software and hardware, the timing of such software and hardware delivery can cause our quarterly gross revenues and cost of revenues to fluctuate significantly. We recognized total revenues from the sale of third party hardware and software of $nil, $4.2 million, $3.6 million and $5.6 million, and cost of such revenues of $nil, $4.2 million, $3.6 million and $5.6 million in 2001, 2002, 2003 and the first nine months of 2004, respectively. However, those fluctuations do not affect our gross profit margins because third party software and hardware-related revenues approximate the costs of those items. Accordingly, our gross profit margins on such revenues were nominal in 2001, 2002, 2003 and the first nine months of 2004. Recognized revenues and profit are subject to adjustments in current periods as the contract progresses to completion. Accordingly, any changes in our estimates would affect our future operating results.

 

Stock-based Compensation Cost

 

Our stock-based employee compensation plans are described in more detail under “Management — Summary of Share Plans.” We grant stock options to our employees, and we record compensation cost for the

 

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excess of the fair value of our ordinary shares at the measurement date over the option exercise price. We amortize stock-based compensation cost by using the straight-line method over the vesting periods of the related options, which are generally three or four years.

 

We did not record deferred stock-based compensation cost as there was no difference between the deemed fair value of our ordinary shares for accounting purposes and the option exercise price. We determined the deemed fair value of our ordinary shares based upon several factors, including a valuation report from an independent appraiser and the price of our then most recent preference share placement. Had different assumptions or criteria been used to determine the deemed fair value of our ordinary shares, materially different amounts of stock-based compensation cost could have been reported.

 

Pro forma information regarding income (loss) and income (loss) per share is required in order to show our net income (loss) as if we had accounted for employee stock options under the fair value method. We use the Black-Scholes option pricing model to calculate the fair value. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions, including the expected stock price volatility. We used projected volatility rates, which are based upon historical volatility rates experienced by comparable public companies. Because our employee stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our stock options.

 

The historical pro forma income (loss) and pro forma income (loss) per share that we used in calculating the fair value of the options granted to employees may not be representative of the pro forma effects in the future years of net income (loss) and earnings per share for the following reasons:

 

    The number of future shares to be issued under these plans is not known; and

 

    The assumptions used to determine the fair value can vary significantly.

 

In addition, we issued non-employee stock options to certain consultants and a director, which were also accounted for under the Black-Scholes option-pricing model to compute the fair value.

 

Results of Operations

 

As noted above under “— Overview,” our financial information is presented on a predecessor/successor basis, with our affiliate, Hurray! Solutions, as the predecessor.

 

The following discussion of our results of operations for the nine months ended September 30, 2003 is based upon our unaudited historical consolidated statement of operations set forth in our summary unaudited historical consolidated financial and operating data included elsewhere in this prospectus. The following discussion of our results of operations for the years ended December 31, 2001, 2002 and 2003 and for the nine months ended September 30, 2004 is based upon our audited historical consolidated financial statements included elsewhere in this prospectus.

 

Results of Operations for the Nine Months Ended September 30, 2004 Compared to Unaudited Results of Operations for the Nine Months Ended September 30, 2003

 

Revenues.

 

2G Services.    Revenues from our 2G services increased 25.8% to $11.4 million for the nine months ended September 30, 2004 from $9.1 million for the nine months ended September 30, 2003, primarily due to the growth in the market of SMS in 2003 and the first quarter of 2004. We did, however, experience a decline in our revenues from 2G service since the first quarter of 2004 due primarily to the overall market shift from 2G to 2.5G services and, to a lesser extent, due to the factors discussed under “Risk Factors—Risks Related to Our Company—Unilateral changes in the policies of China Mobile and China Unicom and in their enforcement of their policies have resulted in our having to pay additional charges to the mobile operators, and further changes could materially and adversely impact our revenue and profitability in the future”; “—In addition to enhanced enforcement of their policies, the mobile operators have been adopting new billing systems which have adversely affected our SMS revenue.” We expect this trend will continue for the next several quarters.

