F-1/A 1 df1a.htm AMENDMENT NO. 1 TO THE FORM F-1 Amendment No. 1 to the Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on November 30, 2010

Registration No. 333-170785

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 1

to

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

iSoftStone Holdings Limited

(Exact name of registrant as specified in its charter)

Not Applicable

(Translation of Registrant’s name into English)

 

Cayman Islands   7371   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

International Software Plaza

Building 9 Zhongguancun Software Park

No. 8 West Dongbeiwang Road, Haidian District

Beijing 100193

People’s Republic of China

(86-10) 5874-9000

(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 10011-5213

(212) 894-8940

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

 

 

Copies to:

 

Kurt J. Berney, Esq.

Portia Ku, Esq.
O’Melveny & Myers LLP

Plaza 66, 37th Floor
1266 Nanjing Road West

Shanghai 200040

People’s Republic of China

(86-21) 2307-7000

 

Z. Julie Gao, Esq.
c/o Skadden, Arps, Slate, Meagher & Flom LLP
42/F, Edinburgh Tower, The Landmark
15 Queen’s Road Central

Hong Kong
(852) 3740-4700

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement

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 earliest effective registration statement for the same offering.   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

 

Title of each class of securities to be registered    Amount to be
registered(1)
   Proposed maximum
offering price
per share(1)
   Proposed maximum
aggregate
offering price(1)
   Amount of
registration  fee(4)

Ordinary Shares, par value $0.0001 per share(2)(3)

   124,583,340    $1.30    $161,958,342    $11,547.63

 

 

(1) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933.
(2) Includes (i) ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public and (ii) ordinary shares that may be purchased by the underwriters pursuant to an option to purchase additional ADSs. These ordinary shares are not being registered for the purposes of sales outside of the United States.
(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 (Registration No.333-170867). Each American depositary share represents ten ordinary shares.
(4) US$3,565 was previously paid.

 

 

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, as amended or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. Neither we nor the selling shareholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (SUBJECT TO COMPLETION)

ISSUED NOVEMBER 30, 2010

10,833,334 American Depositary Shares

Representing 108,333,340 Ordinary Shares

LOGO

iSoftStone Holdings Limited

This is an initial public offering of our American depositary shares, or ADSs, each representing ten ordinary shares. We are offering 7,322,223 ADSs, and the selling shareholders identified in this prospectus are offering 3,511,111 ADSs. We will not receive any of the proceeds from the ADSs sold by the selling shareholders. We anticipate that the initial offering price of the ADSs will be between $11.00 and $13.00 per ADS.

Prior to this offering, there has been no public market for the ADSs or the ordinary shares. We have applied to have our ADSs listed on the New York Stock Exchange under the symbol “ISS.”

Investing in the ADSs and ordinary shares involves risks that are described in the “Risk Factors” section beginning on page 15 of this prospectus.

 

     Price to Public      Underwriting
Discounts  and
Commissions
     Proceeds, before
expenses, to Us
     Proceeds, before
expenses, to
the Selling
Shareholders
 

Per ADS

   $                   $                   $                   $               

Total

   $         $         $         $     

The underwriters have an option to purchase up to 1,625,000 additional ADSs from us at the public offering price, less underwriting discounts and commissions, within 30 days from the date of this prospectus.

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.

The underwriters expect to deliver the ADSs to purchasers on or about             , 2010.

 

 

 

UBS Investment Bank   J.P. Morgan   Morgan Stanley

Needham & Company, LLC

The date of this prospectus is             , 2010.


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LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

The Offering

     7   

Summary Consolidated Financial Data

     10   

Risk Factors

     15   

Special Note Regarding Forward-Looking Statements

     47   

Corporate History and Structure

     48   

Use of Proceeds

     52   

Dividend Policy

     53   

Capitalization

     54   

Dilution

     56   

Exchange Rate Information

     58   

Selected Consolidated Financial Data

     59   

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

     65   

Our Business

     112   

Regulations

     133   

Management

     138   

Principal and Selling Shareholders

     147   

Related Party Transactions

     151   

Description of Share Capital

     157   

Description of American Depositary Shares

     169   

Shares Eligible for Future Sale

     179   

Taxation

     182   

Underwriting

     188   

Expenses Relating to This Offering

     197   

Enforceability of Civil Liabilities

     198   

Legal Matters

     200   

Experts

     201   

Where You Can Find More Information

     202   

Glossary of Terms

     203   

Index to Consolidated Financial Statements

     F-1   

 

 

You should rely only on the information contained in this prospectus or in any related free-writing prospectus that we have filed with the Securities and Exchange Commission, or the SEC. Neither we, the selling shareholders nor the underwriters have authorized anyone, including the selling shareholders, to provide you with information that is different from that contained in this prospectus. This prospectus may only be used where it is legal to offer and sell these securities. The information in this prospectus is only accurate as of the date of this prospectus.

Until                     2010 (the 25th day after the date of this prospectus), all dealers that buy, sell, or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.


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PROSPECTUS SUMMARY

This summary highlights key aspects of the information contained elsewhere in this prospectus. As this is a summary, it does not contain all of the information that you should consider before making an investment decision. You should read the entire prospectus carefully, including the “Risk Factors” section and the financial statements and the accompanying notes to those statements, before deciding whether to buy our ADSs.

Our Business

We are a leading China-based IT services provider, serving both Greater China and Global clients. To date, we have focused on serving clients in four target industry verticals, each with large and growing demand for IT services and solutions: technology; communications; banking, financial services and insurance, or BFSI; and energy, transportation and public sector. We believe that maintaining a balanced business mix between key industry verticals across both Greater China and Global clients positions us well to capture greater opportunities in China’s unique and rapidly evolving market for IT services.

We provide an integrated suite of IT services and solutions, including Consulting & Solutions, IT Services and business process outsourcing, or BPO, services. We believe that our comprehensive end-to-end service offerings support expansion in scope and scale of client engagements. Through both organic growth and strategic acquisitions, we have proactively invested in developing new service lines to complement our existing suite to better serve our clients. Our IT Services, Consulting & Solutions and BPO service lines accounted for 64.1%, 33.1% and 2.8% of our net revenues in 2009, and 67.2%, 29.4% and 3.4% of our net revenues in the nine months ended September 30, 2010, respectively.

Our clients primarily include large corporations headquartered in China, the United States, Europe and Japan. In the twelve months ended September 30, 2010, our clients included 71 Fortune 500 companies, of which 23 were Greater China clients and 48 were Global clients. By serving both Greater China and Global clients on a common platform with shared resources, management, industry expertise and technology know-how, we are able to leverage synergies in winning new business and remaining cost competitive. Net revenues from our Greater China and Global clients accounted for 57.6% and 42.4% of our net revenues in 2009, and 55.6% and 44.4% of our net revenues in the nine months ended September 30, 2010, respectively. Revenues from our Greater China clients include all revenues from companies headquartered in Greater China and revenues from Global clients include all revenues from companies headquartered outside of Greater China, including revenues from the Greater China-based operations for these overseas clients. We have successfully established strong client relationships with both Greater China and Global clients within our primary industry verticals: for example, our key relationships include IBM, Microsoft and Sharp in technology, Alcatel-Lucent, AT&T and Huawei in communications, and Bank of China, China Life and UBS in BFSI, in each case as measured by revenue contribution in the nine months ended September 30, 2010. Our technology, communications, BFSI, and energy, transportation and public sector industry verticals accounted for 40.0%, 32.6%, 14.3% and 10.0% of our net revenues in 2009, and 34.4%, 38.9%, 14.7% and 7.0% of our net revenues in the nine months ended September 30, 2010, respectively.

We believe we have built one of the largest sales and service delivery platforms for IT services and solutions in China. We have grown from six sales and delivery centers as of January 1, 2007 to 19 sales and delivery centers as of the date of this prospectus, of which 12 are located in China, spanning tier one cities, such as Beijing, Shanghai and Shenzhen, as well as key tier two and three cities, such as Dalian, Nanjing, Tianjin, Wuhan and Wuxi. We were early to recognize the benefits of expanding into China’s tier two and three cities, including more favorable blended labor costs and the ability to attract and retain required talent in increasing scale. We also have operations in the United States, Europe and Japan that are close to the main offices of key Global clients. By combining onsite/onshore support and consulting with scalable and lower-cost offsite/offshore services and processing, we are able to meet client demands in a cost-effective manner while retaining significant operational flexibility.

 

 

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We believe resource management and planning is critically important to supporting our growth, and we are committed to effectively recruiting, training, developing and retaining our human capital. Our total number of employees has grown from 1,527 employees as of January 1, 2007 to 9,172 employees as of September 30, 2010. We have established three major training centers in Guangzhou, Tianjin and Wuxi. The training center in Wuxi that we helped establish and fund in cooperation with the Wuxi City government, the iCarnegie-iSoftStone training institute, in which we have an equity investment, utilizes the technical curriculum and professional certifications developed and maintained by iCarnegie Inc., an affiliate of Carnegie Mellon University, with annual training capacity of up to 10,000 students. In addition, our “Top 300” leadership development program is focused on identifying, training, promoting and relocating, as appropriate, qualified candidates to meet our middle and senior management needs.