 

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2.5G Services.    Revenues from our 2.5G services increased significantly to $19.2 million for the nine months ended September 30, 2004 from $2.0 million for the nine months ended September 30, 2003, primarily due to increases in China Unicom’s user base, particularly from the third quarter of 2003 when China Unicom’s nation-wide WAP portal was launched, and related growth in sales of our services, as well as consolidation of Beijing Enterprise’s revenues from the second quarter of 2004 after our acquisition in April 2004.

 

Software and system integration services.    Revenues from our software and system integration services increased 107.2% to $8.8 million for the nine months ended September 30, 2004 from $4.2 million for the nine months ended September 30, 2003, as we substantially completed implementation of China Unicom’s Phase III capacity expansion project for its nation-wide WAP portal and certain provincial level projects in the nine months ended September 30, 2004.

 

Cost of Revenues.

 

2G Services.    Our cost of 2G services increased 76.1% to $5.4 million for the nine months ended September 30, 2004 from $3.1 million for the same period in 2003. This increase reflects increased service and network fees corresponding to the growth in sales of our 2G services in the nine months ended September 30, 2004 compared to the same period in 2003, and higher levels of costs related to revenue sharing with promotional partners and third party content providers.

 

2.5G Services.    Our cost of 2.5G services increased dramatically to $7.6 million for the nine months ended September 30, 2004 from $1.0 million for the same period in 2003, due primarily to increased service and network fees corresponding to the growth in sales of our 2.5G services in the nine months ended September 30, 2004 compared to the same period in 2003.

 

Software and system integration services.    Our cost of software and system integration services increased 76.5% to $6.1 million for the nine months ended September 30, 2004 from $3.5 million for the same period in 2003, due to increased cost of third party hardware and software sold to China Unicom in connection with the implementation of Phase III of its nation-wide WAP portal and certain provincial level projects in the nine months ended September 30, 2004, as compared to the lower amount of such costs related to the initial implementation of an interim upgrade of the Phase II stage in the nine months ended September 30, 2003.

 

Gross Profits.    Our gross profits increased 161.0% to $20.3 million for the nine months ended September 30, 2004 from $7.8 million for the same period in 2003, reflecting increased profits from all our business segments, in particular from our 2.5G services. Our gross profit margins increased to 51.6% for the nine months ended September 30, 2004 from 51.0% for the same period in 2003, due primarily to increased margins from our 2.5G services, which resulted from enhanced economies of scale, and to a lesser extent, from our software and system integration services, which experienced a decrease in low margin third party hardware and software as a percentage of total revenues for the nine months ended September 30, 2004 compared to the same period a year ago.

 

Operating Expenses.    Operating expenses increased 61.9% to $8.1 million for the nine months ended September 30, 2004 from $5.0 million for the same period in 2003, due primarily to increases in personnel costs related to sales and marketing staff and product development for the growth in sales of our 2G and 2.5G services.

 

Income from Operations.    Income from operations increased significantly to $12.2 million for the nine months ended September 30, 2004 from $2.8 million for the same period in 2003.

 

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Interest Expense.     Interest expense, net, decreased to $0.2 million for the nine months ended September 30, 2004 from $0.3 million for the same period in 2003.

 

Net Income.     As a result of the foregoing, net income increased significantly to $12.0 million for the nine months ended September 30, 2004 from $2.5 million for the same period in 2003.

 

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 (Predecessor Except as Indicated)

 

Revenues.    Our revenues increased 120.0% to $23.1 million in 2003 from $10.5 million in 2002. This increase was primarily due to an increase in revenues from our 2G services and revenues from sales of our 2.5G services, the sales of which increased significantly in the second half of 2003.

 

2G Services.    Revenues from 2G services increased 126.5% to $13.5 million in 2003 from $5.9 million in 2002, primarily as a result of the continued overall expansion of the market for our 2G services and migration of our users from per-use purchases of 2G services to subscription purchases. In 2003, revenue from subscription services and per-use services were $11.6 million and $1.9 million, respectively, compared with $1.3 million and $4.6 million, respectively, in 2002. The increase in revenues from 2G services contributed to 59.7% of the increase in total revenues in 2003.