In 2007, 2008 and 2009, our net revenues were $36.4 million, $82.5 million and $134.4 million, respectively, representing a CAGR of 92.1%, and in the nine months ended September 30, 2009 and 2010, our net revenues were $90.0 million and $135.2 million, an increase of 50.2%. In 2007, 2008 and 2009, our net income (loss) increased from a net loss of $10.3 million, to a net loss of $3,000 and then to net income of $9.0 million, and in the nine months ended September 30, 2009 and 2010, our net income decreased from $5.7 million to $0.3 million primarily due to share-based compensation charges on options granted to directors, employees and consultants. Our non-GAAP net income (loss) for 2007, 2008 and 2009, which excludes share-based compensation, interest expense of convertible notes, changes in fair value of certain liabilities carried at fair value, amortization of intangible assets from acquisitions and gain on bargain purchase of a business from net income (loss), were $(4.3) million, $4.7 million and $13.4 million, respectively. For the nine months ended September 30, 2009 and 2010, our non-GAAP net income were $7.9 million and $10.7 million, respectively. For a reconciliation of our non-GAAP net income (loss) to our U.S. GAAP net income (loss), see footnote (3) on page 13 of this prospectus.

Early on, we sought to identify and benefit from the various government incentives, subsidies and other efforts designed to promote growth of the IT services industry in China. In 2007, 2008, 2009 and the nine months ended September 30, 2009 and 2010, we recognized government subsidies as a reduction to cost of revenue and expenses, primarily cost of revenues, of nil, $1.7 million, $2.1 million, $1.5 million and $5.8 million, respectively, and recognized government subsidies as other income of $2.8 million, $0.9 million, $3.0 million, $1.9 million and $2.9 million, respectively.

Our operations and our growth have primarily been financed by cash collected from customers, issuances of our preference shares and convertible notes and short-term bank borrowings.

 

 

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Industry Background

Businesses, both domestically in China and globally, are outsourcing a growing portion of their IT services and business processes to China-based IT services providers. China is one of the largest and fastest growing markets for IT services, and as shown in the charts below, China’s domestic IT services market and offshore software development market are expected to experience significant growth in the coming years.

 

LOGO   LOGO

There are several factors driving the overall growth of China’s IT services industry, including the rapid growth of China’s economy and domestic demand for IT services, the strategic importance of China as a target market for Global clients, strong offshore outsourcing demand, availability of low-cost qualified IT professionals with global and regional language skills, well-developed infrastructure in China and strong government support and spending.

We believe we are well positioned to capture the significant market opportunities in the IT services industry in China.

Our Competitive Strengths, Strategies and Challenges

We believe that the following strengths have contributed to our growth and success:

 

   

geographically balanced client mix and service capabilities;

 

   

deep domain knowledge and solutions in target industry verticals;

 

   

strategic engagements with diverse blue-chip clients;

 

   

comprehensive end-to-end service offerings with a Consulting & Solutions front end;

 

   

robust and scalable China-based delivery platform with global market reach;

 

   

systematic development and management of human capital; and

 

   

experienced senior management team with proven track record of success.

 

 

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Our goal is to be the leading China-based provider of IT services and solutions to companies throughout Greater China and globally. We intend to achieve this objective by implementing the following strategies:

 

   

grow revenue with existing and new clients;

 

   

continue to invest in research and development, deepen domain expertise and develop specific solutions for target industry verticals;

 

   

continue to invest in training and development for our world-class human capital base;

 

   

drive efficiencies through ongoing improvements in operational excellence; and

 

   

capture new growth opportunities through strategic alliances and acquisitions.

We expect to face certain risks and uncertainties, including:

 

   

our ability to effectively manage our rapid growth;

 

   

intense competition from China-based and international IT services companies;

 

   

our ability to attract and retain sufficiently trained professionals to support our operations;

 

   

concentration of revenue and receivables in a small number of major clients;

 

   

our ability to anticipate and develop new services and enhance existing services to keep pace with rapid changes in technology and in our target industry verticals; and

 

   

our ability to identify, execute, integrate and manage new strategic alliances and acquisitions.

Please see “Risk Factors” and other information included in this prospectus for a discussion of these and other risks. Additionally, a significant majority of our outstanding shares is held by a small number of our existing shareholders, and these shareholders may have significantly greater influence on us and our corporate actions by virtue of the size of their shareholdings relative to our public shareholders. For example, our directors and executive officers, as a group, will beneficially own 26.7% of our outstanding ordinary shares following this offering, and our principal shareholders, as a group, will beneficially own approximately 66.2% of our outstanding ordinary shares following this offering. Our current principal shareholders and management will also continue to represent a majority of our board of directors.

Corporate History and Structure

We commenced operations in October 2001 through Beijing iSoftStone Technologies Ltd., or Beijing iSoftStone, a limited liability company established in China and majority owned by our founder Tianwen Liu. To enable us to raise equity capital from investors outside of China, in November 2005, we reorganized our corporate structure by establishing our current Cayman Islands holding company, iSoftStone Holdings Limited, or iSoftStone Holdings, and transferred substantially all the IT services business and related assets and liabilities of Beijing iSoftStone into iSoftStone Information Technology (Group) Co., Ltd., or iSoftStone WFOE, a wholly owned subsidiary of iSoftStone Holdings, in exchange for issuance of ordinary shares of iSoftStone Holdings to our founder Tianwen Liu and other shareholders of Beijing iSoftStone. Concurrently, because certain businesses cannot be conducted by foreign invested enterprises, iSoftStone WFOE entered into a series of contractual arrangements with Beijing iSoftStone and its shareholders.

 

 

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The following diagram illustrates our current corporate structure and the place of formation and the ownership of our major subsidiaries and affiliated entity as of the date of this prospectus. All of our subsidiaries are 100% owned or controlled by us except for Beijing Guodian Ruantong Technology Co., Ltd., in which we have a 60% equity interest, and Beijing iSoftStone Jiewen Information Technology Co., Ltd., in which we have a 67% equity interest.

LOGO

 

(1) Include a series of contractual arrangements among iSoftStone WFOE, Beijing iSoftStone, and certain shareholders of Beijing iSoftStone, including an exclusive outsourcing agreement, an exclusive technology consulting and management service agreement, a trademark and software licensing agreement, an equity pledge agreement, and an irrevocable proxy. For a more detailed discussion of these contractual arrangements, see “Related Party Transactions—Contractual Arrangements with Beijing iSoftStone.”

Corporate Information

Our principal executive offices are located at International Software Plaza, Building 9 Zhongguancun Software Park, No. 8 West Dongbeiwang Road, Haidian District, Beijing 100193, People’s Republic of China. Our telephone number at this address is (86-10) 5874-9000 and our fax number is (86-10) 5874-9002. Our website is http://www.isoftstone.com. The information contained in our website is not a part of this prospectus.

 

 

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Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.

Unless otherwise indicated, (a) references in this prospectus to this offering are to our offering of ADSs pursuant to this prospectus; (b) information in this prospectus assumes that (i) this offering is closed on December 17, 2010, (ii) the underwriters do not exercise their over-allotment option to purchase additional ADSs, (iii) the automatic conversion of all of our outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares upon the closing of this offering, and (iv) the issuance of 19,913,824 ordinary shares upon the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million upon the closing of this offering, based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus; and (c) information in this prospectus does not assume the issuance of (i) 85,121,280 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus, (ii) 7,412,746 ordinary shares reserved for future issuance under our share incentive plans, (iii) ordinary shares issuable upon the conversion of our convertible notes with an aggregate principal amount of $20 million outstanding at the date of this prospectus, (iv) acquisition consideration (A) relating to our October 2010 acquisition of Ascend Technologies, Inc. of a number of ordinary shares to be determined by dividing $963,902 by a per share issue price equal to 90% of the per share equivalent price in this offering if this offering is closed prior to December 24, 2010, or 892,502 ordinary shares assuming an initial public offering price of $12.00 per ADS (the mid-point of the estimated range of the offering price), and (B) relating to our November 2010 acquisition of Shanghai Kangshi Information Systems Company Limited of a number of ordinary shares to be determined by dividing $1,198,215 by a per ordinary share price equal to 95% of the per share equivalent of the initial offering price, or 1,051,066 ordinary shares assuming an initial public offering price of $12.00 per ADS (the mid-point of the estimated range of the offering price), and (v) up to 1,361,058 ordinary shares and an additional $67,898 worth of ordinary shares issuable, conditionally or unconditionally, pursuant to certain share-based compensation arrangements in connection with certain acquisitions that we made prior to the date of this prospectus. For more information relating to such acquisitions, see “Corporate History and Structure—Corporate History” and “Related Party Transactions—Acquisition Related Shares Issuance.”

This prospectus contains translations of Renminbi amounts into U.S. dollars at specified rates. Unless otherwise noted, all translations from Renminbi to U.S. dollar amounts were made at the noon buying rate in the City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York as of September 30, 2010, which was RMB6.6905 to $1.00. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. The PRC government restricts or prohibits the conversion of Renminbi into foreign currency and foreign currency into Renminbi for certain types of transactions. On November 26, 2010, the noon buying rate was RMB6.6675 to $1.00.

Conventions Used in This Prospectus

We have included elsewhere in this prospectus a glossary of industry and other terms that we refer to throughout the prospectus. See “Glossary of Terms”.

 

 

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THE OFFERING

 

Price per ADS:

We currently estimate that the initial public offering price will be between $11.00 and $13.00 per ADS.