 

2.5G Services.    Revenues from 2.5G services were $4.3 million in 2003 compared to no revenues in 2002, as we launched 2.5G services in late 2002 and commenced billing for the 2.5G services in 2003. Growth in revenues from 2.5G services reflect the nation-wide commercial launch of China Unicom’s WAP portal services in July 2003 and the prominent positioning of our services on the menus of services which appear on that portal. The increase in revenues from 2.5G services contributed to 34.0% of the increase in total revenues in 2003.

 

Software and System Integration Services.    Our software and system integration services revenues increased 17.5% to $5.4 million in 2003 from $4.6 million in 2002. This increase was primarily due to ongoing implementation of our services provisioning and management software on China Unicom’s nation-wide WAP portal and on several provincial level China Unicom WAP portals. In 2003, we substantially completed implementation of Phase II of China Unicom’s nation-wide WAP portal, which expanded the number of users it could support from 0.5 million to 1.5 million, and Guangdong, Jiangsu and Shandong provincial WAP portals. These national and provincial projects contributed $3.5 million of revenues in 2003. We also provided an interim upgrade of the Phase II platform, which contributed $1.2 million of revenues in 2003, and commenced initial third party hardware and software deliveries in respect to the Phase III expansion to 5 million users, which contributed $0.2 million of revenues in 2003. The increase in revenues from these services contributed to 6.3% of the increase in total revenues in 2003.

 

Cost of Revenues.    Our cost of revenues increased 38.3% to $10.8 million in 2003 from $7.8 million in 2002 primarily due to the increased service fees related to the increase in sales of our 2G and 2.5G services.

 

Cost of 2G Services.    Cost of 2G services increased 36.4% to $4.6 million in 2003 from $3.4 million in 2002 as a result of the continued increase in our sales of 2G services. During 2003, sales were affected by the continued migration of 2G users from purchasing on a per-use basis to a subscription basis. The increase in cost of 2G services contributed to 40.7% of the increase in total cost of revenues in 2003.

 

Cost of 2.5G Services.    Cost of 2.5G services was $2.1 million in 2003 compared with no costs in 2002. These costs reflect the launch and expansion of our 2.5G services through China Unicom’s nation-wide WAP

 

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portal in the second half of 2003 and sales of 2.5G services through several of China Unicom’s provincial portals. The costs also reflect the generally higher service fees of our 2.5G services compared to 2G services and network fees, fees paid to content providers in connection with the launch of our 2.5G services on China Unicom’s nation-wide WAP portal and depreciation costs related to software and hardware used to provide these services. The increase in cost of 2.5G services contributed to 70.1% of the increase in total cost of revenues in 2003.

 

Cost of Software and System Integration Services.    Cost of software and system integration services decreased 7.3% from $4.5 million in 2002 to $4.2 million in 2003 primarily due to the higher percentage of our revenues related to our own software and system integration services in 2003. Our own software and system integration services increased to 33.3% in 2003 from 6.5% in 2002. Our costs related to our own software and system integration services are lower and profit margins higher than those for third party hardware and software. The higher percentage of our own software and services reflects the completion of Phase II and an interim expansion of the Phase II platform. The decrease in the cost of these services helped to offset 10.9% of the increase in total cost of revenues in 2003.

 

Gross Profit.    As a result of the foregoing, our gross profit increased 359.6% to $12.3 million in 2003 from $2.7 million in 2002.

 

Operating Expenses.    Our total operating expenses increased 42.5% to $7.3 million in 2003 from $5.2 million in 2002.

 

Product Development Expenses.    Our product development expenses increased 56.6% to $1.4 million in 2003 from $0.9 million in 2002. This increase was primarily due to increased staff cost related to the increased headcount needed for research and development of 2.5G services and software products and systems.