ADSs Offered:

 

By us

7,322,223 ADSs

By the selling shareholders

3,511,111 ADSs

Total

10,833,334 ADSs

 

Concurrent Private Placement

In conjunction with, and subject to, the closing of the offering of our ADSs, Bayfront Investments (Mauritius) Pte. Ltd., which we refer to as Bayfront, has agreed to purchase $20 million of our ordinary shares at a per share price equal to the per share equivalent of the initial offering price, or 16,666,667 ordinary shares assuming an initial public offering price of US$12.00 per ADS, the mid-point of the estimated range of the initial public offering price, subject to certain closing conditions. This investment is being made pursuant to an offer exempt from registration with the U.S. Securities and Exchange Commission pursuant to Regulation S and Section 4(2) of the Securities Act of 1933, as amended. Bayfront is a private company limited by shares incorporated in Mauritius and an indirect wholly-owned subsidiary of Temasek Holdings (Private) Limited, which we refer to as Temasek. See “Underwriting—Concurrent Private Placement.”

 

ADSs Outstanding Immediately After This Offering

10,833,334 ADSs (or 12,458,334 ADSs if the underwriters exercise the option to purchase additional 1,625,000 ADSs in full).

 

Ordinary Shares Outstanding Immediately After This Offering

509,693,868 ordinary shares(1) (or 525,943,868 ordinary shares if the underwriters exercise the option to purchase additional ADSs in full).

 

Option to Purchase Additional ADSs

We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of 1,625,000 additional ADSs at the initial public offering price, less underwriting discounts and commissions, solely for the purpose of covering over-allotments.

 

(1) The number of ordinary shares that will be outstanding immediately after this offering:

 

   

includes 16,666,667 ordinary shares issued to Bayfront, an affiliate of Temasek, for its investment in our ordinary shares, assuming a price per ADS of US$12.00, the mid-point of the estimated range of the initial public offering price;

 

   

assumes the automatic conversion of all of our outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares upon the closing of this offering;

 

   

assumes the issuance of 19,913,824 ordinary shares upon the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million upon the closing of this offering, based on an assumed initial public

 

 

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offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus;

 

   

excludes ordinary shares issuable upon the conversion of our convertible notes with an aggregate principal amount of $20 million outstanding at the date of this prospectus. Within 12 months of the closing of this offering, such convertible notes are convertible into our ordinary shares at a significant discount to the offering price or redeemable for cash at the holders’ option. See “Related Party Transactions—Private Placements—Convertible Notes Financing”;

 

   

excludes 85,121,280 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus;

 

   

excludes 7,412,746 ordinary shares reserved for future issuances under our share incentive plans;

 

   

excludes acquisition consideration (A) relating to our October 2010 acquisition of Ascend Technologies, Inc. of a number of ordinary shares to be determined by dividing $963,902 by a per share issue price equal to 90% of the per share equivalent price in this offering if this offering is closed prior to December 24, 2010, or 892,502 ordinary shares assuming an initial public offering price of $12.00 per ADS (the mid-point of the estimated range of the offering price), and (B) relating to our November 2010 acquisition of Shanghai Kangshi Information Systems Company Limited of a number of ordinary shares to be determined by dividing $1,198,215 by a per ordinary share price equal to 95% of the per share equivalent of the initial offering price, or 1,051,066 ordinary shares assuming an initial public offering price of $12.00 per ADS (the mid-point of the estimated range of the offering price); and

 

   

excludes up to 1,361,058 ordinary shares and an additional $67,898 worth of ordinary shares issuable, conditionally or unconditionally, pursuant to certain share-based compensation arrangements in connection with certain acquisitions that we made prior to the date of this prospectus. For more information relating to such acquisitions, see “Corporate History and Structure—Corporate History” and “Related Party Transactions—Acquisition Related Shares Issuance.”

 

The ADSs

Each ADS represents ten ordinary shares, par value $0.0001 per share.

The depositary will be the holder of the ordinary shares underlying the ADSs and you will have the rights of an ADS holder as provided in the deposit agreement.

You may surrender your ADSs to the depositary to withdraw the ordinary shares underlying your ADSs. The depositary will charge you a fee for such an exchange.

We may amend or terminate the deposit agreement for any reason without your consent. If an amendment becomes effective, you will be bound by the deposit agreement as amended if you continue to hold your ADSs.

To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American

 

 

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Depositary Shares.” You should also read the deposit agreement, which is filed as an exhibit to the registration statement on Form F-6.

 

Settlement

The ADSs are expected to be delivered against payment on or around                     , 2010.

 

Use of Proceeds

We estimate that we will receive net proceeds of approximately $97.3 million from this offering and from the investment by Bayfront, an affiliate of Temasek, in our ordinary shares, or $115.4 million if the underwriters exercise their option to purchase additional ADSs in full, assuming an initial public offering price of $12.00 per ADS, the mid-point of the estimated range of the offering price, after deducting estimated underwriter discounts, commissions and estimated offering expenses payable by us (without giving effect to any placement fees payable by us in connection with the concurrent private placement with Bayfront). We intend to use $36.8 million of our net proceeds from this offering to repay outstanding bank borrowings, and use the remainder for other general corporate purposes, such as working capital, facilities acquisitions and funding potential acquisitions of, or investments in, other businesses or technologies that we believe will complement our current business and expansion strategies.

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

 

Risk Factors

See “Risk Factors” and other information included in this prospectus for a discussion of the risks you should carefully consider before deciding to invest in our ADSs.

 

Listing

We have applied to have our ADSs listed on the New York Stock Exchange, or the NYSE. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system.

 

Proposed NYSE Symbol

“ISS”

 

Depositary

JPMorgan Chase Bank, N.A.

 

Lock-Up

We, each of our directors and executive officers, the shareholders holding substantially all of our outstanding ordinary shares, all of the holders of our convertible notes, our significant optionholders and Bayfront, an affiliate of Temasek, have agreed with the underwriters (or with us for the benefit of the underwriters) not to sell, transfer or dispose of any ADSs or ordinary shares for a period of up to 180 days after the date of this prospectus without the consent of the representatives of the underwriters. See “Underwriting.”

 

Reserved ADSs

At our request, the underwriters have reserved for sale, at the public offering price, up to an aggregate of 650,000 ADSs offered by this prospectus to our directors, officers, employees, business associates and other related persons through a directed share program.

 

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following summary consolidated statements of operations data for the years ended December 31, 2007, 2008 and 2009 and the summary consolidated balance sheet data as of December 31, 2008 and 2009 have been derived from our audited consolidated financial statements included elsewhere in this prospectus, which have been audited by Deloitte Touche Tomatsu CPA Ltd., an independent registered public accounting firm. The report of Deloitte Touche Tomatsu CPA Ltd. on our audited financial statements is included elsewhere in this prospectus. The summary consolidated balance sheet data as of December 31, 2007 have been derived from our audited consolidated financial statements not included elsewhere in this prospectus. Our audited consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. Our historical results do not necessarily indicate our expected results for any future periods. Our summary consolidated statements of operations data for each of the nine month periods ended September 30, 2009 and 2010 and summary consolidated balance sheet data as of September 30, 2010 have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. We have prepared the unaudited consolidated financial information on the same basis as our audited consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Results for the nine months ended September 30, 2010 are not necessarily indicative of results that may be expected for the full year. You should read the summary consolidated financial data in conjunction with those financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

 

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Summary Consolidated Statements of Operations Data

 

     For the year ended December 31,          For the nine months ended September 30,       
     2007      2008      2009          2009              2010      
    

(dollars in thousands, except share

and per share data or as otherwise noted)

 

Net revenues

   $ 36,417       $ 82,464       $ 134,387       $ 90,032       $ 135,198   

Cost of revenues(1)(2)

     (24,399      (55,083      (88,391      (59,585      (87,334
                                            

Gross profit

     12,018         27,381         45,996         30,447         47,864   
                                            

Operating expenses:

              

General and administrative expenses(1)

     (12,762      (16,344      (26,654      (17,482      (32,965

Selling and marketing expenses(1)(2)

     (6,150      (11,264      (13,205      (9,487      (11,485

Research and development expenses(1)

     (4,498      (1,057      (1,222      (643      (2,517
                                            

Total operating expenses

     (23,410      (28,665      (41,081      (27,612      (46,967
                                            

Changes in fair value of contingent consideration in connection with business combination

     —           —           (3      —           231   

Change in fair value of return rate reset feature of convertible notes

     —           —           —           —           (1,028

Other income, net

     56         800         981         789         25   

Government subsidies

     2,822         862         2,999         1,929         2,910   

Gain on sale of equity of a subsidiary

     —           —           —           —           1,079   
                                            

(Loss) income from operations

     (8,514      378         8,892         5,553         4,114   
                                            

Interest income

     90         228         138         110         98   

Interest expense

     (71      (363      (878      (522      (3,581

Change in fair value of warrants

     (1,419      (676      —           —           —     

Gain on bargain purchase of a business

     —           —           66         66         —     
                                            

(Loss) income before provision for income taxes and loss in equity method investments, net of income taxes

     (9,914      (433      8,218         5,207         631   

Income taxes (expenses) benefit

     (373      492         823         518         (171
                                            

(Loss) income after income taxes before loss in equity method investments, net of income taxes

     (10,287      59         9,041         5,725         460   

Loss in equity method investments, net of income taxes

     (21      (62      (13      (11      (188
                                            

Net (loss) income(3)

     (10,308      (3      9,028         5,714         272   

Less: Net loss attributable to noncontrolling interest

     114         101         21         14         514   
                                            

Net (loss) income attributable to iSoftStone Holdings Limited

   $ (10,194    $ 98       $ 9,049       $ 5,728       $ 786   
                                            

 