 

Selling and Marketing Expenses.    Our selling and marketing expenses increased 57.5% to $4.6 million in 2003 from $2.9 million in 2002. This increase was primarily due to increases in staff costs as we increased sales and marketing staff to accommodate the growth and expansion of our 2G and 2.5G services nation-wide. Sales and marketing expenses also increased by $0.1 million in connection with the amortization of customer lists of Hurray! Solutions in 2003.

 

General and Administrative Expenses.    Our general and administrative expenses decreased 9.4% to $1.2 million in 2003 from $1.4 million in 2002. This decrease reflects our efforts to limit growth of the non-revenue generating aspects of our business and operations.

 

Stock-based Compensation.    We incurred stock-based compensation expenses of $0.2 million in 2003. These costs relate to the amortization of stock-based compensation cost arising from options granted to non-employee consultants and a non-employee member of our board of directors in 2003. Our predecessor, Hurray! Solutions, did not incur any stock-based compensation expense in 2002. However, Hurray! Holding, which is a successor entity for 2003 and subsequent periods for purposes of our financial statements, incurred stock-based compensation expense of $0.4 million in 2002, which arose from options granted to non-employees.

 

Income/(Loss) from Operations.    As a result of the foregoing, our income from operations was $4.9 million in 2003 compared to a loss of $2.5 million in 2002. Combining the results of Hurray! Solutions (predecessor) and Hurray! Holding (successor) on a pro forma basis, the loss from operations was $2.8 million in 2002.

 

Interest Expense.    Our interest expense, which is related to short-term bank loans, remained relatively unchanged at approximately $0.4 million in 2003 and 2002.

 

Net Income (Loss).    As a result of the foregoing, our net income was $4.5 million in 2003 compared to a net loss of $2.8 million in 2002. Combining the results of Hurray! Solutions (predecessor) and Hurray! Holding (successor) on a pro forma basis, the net loss was $3.2 million in 2002.

 

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Deemed Dividends on Series A Convertible Preference Shares.    We effected a deemed dividend of $0.1 million in 2003 due to the difference between the sale and conversion prices and fair market values of warrants and Series A convertible preference shares that we issued in the first and second quarters of 2003. We did not have a deemed dividend in 2002.

 

Income (Loss) Attributable to Holders of Ordinary Shares.    As a result of the foregoing, our net income attributable to holders of ordinary shares was $4.4 million in 2003 compared with a loss of $2.8 million in 2002. Combining the results of Hurray! Solutions (predecessor) and Hurray! Holding (successor) on a pro forma basis, the net loss attributable to holders of ordinary shares was $3.2 million in 2002.

 

Year Ended December 31, 2002 (Predecessor Except as Indicated) Compared to Year Ended December 31, 2001 (Predecessor)

 

Revenues.    Our revenues increased 643.7% to $10.5 million in 2002 from $1.4 million in 2001. This increase was primarily due to an increase in revenues from both our 2G services and our VASPro services provisioning and management software and related system integration services.

 

2G Services.    Revenues from 2G services increased 320.8% to $5.9 million in 2002 from $1.4 million in 2001, primarily as a result of strong growth in the market for 2G services and the increase in both per-use purchases and subscriptions of our 2G services. In 2002, revenues from per-use and subscription services were $4.6 million and $1.3 million, respectively, compared with $1.4 million and $nil, respectively, in 2001. We launched our 2G services in July 2001 and initially focused on per-use purchases of our 2G services, but began modifying our strategy to focus on migrating our users from per-use purchases to subscriptions. The increase in revenues from 2G services contributed to 49.8% of the increase in total revenues in 2002.

 

2.5G Services.    We did not record any revenues from our 2.5G services in 2001 and 2002 because we did not commercially launch 2.5G services until September 2002 and did not begin billing users for these services until the beginning of 2003.

 

Software and System Integration Services.    Our software and system integration services revenues increased to $4.6 million in 2002 from no revenues in 2001. This increase reflects our substantial completion of the implementation of Phase I of our VASPro services provisioning and management software with China Unicom in connection with the construction of its nation-wide WAP portal in 2002, which initially supported 0.5 million users. The increase in revenues from these services contributed to 50.2% of the increase in total revenues in 2002.