 

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     For the year ended December 31,      For the nine months ended
September 30,
 
     2007     2008     2009      2009      2010  
     (dollars in thousands, except share and per share data or as otherwise noted)  

Net (loss) income per share attributable to ordinary shareholders of iSoftStone Holdings Limited:

            

Basic

   $ (0.10   $ (0.03   $ 0.01       $ 0.01       $ (0.02

Diluted

   $ (0.10   $ (0.03   $ 0.01       $ 0.01       $ (0.02
                                          

Weighted average shares used in calculating net (loss) income per ordinary share

            

Basic

     38,827,820        122,681,330        125,106,274         123,388,300         133,652,540   

Diluted

     38,827,820        122,681,330        131,892,325         129,641,280         133,652,540   
                                          

 

(1) Includes share-based compensation charges totaling $4.0 million, $1.4 million and $2.4 million in 2007, 2008 and 2009, and $0.7 million and $5.8 million in the nine months ended September 30, 2009 and 2010, respectively, allocated as follows:

 

     For the year ended December 31,      For the nine months ended September 30,  
       2007          2008          2009            2009              2010      
     (dollars in thousands)  

Cost of revenues

   $ 56       $ 85       $ 159       $ 69       $ 106   

Operating expenses:

              

General and administrative expenses

     3,895         1,258         2,074         618         5,508   

Selling and marketing expenses

     18         44         110         39         198   

Research and development expenses

     1         1         7         1         5   
                                            

Total share-based compensation expenses

   $ 3,970       $ 1,388       $ 2,350       $ 727       $ 5,817   
                                            

 

(2) Includes amortization of intangible assets totaling $0.6 million, $2.6 million and $2.0 million in 2007, 2008 and 2009, and $1.5 million and $1.2 million in the nine months ended September 30, 2009 and 2010, respectively, allocated as follows:

 

     For the year ended December 31,      For the nine months ended September 30,  
         2007              2008              2009              2009              2010      
     (dollars in thousands)  

Cost of revenues

   $ 166       $ 447       $ 87       $ 67       $ 87   

Operating expenses:

              

Selling and marketing expenses

     416         2,202         1,928         1,443         1,071   
                                            

Total amortization of intangible assets expenses

   $ 582       $ 2,649       $ 2,015       $ 1,510       $ 1,158   
                                            

 

 

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(3) To supplement our net income presented in accordance with U.S. GAAP, we use the non-GAAP financial measure of net income, which is adjusted from results based on U.S. GAAP to exclude share-based compensation, interest expense of convertible notes, changes in fair value of certain liabilities carried at fair value, amortization of intangible assets from acquisitions and gain on bargain purchase of a business. This non-GAAP financial measure is provided as additional information to help our investors compare business trends among different reporting periods on a consistent basis and to enhance investors’ overall understanding of the historical and current financial performance of our continuing operations and our prospects for the future. This non-GAAP financial measure should be considered in addition to results prepared in accordance with U.S. GAAP, but should not be considered a substitute for or superior to U.S. GAAP results. In addition, our calculation of this non-GAAP financial measure may be different from the calculation used by other companies, and therefore comparability may be limited.

The following table sets forth the reconciliation of our non-GAAP net income (loss) to our U.S. GAAP net income (loss):

 

     For the Year Ended
December 31,
    For the Nine Months
Ended

September 30,
 
         2007             2008             2009             2009             2010      
     (U.S. dollars in thousands)  

Net income (loss) (U.S. GAAP)

     (10,308     (3     9,028        5,714        272   

Share-based compensation

     3,970        1,388        2,350        727        5,817   

Amortization of intangible assets from acquisitions

     582        2,649        2,015        1,510        1,158   

Interest expense of convertible notes

     —          —          63        —          2,677   

Changes in fair value of contingent consideration in connection with business combinations

     —          —          3        —          (231

Changes in fair value of the return rate reset feature of convertible notes

     —          —          —          —          1,028   

Changes in fair value of warrants

     1,419        676        —          —          —     

Gain on bargain purchase of a business

     —            (66     (66     —     
                                        

Total non-GAAP adjustments

     5,971        4,713        4,365        2,171        10,449   
                                        

Net income (loss) (non-GAAP)

     (4,337     4,710        13,393        7,885        10,721   
                                        

 

 

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Summary Consolidated Balance Sheet Data

 

     December 31,
2007
    December 31,
2008
    December 31,
2009
    September 30,
2010
     September 30,
2010
 
                              Pro forma(1)  
     (dollars in thousands)         

Cash

   $ 12,963      $ 33,776      $ 55,138      $ 40,414       $ 40,414   

Accounts receivable, net of allowance for doubtful accounts of $292,000, $309,000, $423,000 and $1,968,000 as of December 31, 2007, 2008, 2009 and September 30, 2010, respectively

     12,572        28,350        69,094        97,443         97,443   

Total assets

     38,961        82,841        162,179        193,252         193,252   

Total liabilities

     17,030        27,158        90,935        115,323         95,806   

Series B convertible redeemable preference shares

     18,130        49,459        52,159        54,164         —     

Total iSoftStone Holdings Limited shareholders’ equity

     3,676 (2)      6,221 (2)      18,590 (2)      23,097         96,778   

Non-controlling interest

     125        3        495        668         668   
                                         

Total equity

     3,801        6,224        19,085        23,765         97,446   
                                         

Total liabilities, series B convertible redeemable preference shares and equity

   $ 38,961      $ 82,841      $ 162,179      $ 193,252       $ 193,252   

 

(1) The pro forma balance sheet information as of September 30, 2010 reflects (a) the automatic conversion of all of our outstanding series A convertible preference shares and series B convertible redeemable preference shares into our ordinary shares using a conversion ratio of one for one upon the closing of this offering, and (b) the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million into 19,913,824 ordinary shares upon the closing of this offering, based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus.
(2) Including series A convertible preference shares with carrying amount of $14.2 million for each of the periods ended December 31, 2007, 2008, 2009 and September 30, 2010.

 

 

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RISK FACTORS

An investment in our ADSs involves a high degree of risk. You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on our business, financial condition, results of operations and prospects if they actually occur. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

Risks Related to Our Business and Industry

We may be unable to effectively manage our rapid growth, which could place significant strain on our management personnel, systems and resources. We may not be able to achieve anticipated growth, which could materially and adversely affect our business and prospects.

We have experienced rapid growth and significantly expanded our business recently. Our net revenues grew from $36.4 million in 2007 to $134.4 million in 2009 and $135.2 million in the nine months ended September 30, 2010. In addition to organic growth, we have also grown through strategic acquisitions. As of the date of this prospectus, we have 19 sales and delivery centers, including 12 in China, two in Japan, four in the United States and one in Taiwan. As of September 30, 2010, we had 9,172 employees, as compared to 1,527 employees as of January 1, 2007. We are actively looking at additional locations to establish new offices and expand our current offices and sales and delivery centers. We intend to continue our expansion in the foreseeable future to pursue existing and potential market opportunities.

Our rapid growth has placed and will continue to place significant demands on our management and our administrative, operational and financial infrastructure. Continued expansion increases the challenges we face in:

 

   

recruiting, training, developing and retaining sufficient skilled technical, sales and management personnel;

 

   

creating and capitalizing upon economies of scale;

 

   

managing a larger number of clients in a greater number of industries and locations;

 

   

maintaining effective oversight of personnel and offices;

 

   

coordinating work among offices and project teams and maintaining high resource utilization rates;

 

   

integrating new management personnel and expanded operations while preserving our culture and values;

 

   

developing and improving our internal administrative infrastructure, particularly our financial, operational, human resources, communications and other internal systems, procedures and controls; and

 

   

adhering to and further improving our high quality and process execution standards and maintaining high levels of client satisfaction.

Moreover, as we introduce new services or enter into new markets, we may face new market, technological and operational risks and challenges with which we are unfamiliar, and it may require substantial management efforts and skills to mitigate these risks and challenges. As a result of any of these problems associated with expansion, our business, results of operations and financial condition could be materially and adversely affected. Furthermore, we may not be able to achieve anticipated growth, which could materially and adversely affect our business and prospects.

 

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Adverse changes in the economic environment, either in China or globally, could reduce our clients’ purchases from us and increase pricing pressure, which could materially and adversely affect our revenues and results of operations.

The IT services industry is particularly sensitive to the economic environment, either in China or globally, and tends to decline during general economic downturns. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to the economic environment, especially for regions in which we and our clients operate, such as the United States, Europe, China and Japan. The recent crisis in the financial and credit markets in the United States, Europe and Asia has led to a global economic slowdown, with the economies of those regions showing significant signs of weakness. During an economic downturn, our clients may cancel, reduce or defer their IT spending or change their IT outsourcing strategy, and reduce their purchases from us. The recent global economic slowdown and any future economic slowdown, and the resulting diminution in IT spending, could also lead to increased pricing pressure from our clients. The occurrence of any of these events could materially and adversely affect our revenues and results of operations.

We face intense competition from onshore and offshore IT services companies, and, if we are unable to compete effectively, we may lose clients and our revenues may decline.

The market for IT services is highly competitive and we expect competition to persist and intensify. We believe that the principal competitive factors in our markets are industry expertise, breadth and depth of service offerings, quality of the services offered, reputation and track record, marketing and selling skills, scalability of infrastructure and price.

In the IT outsourcing market, we face competition from the following major competitors:

 

   

Chinese IT services companies, such as Camelot Information Systems, ChinaSoft International Ltd., HiSoft Technology International Limited, Longtop Financial Technologies Limited, Neusoft Group Ltd., and VanceInfo Technologies Inc.;

 

   

Indian IT services companies, such as Cognizant Technology Solutions Corp., HCL Technologies, Infosys Technologies Ltd., Tata Consultancy Services Ltd. and Wipro Technologies;

 

   

offshore IT services providers in emerging outsourcing destinations with low wage costs such as Southeast Asia, Latin America and Eastern Europe; and

 

   

in-house IT departments of large corporations.

To date, we do not typically compete directly with the larger global consulting and outsourcing firms, such as Accenture, Capgemini, Hewlett-Packard and IBM, who are typically engaged in conjunction with large global projects. However, we may compete with these firms if they seek smaller engagements, particularly in conjunction with a strategy to enter the domestic China market. In addition, the trend towards offshore outsourcing, international expansion by foreign and domestic competitors and continuing technological changes will result in new and different competitors entering our markets.

In the IT outsourcing market, clients tend to engage multiple outsourcing service providers instead of using an exclusive service provider, which could reduce our revenues to the extent that clients obtain services from other competing providers. Clients may prefer service providers that have facilities located globally or that are based in countries more cost-competitive than China. Our ability to compete also depends in part on a number of factors beyond our control, including the ability of our competitors to recruit, train, develop and retain highly skilled professionals, the price at which our competitors offer comparable services and our competitors’ responsiveness to client needs. Therefore, we cannot assure you that we will be able to retain our clients while competing against such competitors. Increased competition, our inability to compete successfully against competitors, pricing pressures or loss of market share could harm our business, financial condition and results of operations.

 

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Due to intense competition for highly skilled personnel, we may fail to attract and retain enough sufficiently trained personnel to support our operations; as a result, our ability to bid for and obtain new projects may be negatively affected and our revenues could decline.

The IT services industry relies on skilled personnel, and our success depends to a significant extent on our ability to recruit, train, develop and retain qualified personnel, especially experienced middle and senior level management. The IT services industry in China has experienced significant levels of employee attrition. Our attrition rates were 13.9%, 17.7%, 12.8% and 14.3% per annum in 2007, 2008, 2009 and the nine months ended September 30, 2010, respectively. We may encounter higher attrition rates in the future, particularly if China continues to experience strong economic growth.

There is significant competition in China for skilled personnel, especially experienced middle and senior level management, with the skills necessary to perform the services we offer to our clients. Increased competition for these personnel, in the IT industry or otherwise, could have an adverse effect on us. A significant increase in our attrition rate could decrease our operating efficiency and productivity and could lead to a decline in demand for our services.

Additionally, failure to recruit, train, develop and retain personnel with the qualifications necessary to fulfill the needs of our existing and future clients or to assimilate new personnel successfully could have a material adverse effect on our business, financial condition and results of operations. Failure to retain our key personnel on client projects or find suitable replacements for key personnel upon their departure may lead to termination of some of our client contracts or cancellation of some of our projects, which could materially and adversely affect our business.

Our success depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose their services.

Our future success heavily depends upon the continued services of our senior executives and other key employees. In particular, we rely on the expertise, experience, client relationships and reputation of Tianwen Liu, our founder, chairman and chief executive officer. We currently do not maintain key man life insurance for any of the senior members of our management team or other key personnel. If one or more of our senior executives or key employees are unable or unwilling to continue in their present positions, it could disrupt our business operations, and we may not be able to replace them easily or at all. In addition, competition for senior executives and key personnel in our industry is intense, and we may be unable to retain our senior executives and key personnel or attract and retain new senior executive and key personnel in the future, in which case our business may be severely disrupted, and our financial condition and results of operations may be materially and adversely affected.

If any of our senior executives or key personnel joins a competitor or forms a competing company, we may lose clients, suppliers, know-how and key professionals and staff members to them. Also, if any of our business development managers, who generally keep a close relationship with our clients, joins a competitor or forms a competing company, we may lose clients, and our revenues may be materially and adversely affected. Additionally, there could be unauthorized disclosure or use of our technical knowledge, practices or procedures by such personnel. Most of our executives and key personnel have entered into employment agreements with us that contain non-competition provisions, non-solicitation and nondisclosure covenants. However, if any dispute arises between our executive officers and key personnel and us, such non-competition, non-solicitation and nondisclosure provisions might not provide effective protection to us, especially in China, where most of these executive officers and key employees reside, in light of the uncertainties with China’s legal system. See “Risk Factors—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could have a material adverse effect on us.”

 

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We generate a significant portion of our revenues from a small number of major clients and any loss of business from these clients could reduce our revenues and significantly harm our business.

We have derived, and believe that in the foreseeable future we will continue to derive, a significant portion of our revenues from a small number of major clients. In 2007, IBM contributed more than 10% of our net revenues; in 2008, Microsoft contributed more than 10% of our net revenues; and in 2009 and the nine months ended September 30, 2010, Huawei and Microsoft each contributed more than 10% of our net revenues, together accounting for 34.4% and 38.1% of our total net revenues, respectively. In the aggregate, our top ten clients accounted for 44.9%, 49.7%, 56.7% and 55.8% of our net revenues in 2007, 2008, 2009 and the nine months ended September 30, 2010, respectively.

Our ability to maintain close relationships with these and other major clients is essential to the growth and profitability of our business. However, the volume of work performed for a specific client is likely to vary from year to year, especially since we are generally not our clients’ exclusive IT services provider and we do not have long-term commitments from any of our clients to purchase our services. A major client in one year may not provide the same level of revenues for us in any subsequent year. The IT services we provide to our clients, and the revenues and income from those services, may decline or vary as the type and quantity of IT services we provide changes over time. In addition, our reliance on any individual client for a significant portion of our revenues may give that client a certain degree of pricing leverage against us when negotiating contracts and terms of service.

In addition, a number of factors other than our performance could cause the loss of or reduction in business or revenues from a client, and these factors are not predictable. For example, a client may decide to reduce spending on technology services or sourcing from us due to a challenging economic environment or other factors, both internal and external, relating to its business. These factors may include corporate restructuring, pricing pressure, changes to its outsourcing strategy, switching to another IT services provider or returning work in-house.

The loss of any of our major clients, or a significant decrease in the volume of work they outsource to us or the price at which we sell our services to them, could adversely affect our financial condition and results of operations.

If we are unable to collect our receivables from our clients, our results of operations and cash flows could be adversely affected.

Our business depends on our ability to successfully obtain payment from our clients of the amounts they owe us for work performed. As of December 31, 2007, 2008 and 2009 and as of September 30, 2010, our billed accounts receivable, net of allowance for doubtful accounts, totaled $6.3 million, $9.5 million, $17.5 million and $21.6 million, respectively, and our unbilled accounts receivable, net of allowance for doubtful accounts, totaled $6.3 million, $18.9 million, $51.6 million and $75.8 million, respectively. Our largest client accounted for 27.6% and 23.1% of our net accounts receivables as of December 31, 2009 and as of September 30, 2010, respectively. Since we generally do not require collateral or other security from our clients, we establish an allowance for doubtful accounts based upon estimates, historical experience and other factors surrounding the credit risk of specific clients. As of December 31, 2007, 2008 and 2009 and as of September 30, 2010, the provision made for doubtful accounts was $0.3 million, $0.3 million, $0.4 million and $2.0 million, respectively. However, actual losses on client receivables balance could differ from those that we anticipate and as a result we might need to adjust our allowance. There is no guarantee that we will accurately assess the creditworthiness of our clients. Macroeconomic conditions, including related turmoil in the global financial system, could also result in financial difficulties for our clients, including limited access to the credit markets, insolvency or bankruptcy, and as a result could cause clients to delay payments to us, request modifications to their payment arrangements that could increase our receivables balance, or default on their payment obligations to us. As a result, an extended delay or default in payment relating to a significant account will have a material and adverse effect on the aging schedule and turnover days of our accounts receivable. If we are unable to collect our receivables from our clients in accordance with the contracts with our clients, our results of operations and cash flows could be adversely affected.

 

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In many cases our client engagements are not long-term, and our clients may terminate contracts before completion or choose not to renew contracts, which could adversely affect our business and reduce our revenues.

Our clients typically retain us on a non-exclusive, project-by-project basis and are not obligated for any long-term commitments to us. Many of our client contracts can be terminated by our clients with or without cause. There are a number of factors relating to our clients that are outside of our control which might lead them to terminate a contract or project with us, including:

 

   

financial difficulties for the client;

 

   

a change in strategic priorities, resulting in elimination of the impetus for the project or a reduced level of technology spending;

 

   

a change in outsourcing strategy resulting in moving more work to the client's in-house technology departments or to our competitors;

 

   

the replacement by our clients of existing software with packaged software supported by licensors; and

 

   

mergers and acquisitions or significant corporate restructurings.

In addition, some of our client contracts specify that if a change of control of our company occurs during the term of the contract, the client has the right to terminate the contract. If any future event triggers any change-of-control provision in our client contracts, these contracts may be terminated, which would result in our loss of revenues in the future. If our clients terminate our contracts before completion or choose not to renew our contracts, our business, financial condition and results of operations may be materially and adversely affected.

If we are not successful in obtaining and managing increasingly large and complex projects, we may not achieve our growth goals and our results of operations may be adversely affected.