 

Cost of Revenues.    Our total cost of revenues increased to $7.8 million in 2002 from $0.6 million in 2001. This increase was primarily due to the recognition of third party hardware and software costs associated with the implementation of Phase I of China Unicom’s nation-wide WAP portal and increases in the sales of 2G services.

 

Cost of 2G Services.    Cost of 2G services increased 420.8% to $3.4 million in 2002 from $0.6 million in 2001 as a result of the increased service and network fees related to the continued increase in our sales of 2G services, marketing partner fees and depreciation related to equipment used to provide the services. The increase in cost of 2G services contributed to 37.8% of the increase in total cost of revenues in 2002.

 

Cost of 2.5G Services.    We did not incur any cost from 2.5G services in 2001 and 2002 because we did not commercially launch 2.5G services until September 2002 and did not begin billing users for these services until the beginning of 2003.

 

Cost of Software and System Integration Services.    Cost of software and system integration services increased to $4.5 million in 2002 from no costs in 2001 primarily due to the recognition of third party hardware

 

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and software costs of $4.2 million associated with implementation of Phase I of China Unicom’s WAP portal in 2002. The increase in the cost of these services contributed to 62.2% of the increase in total cost of revenues in 2002.

 

Gross Profit.    As a result of the foregoing, our gross profit increased 248.1% to $2.7 million in 2002, compared to $0.8 million in 2001.

 

Operating Expenses.    Our total operating expenses increased 13.4% to $5.2 million in 2002 from $4.5 million in 2001.

 

Product Development Expenses.    Our product development expenses increased 59.7% to $0.9 million in 2002 from $0.6 million in 2001. This increase was primarily due to significantly increased research and development staff costs related to development of our 2.5G services and our VASPro service provisioning and management software.

 

Selling and Marketing Expenses.    Our selling and marketing expenses increased 14.8% to $2.9 million in 2002 from $2.5 million in 2001. This increase was primarily due to increased staff costs related to sales and marketing efforts to promote 2G services and the roll-out of 2.5G services in the fourth quarter of 2002.

 

General and Administrative Expenses.    Our general and administrative expenses increased 2.3% to $1.4 million in 2002 from $1.3 million in 2001. This increase was due to modest increases in general and administrative staff compensation related to the growth in the size and level of our business activities.

 

Stock-based Compensation.    Our predecessor, Hurray! Solutions, did not incur stock-based compensation expenses in 2002. However, Hurray! Holding, which is a successor entity for 2003 and subsequent periods for purposes of our financial statements, incurred stock-based compensation expense of $0.4 million in 2002, which arose from options granted to non-employees.

 

Asset Impairment.    We had no asset impairment expenses in 2002 and a $0.1 million expenses in 2001. The expenses in 2001 resulted from the asset impairment of related computer equipment and software.

 

Income/(Loss) from Operations.    As a result of the foregoing, our loss from operations was $2.5 million in 2002 compared to a loss of $3.8 million in 2001. Combining the results of Hurray! Solutions (predecessor) and Hurray! Holding (successor) on a pro forma basis, the loss from operations was $2.8 million in 2002.

 

Interest Expense.    Our interest expense, which is related to short-term bank loans, increased 292.7% to $0.4 million in 2002 from $91,022 in 2001, as a result of an increase in the interest rates on short-term bank loans borrowed in 2002.

 

Net Loss.    As a result of the foregoing, our net loss attributable to shareholders decreased to $2.8 million in 2002 from and $3.9 million in 2001. Combining the results of Hurray! Solutions (predecessor) and Hurray! Holding (successor) on a pro forma basis, the net loss was $3.2 million in 2002.