As our domain knowledge in the industries we serve deepens and our relationships with clients strengthen, more clients have engaged us to undertake increasingly large and complex projects. To successfully obtain and manage larger and more complex projects, we need to establish closer relationships with our clients and develop a thorough understanding of their operations. In addition, we may face a number of challenges managing larger and more complex projects, including maintaining high quality control and process execution standards and controlling costs. In addition, we must maintain close client contact and high levels of client satisfaction, while at the same time maintaining continuity in personnel engaged in a particular project.

Our ability to successfully obtain and manage larger and more complex projects depends significantly on the skills of our management personnel and professionals, some of whom do not have experience managing large or complex projects. Larger and more complex projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages or may cancel or delay additional planned engagements. Such cancellations or delays make it difficult to plan for project resource requirements.

If we are not able to successfully obtain engagements for larger and more complex projects, we may not achieve our growth goals. Even if we are successful in obtaining such engagements, a failure by us to effectively manage these larger and more complex projects could cause us to lose business and may adversely affect our reputation and results of operations.

The growth and success of our business depends on our ability to anticipate and develop new services and enhance existing services in order to keep pace with rapid changes in technology and in the industries we focus.

The IT services market is characterized by rapid technological change, evolving industry standards, changing client preferences and new product and service introductions. Our future growth and success depend

 

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significantly on our ability to anticipate developments in IT services, and offer and develop new product and service lines to meet our clients’ evolving needs. We may not be successful in anticipating or responding to these developments in a timely manner, or if we do respond, the services or technologies we develop may not be successful in the marketplace. The development of some of the services and technologies may involve significant upfront investments and the failure of these services and technologies may result in our being unable to recover these investments, in part or in full. Further, services or technologies that are developed by our competitors may render our services uncompetitive or obsolete. In addition, new technologies may be developed that allow our clients to more cost-effectively perform the services that we provide, thereby reducing demand for our services. Should we fail to adapt to the rapidly changing IT services market or if we fail to develop suitable services to meet the evolving and increasingly sophisticated requirements of our clients in a timely manner, our business and results of operations could be materially and adversely affected.

We may be unsuccessful in entering into strategic alliances or identifying and acquiring suitable acquisition candidates, which could impede our growth and negatively affect our revenues and net income.

We have pursued and may continue to pursue strategic alliances and strategic acquisition opportunities to increase our scale and geographic presence, expand our service offerings and capabilities and enhance our industry and technical expertise. However, it is possible that in the future we may not succeed in identifying suitable alliances or acquisition candidates. Even if we identify suitable candidates, we may not be able to consummate these arrangements on terms commercially acceptable to us or to obtain necessary regulatory approvals in the case of acquisitions. Many of our competitors are likely to be seeking to enter into similar arrangements or acquire the same targets that we are looking to enter into or acquire. Such competitors may have substantially greater financial resources than we do and may be more attractive to our strategic partners or be able to outbid us for the targets. In addition, we may also be unable to timely deploy our existing cash balances to effect a potential acquisition, as use of cash balances located onshore in China may require specific governmental approvals or result in withholding and other tax payments. If we are unable to enter into suitable strategic alliances or complete suitable acquisitions, our growth strategy may be impeded and our revenues and net income could be negatively affected.

If we fail to integrate or manage acquired companies efficiently, or if the acquired companies do not perform to our expectations, we may not be able to realize the benefits envisioned for such acquisitions, and our overall profitability and growth plans may be adversely affected.

Historically, we have expanded our service capabilities and gained new clients through selective acquisitions. Our ability to successfully integrate an acquired entity and realize the benefits of any acquisition requires, among other things, successful integration of technologies, operations and personnel. Challenges we face in the acquisition and integration process include:

 

   

integrating operations, services and personnel in a timely and efficient manner;

 

   

unforeseen or undisclosed liabilities;

 

   

generating sufficient revenue and net income to offset acquisition costs;

 

   

potential loss of, or harm to, employee or client relationships;

 

   

properly structuring our acquisition consideration and any related post-acquisition earn-outs and successfully monitoring any earn-out calculations and payments;

 

   

retaining key senior management and key sales and marketing and research and development personnel;

 

   

potential incompatibility of solutions, services and technology or corporate cultures;

 

   

consolidating and rationalizing corporate, information technology and administrative infrastructures;

 

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integrating and documenting processes and controls;

 

   

entry into unfamiliar markets; and

 

   

increased complexity from potentially operating additional geographically dispersed sites, particularly if we acquire a company or business with facilities or operations outside of China.

In addition, the primary value of many potential targets in the outsourcing industry lies in their skilled professionals and established client relationships. Transitioning these types of assets to our business can be particularly difficult due to different corporate cultures and values, geographic distance and other intangible factors. For example, some newly acquired employees may decide not to work with us or to leave shortly after their move to our company and some acquired clients may decide to discontinue their commercial relationships with us. These challenges could disrupt our ongoing business, distract our management and employees and increase our expenses, including causing us to incur significant one-time expenses and write-offs, and make it more difficult and complex for our management to effectively manage our operations. If we are not able to successfully integrate an acquired entity and its operations and to realize the benefits envisioned for such acquisition, our overall growth and profitability plans may be adversely affected.

If we do not succeed in attracting new clients for our services and/or growing revenues from existing clients, we may not achieve our revenue growth goals.

We plan to significantly expand the number of clients we serve to diversify our client base and grow our revenues. Revenues from a new client often rise quickly over the first several years following our initial engagement as we expand the services that we provide to that client. Therefore, obtaining new clients is important for us to achieve rapid revenue growth. We also plan to grow revenues from our existing clients by identifying and selling additional services to them. Our ability to attract new clients, as well as our ability to grow revenues from existing clients, depends on a number of factors, including our ability to offer high quality services at competitive prices, the strength of our competitors and the capabilities of our sales and marketing teams. If we are not able to continue to attract new clients or to grow revenues from our existing clients in the future, we may not be able to grow our revenues as quickly as we anticipate or at all.

As a result of our significant growth and acquisitions in recent years, evaluating our business and prospects may be difficult and our past results may not be indicative of our future performance.

Our future success depends on our ability to significantly increase revenue and maintain profitability from our operations. Our business has grown and evolved significantly in recent years, through both organic growth and strategic acquisitions. Our significant growth and several acquisitions in recent years make it difficult to evaluate our historical performance and make a period-to-period comparison of our historical operating results less meaningful. We may not be able to achieve a similar growth rate or maintain profitability in future periods. Furthermore, certain members of our senior management team have worked together for a relatively short period of time, and it may be difficult for you to evaluate their effectiveness, on an individual or collective basis, and their ability to address future challenges to our business. Therefore, you should not rely on our past results or our historic rate of growth as an indication of our future performance.

You should consider our future prospects in light of the risks and challenges encountered by a company seeking to grow and expand in a competitive industry that is characterized by rapid technological change, evolving industry standards, changing client preferences and new product and service introductions. These risks and challenges include, among others:

 

   

the uncertainties associated with our ability to continue our growth and maintain profitability;

 

   

preserving our competitive position in the IT services industry in China;

 

   

offering consistent and high-quality services to retain and attract clients;

 

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implementing our strategy and modifying it from time to time to respond effectively to competition and changes in client preferences;

 

   

managing our expanding operations, including the integration of our past and future acquisitions, and successfully expanding our solution and service offerings;

 

   

responding in a timely manner to technological or other changes in the IT services industry;

 

   

managing risks associated with intellectual property; and

 

   

recruiting, training, developing and retaining qualified managerial and other personnel.

If we are unsuccessful in addressing any of these risks or challenges, our business may be materially and adversely affected.

We face risks associated with having a long selling and implementation cycle for our services that require us to make significant resource commitments prior to realizing revenues for those services.

We have a long selling cycle for our technology services, which requires significant investment of capital, human resources and time by both our clients and us. Before committing to use our services, potential clients require us to expend substantial time and resources educating them on the value of our services and our ability to meet their requirements. Therefore, our selling cycle is subject to many risks and delays over which we have little or no control, including our clients’ decision to choose alternatives to our services (such as other providers or in-house resources) and the timing of our clients’ budget cycles and approval processes. For certain clients, we may begin work and incur substantial costs prior to concluding the contract.

Implementing our services also involves a significant commitment of resources over an extended period of time from both our clients and us. Our clients may experience delays in obtaining internal approvals or delays associated with technology, thereby further delaying the implementation process. Our current and future clients may not be willing or able to invest the time and resources necessary to implement our services, and we may fail to close sales with potential clients to which we have devoted significant time and resources, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Our profitability will suffer if we are not able to maintain our resource utilization levels and continue to improve our productivity levels.

Our gross margin and profitability are significantly impacted by our utilization levels of human resources as well as other resources, such as computers, IT infrastructure and office space, and our ability to increase our productivity levels. We have expanded our operations significantly in recent years through organic growth and external acquisitions, which has resulted in a significant increase in our headcount and fixed overhead costs. We may face difficulties maintaining high levels of utilization, especially for our newly established or newly acquired businesses and resources.

The master service agreements with our clients typically do not impose a minimum or maximum purchase amount and allow our clients to place service orders from time to time at their discretion. Client demand may fall to zero or surge to a level that we can not cost-effectively satisfy. Although we try to use all commercially reasonable efforts to accurately estimate service orders and resource requirements from our clients, we may overestimate or underestimate, which may result in unexpected cost and strain or redundancy of our human capital and adversely impact our utilization levels. In addition, some of our professionals are specially trained to work for specific clients or on specific projects and some of our sales and delivery center facilities are dedicated to specific clients or specific projects. Our ability to continually increase our productivity levels depends significantly on our ability to recruit, train, develop and retain high-performing professionals, staff projects appropriately and optimize our mix of services and delivery methods.

 

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If we experience a slowdown or stoppage of work for any client or on any project for which we have dedicated professionals or facilities, we may not be able to efficiently reallocate these professionals and facilities to other clients and projects to keep their utilization and productivity levels high. If we are not able to maintain high resource utilization levels without corresponding cost reductions or price increases, our profitability will suffer.

A significant portion of our income is generated, and will in the future continue to be generated, on a project basis with a fixed price; we may not be able to accurately estimate costs and determine resource requirements in relation to our projects, which would reduce our margins and profitability.

A significant portion of our income is generated, and will in the future continue to be generated, from fees we receive for our projects with a fixed price. Our projects often involve complex technologies, entail the coordination of operations and workforces in multiple locations, utilizing workforces with different skill sets and competencies and geographically distributed service centers, and must be completed within compressed timeframes and meet client requirements that are subject to change and increasingly stringent. In addition, some of our fixed-price projects are multi-year projects that require us to undertake significant projections and planning related to resource utilization and costs. If we fail to accurately assess the time and resources required for completing projects and to price our projects profitably, our business, results of operations and financial condition could be adversely affected.

Increases in wages for professionals in China could prevent us from sustaining our competitive advantage and could reduce our profit margins.

Our most significant costs are the salaries and other compensation expenses for our professionals and other employees. Wage costs for professionals in China are lower than those in more developed countries and India. However, because of rapid economic growth, increased productivity levels, and increased competition for skilled employees in China, wages for highly skilled employees in China, in particular middle- and senior-level managers, are increasing at a faster rate than in the past. We may need to increase the levels of employee compensation more rapidly than in the past to remain competitive in attracting and retaining the quality and number of employees that our business requires. Increases in the wages and other compensation we pay our employees in China could reduce our competitive advantage unless we are able to increase the efficiency and productivity of our professionals as well as the prices we can charge for our services. In addition, any appreciation in the value of the Renminbi relative to U.S. dollar and other foreign currencies will cause an increase in the relative wage levels in China, which could further reduce our competitive advantage and adversely impact our profit margin. For more information relating to the impact of fluctuation in the value of the Renminbi to our business, please see “Risk Factors—Risks Related to Our Business and Industry—Fluctuation in the value of the Renminbi and other currencies may have a material adverse effect on the value of your investment.”

Our business operations and financial condition could be adversely affected if we cease to enjoy, or breach the restrictions imposed for, the financial incentives and subsidies provided by certain PRC government agencies.

We have in the past received financial incentives and subsidies granted by various PRC government authorities in support of our business. Our net income (loss) for 2007, 2008, 2009 and the nine months ended September 30, 2009 and 2010 was $(10.3) million, $3,000, $9.0 million, $5.7 million and $0.3 million, respectively. Our non-GAAP net income (loss) for 2007, 2008 and 2009, which excludes share-based compensation, interest expense of convertible notes, changes in fair value of certain liabilities carried at fair value, amortization of intangible assets from acquisitions and gain on bargain purchase of a business from net income (loss), were $(4.3) million, $4.7 million and $13.4 million, respectively. For the nine months ended September 30, 2009 and 2010, our non-GAAP net income were $7.9 million and $10.7 million, respectively. For a reconciliation of our non-GAAP net income (loss) to our U.S. GAAP net income (loss), see footnote (3) on page 13 of this prospectus.

In 2007, 2008, 2009 and the nine months ended September 30, 2009 and 2010, we recognized government subsidies as a reduction to cost of revenue and expenses, primarily cost of revenues, of nil, $1.7 million, $2.1

 

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million, $1.5 million and $5.8 million, respectively, and recognized government subsidies as other income of $2.8 million, $0.9 million, $3.0 million, $1.9 million and $2.9 million, respectively. However, we cannot assure you of the continued availability of such financial incentives and subsidies in the future. The discontinuation of these financial incentives and subsidies could adversely affect our financial condition and results of operations. In addition, future financial incentives, grants and subsidies may impose certain requirements and restrictions on our business operations. These financial incentives, grants and subsidies, for example, might impose development time and local use requirements for certain projects funded by a government incentive, grant or subsidy, which can potentially limit the manner that we operate and expand our business.

We expect to rely on a newly formed, non-exclusive arrangement with an independent third party to help train new recruits for our company, and if this arrangement does not yield the expected benefits, our ability to attract, train and retain skilled personnel would suffer, which could adversely affect our ability to maintain and expand our business.

Our ability to maintain and renew existing client engagements and obtain new business will depend, in large part, on our ability to recruit, train, develop and retain skilled personnel that enable us to keep pace with growing demands for IT services, evolving industry standards and changing client preferences. To better source well-trained professionals for our business, we helped establish and fund in cooperation with the Wuxi City government the iCarnegie-iSoftStone training institute, which uses training materials licensed from iCarnegie Inc. to train college students and others in the Yangtze River Delta region. We expect this school to be an important channel to source and train our future professionals. However, this school may not be able to yield the expected benefits. The school opened in September 2009, and our first class of graduates was certified in June 2010. Therefore, we have very limited experience with the project, and we are unable to accurately ascertain how successful it may be or how qualified the graduates will be.

In addition, our relationship with iCarnegie Inc. is not exclusive, and iCarnegie Inc. can terminate its license arrangement with us in the event of a material breach of contract by us and such breach is not cured within 30 days after iCarnegie Inc. gives us notice. If the iCarnegie-iSoftStone training institute does not succeed in producing well-trained professionals who are qualified and willing to join our company, our ability to recruit, train, develop and retain skilled personnel would suffer, which could adversely affect our ability to maintain and expand our business.

Our subcontracting practices may expose us to technical uncertainties, potential liabilities and reputational harm.

In order to meet our personnel needs, increase workforce flexibility, and improve pricing competitiveness, we subcontract portions of certain projects to third parties. Despite certain advantages of subcontracting, such arrangements also give rise to a number of risks.

Although we try to source competent and credible third parties as our subcontractors, they may not be able to deliver the level of service that our clients expect us to deliver. Furthermore, we enter into confidentiality agreements with our subcontractors, but we cannot guarantee that they will not breach the confidentiality of our clients and misappropriate our or our clients’ proprietary information and technology in the course of providing service. We, as the party to the contract with the client, are directly responsible for the losses our subcontractors cause our clients. Under the subcontracting agreements we enter, our subcontractors promise to indemnify us for damages caused by their breach, but we may be unable to collect under these agreements. Moreover, their breaches may damage our reputation and adversely affect our ability to acquire new business in the future.

In some limited cases and despite internal restrictions designed to prevent these actions, we may have subcontracted certain contractual obligations to third parties without first obtaining our clients’ prior written consent under the related client contracts. Although we have not been subject to adverse claims by our clients for these actions, we cannot assure you that these actions would not result in improper disclosure of client information, or result in client dissatisfaction or client loss.

 

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The international nature of our business exposes us to risks that could adversely affect our financial condition and results of operations.

We conduct our business throughout the world in multiple locations. Our corporate structure also spans multiple jurisdictions, with our parent holding company incorporated in the Cayman Islands and intermediate and operating subsidiaries incorporated in China, Hong Kong, the United States, Japan and Korea. As a result, we are exposed to risks typically associated with conducting business internationally, many of which are beyond our control. These risks include:

 

   

significant currency fluctuations between the Renminbi and the U.S. dollar and other currencies in which we transact business;

 

   

legal uncertainty owing to the overlap and inconsistencies of different legal regimes, problems in asserting contractual or other rights across international borders and the burden and expense of complying with the laws and regulations of various jurisdictions;

 

   

potentially adverse tax consequences, such as scrutiny of transfer pricing arrangements by authorities in the countries in which we operate;

 

   

current and future tariffs and other trade barriers, including restrictions on technology and data transfers;

 

   

unexpected changes in regulatory requirements; and

 

   

terrorist attacks and other acts of violence or war.

The occurrence of any of these events could have a material adverse effect on our results of operations and financial condition.

Our net revenues and results of operations are affected by seasonal trends.

Our business is affected by seasonal trends. In particular, our net revenues are typically progressively higher in the second, third and fourth quarters of each year compared to the first quarter of each year due to seasonal trends, such as: (i) a general slowdown in business activities and a reduced number of working days for our professionals during the first quarter of each year as a result of the Chinese New Year holiday period, and (ii) our customers in general tend to spend their IT budgets in the second half of the year and in particular the fourth quarter. Other factors that may cause our quarterly operating results to fluctuate include, among others, changes in general economic conditions in China and the impact of unforeseen events. We believe that our net revenues will continue to be affected in the future by seasonal trends. As a result, you may not be able to rely on period to period comparisons of our operating results as an indication of our future performance, and we believe it is more meaningful to evaluate our business on an annual basis.

We may be forced to reduce the prices of our services due to increased competition and reduced bargaining power with our clients, which could lead to reduced revenues and profitability.