 

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Liquidity and Capital Resources

 

Cash Flows and Working Capital

 

The following table sets forth our cash flows with respect to operating activities, investing activities and financing activities for the periods indicated:

 

    

For the Year Ended

December 31,


  

For the Nine Months
Ended September 30,


 
    

2001

(Predecessor)


   

2002

(Predecessor)


   

2003


  

2003

(unaudited)


  

2004


 
     (in thousands of U.S. dollars)  

Net cash provided by (used in) operating activities

   $ (2,325 )   $ (221 )   $ 3,093    $ 1,249    $ 7,217  

Net cash provided by (used in) investing activities

     (1,444 )     (397 )     1,254      1,883      (13,166 )

Net cash provided by financing activities

     4,365       2,375       6,792      6,791      3,384  
    


 


 

  

  


Net increase (decrease) in cash and cash equivalents

   $ 596     $ 1,757     $ 11,139    $ 9,923    $ (2,565 )
    


 


 

  

  


 

To date, we have primarily financed our operations through the private placement of equity to investors and our current management, capital contributions, short-term borrowings and cash flow from our operating subsidiaries.

 

Net cash provided by operating activities was $7.2 million for the first nine months of 2004, primarily reflecting our net income of $12.0 million, partially offset by accounts receivable, net of accounts payable, of $1.5 million in that period. Net cash used in investing activities for the first nine months of 2004 amounted to $13.2 million, which was used primarily in our acquisition of Beijing Palmsky and Beijing Enterprise in March and April 2004, respectively, net of cash acquired from these two entities, in an aggregate amount of $12.0 million. Net cash provided by financing activities was $3.4 million for the first nine months of 2004, mainly reflecting proceeds from the exercise of our warrants and an increase in restricted cash, partially offset by repayments of our short-term loans.

 

Net cash provided by operating activities was $3.1 million in 2003 compared to net cash used in operating activities of $0.2 million in 2002. This increase was primarily due to an increase in our net income and accrued expenses and other current liabilities, partially offset by an increase in our accounts receivable. Prior to 2003, we experienced significant negative cash flows from our operating activities.

 

Net accounts receivable increased from $0.8 million as of December 31, 2001, to $2.9 million as of December 31, 2002, and to $7.9 million as of December 31, 2003. This increase is primarily due to an increase in our revenues and the resulting increase in net accounts receivable at any given point in time. The average collection time for our accounts receivable from 2G and 2.5G services decreased from 104 days in 2001 to 61 days in 2002, increased to 63 days in 2003 and decreased to 58 days in the nine months ended September 30, 2004, while the average collection time for our accounts receivable from software and system integrations services increased from 130 days in 2002 to 153 days in 2003 and decreased to 130 days in the nine months ended September 30, 2004. The decrease in collection time for 2G and 2.5G services in 2002 was primarily due to our increased collection efforts, which decreased our receivables from the mobile operators. The increase in collection time for software and system integration services in 2003 was due to our increased revenues and work in progress. The decrease in collection time for our 2G and 2.5G services and software and system integration services in the nine months ended September 30, 2004 was due to our increased collection efforts and, in particular, an increase in accounts receivables from 2.5G services, which generally have a shorter collection time compared to 2G services. Consequently, the average collection time for our combined accounts receivable fluctuated from 104 days in 2001 to 85 days in 2002, to 109 days in 2003 and to 73 days in the nine months

 

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ended September 30, 2004. We establish provisions for bad debts in accordance with our provisioning policy, which is based upon several factors including the amount of time that a receivable has been overdue.

 

Currently, the majority of our net accounts receivable consist of fees due to us from mobile operators pursuant to our network service agreements related to our 2G and 2.5G services. We have entered into separate network service agreements with China Unicom, China Mobile and several of their respective provincial offices. In 2003, the majority of our 2G and 2.5G services revenues were contributed by twelve separate entities of these mobile operators, upon whom we rely for billing and collection services. In the event that the mobile operators or any of their provincial offices should withhold, suspend or delay the payment of such fees to us, we may experience cash flow difficulties, in that our net cash from operating activities may not be sufficient to meet our cash needs. See “Risk Factors — Risks Related to our Company — Risks Related to our 2G and 2.5G Services — We depend on China Unicom and, to a lesser extent, China Mobile, the two principal mobile operators in China, for substantially all of our revenue, and any loss or deterioration of our relationship with China Unicom and China Mobile may result in severe disruptions to our busi