The services outsourcing industry in China is developing rapidly and related technology trends are constantly evolving. This results in the frequent introduction of new services and significant price competition from our competitors. We may be unable to offset the effect of declining average sales prices through increased sales volumes and/or reductions in our costs. Furthermore, we may be forced to reduce the prices of our services in response to offerings made by our competitors. Finally, we may not have the same level of bargaining power we have enjoyed in the past when it comes to negotiating for the prices of our services.

Our ability to expand our business, procure new contracts, enter into beneficial business arrangements or leverage our skills and knowledge may be affected by non-competition clauses in our agreements with existing clients.

Certain of our existing client contracts have non-competition clauses, which restrict us from providing services to customers of our existing clients. Many of our client contracts contain clauses that restrict our

 

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employees working for a particular client from providing services to the competitors of those clients, and/or in similar assignments to third parties even if they are not competitors of those clients. Our contracts with some of our clients provide that, during the term of the contract and for up to a 12-month period thereafter and under specified circumstances, we may not accept any assignments from, or render services to, those clients’ customers. These restrictions may hamper our ability to compete for and provide services to other clients in a specific industry or market in which we have expertise and may adversely affect our revenues and future profitability.

Under certain contracts, we are prohibited from using any skills and techniques used for a certain client in other projects. Such clauses may restrict our ability to develop other clients in a commercially desirable way and to extract the maximum value from the skills and knowledge we have accumulated while providing service.

If we cause disruptions to our clients’ businesses or provide inadequate service, our clients may have claims for substantial damages against us, and as a result our profits may be substantially reduced.

If our professionals make errors in the course of delivering services to our clients or fail to consistently meet service requirements of a client, these errors or failures could disrupt the client’s business, which could result in a reduction in our net revenues or a claim for substantial damages against us. In addition, a failure or inability to meet a contractual requirement could seriously damage our reputation and affect our ability to attract new business.

The services we provide are often critical to our clients’ businesses. Certain of our client contracts require us to comply with security obligations including maintaining network security and back-up data, ensuring our network is virus-free, maintaining business continuity planning procedures, and verifying the integrity of employees that work with our clients by conducting background checks. Any failure in a client's system or breach of security relating to the services we provide to the client could damage our reputation or result in a claim for substantial damages against us. Any significant failure of our equipment or systems, or any major disruption to basic infrastructure like power and telecommunications in the locations in which we operate, could impede our ability to provide services to our clients, have a negative impact on our reputation, cause us to lose clients, reduce our revenues and harm our business.

Under our contracts with our clients, our liability for breach of our obligations is in some cases limited to a certain percentage of contract price. Such limitations may be unenforceable or otherwise may not protect us from liability for damages. In addition, certain liabilities, such as claims of third parties for which we may be required to indemnify our clients, are generally not limited under our contracts. We currently do not have commercial general or public liability insurance. The successful assertion of one or more large claims against us could have a material adverse effect on our business, reputation, results of operations, financial condition and cash flows. Even if such assertions against us are unsuccessful, we may incur reputational harm and substantial legal fees.

We may be liable to our clients for damages caused by unauthorized disclosure of sensitive and confidential information, whether through our employees or otherwise.

We are typically required to manage, utilize and store sensitive or confidential client data in connection with the services we provide. Under the terms of our client contracts, we are required to keep such information strictly confidential. We use network security technologies, surveillance equipment and other methods to protect sensitive and confidential client data. We also require our employees and subcontractors to enter into confidentiality agreements to limit access to and distribution of our clients’ sensitive and confidential information as well as our own trade secrets. We can give no assurance that the steps taken by us in this regard will be adequate to protect our clients’ confidential information. If our clients’ proprietary rights are misappropriated by our employees or our subcontractors or their employees, in violation of any applicable confidentiality agreements or otherwise, our clients may consider us liable for those acts and seek damages and compensation from us. Any such acts could cause us to lose existing and future business and damage our reputation in the market. In addition, we currently do not have any insurance coverage for mismanagement or misappropriation of such information by our subcontractors or employees. Any litigation with respect to

 

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unauthorized disclosure of sensitive and confidential information might result in substantial costs and diversion of resources and management attention.

We may not be able to prevent others from unauthorized use of intellectual property of our clients, which could harm our business and competitive position.

We rely on software licenses from our clients with respect to certain projects. To protect proprietary information and other intellectual property of our clients, we require our employees, subcontractors, consultants, advisors and collaborators to enter into confidentiality agreements with us. These agreements may not provide effective protection for trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. Implementation of intellectual property-related laws in China has historically been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, protection of intellectual property rights and confidentiality in China may not be as effective as that in the United States or other developed countries. Policing unauthorized use of proprietary technology is difficult and expensive. The steps we have taken may be inadequate to prevent the misappropriation of proprietary technology of our clients. Reverse engineering, unauthorized copying or other misappropriation of proprietary technologies of our clients could enable third parties to benefit from our or our clients’ technologies without paying us and our clients for doing so, and our clients may hold us liable for that act and seek damages and compensation from us, which could harm our business and competitive position.

We may not be able to prevent others from unauthorized use of our intellectual property, which could cause a loss of clients, reduce our revenues and harm our competitive position.

We rely on a combination of patent, copyright, trademark, software registration, anti-unfair competition and trade secret laws, as well as confidentiality agreements and other methods to protect our intellectual property rights. As of September 30, 2010, we had one trademark registration, two patent applications, eight trademark applications and 82 software copyright registrations in China. A patent filing may not result in an issued patent and an issued patent may not sufficiently protect our intellectual property rights. Furthermore, our current lack of patent protection may prevent us from being able to stop any unauthorized use of our software or other intellectual property. To protect our trade secrets and other proprietary information, employees, clients, subcontractors, consultants, advisors and collaborators are required to enter into confidentiality agreements. These agreements might not provide effective protection for the trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. Implementation of intellectual property-related laws in China has historically been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as those in the United States or other developed countries, and infringement of intellectual property rights continues to pose a serious risk of doing business in China. Policing unauthorized use of proprietary technology is difficult and expensive. The steps we have taken may be inadequate to prevent the misappropriation of our proprietary technology. Reverse engineering, unauthorized copying, other misappropriation, or negligent or accidental leakage of our proprietary technologies could enable third parties to benefit from our technologies without obtaining our consent or paying us for doing so, which could harm our business and competitive position. Though we are not currently involved in any litigation with respect to intellectual property, we may need to enforce our intellectual property rights through litigation. Litigation relating to our intellectual property may not prove successful and might result in substantial costs and diversion of resources and management attention.

We may face intellectual property infringement claims that could be time-consuming and costly to defend. If we fail to defend ourselves against such claims, we may lose significant intellectual property rights and may be unable to continue providing our existing services.

Our success largely depends on our ability to use and develop our technology and services without infringing the intellectual property rights of third parties, including patents, copyrights, trade secrets and

 

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trademarks. We may be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties. We typically indemnify clients who purchase our services and solutions against potential infringement of intellectual property rights underlying our services and solutions, which subjects us to the risk of indemnification claims. The holders of patents and other intellectual property rights potentially relevant to our service offerings may make it difficult for us to acquire a license on commercially acceptable terms. Also, we may be unaware of intellectual property registrations or applications relating to our services that may give rise to potential infringement claims against us. There may also be technologies licensed to and relied on by us that are subject to infringement or other corresponding allegations or claims by third parties which may damage our ability to rely on such technologies. We are subject to additional risks as a result of our recent and proposed acquisitions and the hiring of new employees who may misappropriate intellectual property from their former employers. Parties making infringement claims may be able to obtain an injunction to prevent us from delivering our services or using technology involving the allegedly infringing intellectual property. Intellectual property litigation is expensive and time-consuming and could divert management’s attention from our business. A successful infringement claim against us, whether with or without merit, could, among others things, require us to pay substantial damages, develop non-infringing technology, or re-brand our name or enter into royalty or license agreements that may not be available on acceptable terms, if at all, and cease making, licensing or using products that have infringed a third party’s intellectual property rights. Protracted litigation could also result in existing or potential clients deferring or limiting their purchase or use of our products until resolution of such litigation, or could require us to indemnify our clients against infringement claims in certain instances. Any intellectual property claim or litigation in this area, whether we ultimately win or lose, could damage our reputation and have a material adverse effect on our business, results of operations or financial condition.

In the course of preparing our consolidated financial statements, one material weakness and one significant deficiency in our internal control over financial reporting were identified. If we are unable to correct this weakness and deficiency, our ability to accurately and timely report our financial results or prevent fraud may be adversely affected, and investor confidence and the market price of our ADSs may be adversely impacted.

Prior to this offering, we have been a private company with limited accounting personnel and other resources for addressing our internal control over financial reporting. In connection with the preparation and audit of our consolidated financial statements included in this prospectus, we and our independent registered public accounting firm identified one material weakness and one significant deficiency, each as defined in the U.S. Public Company Accounting Oversight Board Standard AU Section 325, Communications About Control Deficiencies in an Audit of Financial Statements, or AU325, in our internal control over financial reporting as of December 31, 2009. As defined in AU325, a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis, and a significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of our financial reporting.

The material weakness identified related to the insufficient accounting personnel with appropriate U.S. GAAP knowledge. The significant deficiency identified was related to the lack of control over a migration from one information system to an upgraded system. Following the identification of the material weakness, significant deficiency and other control deficiencies, we have taken measures and plan to continue to take measures to remediate these weakness and deficiencies. For a discussion of the remedial measures we have undertaken or are in the process of undertaking, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control Over Financial Reporting,” included elsewhere in this prospectus. However, the implementation of these measures may not fully address the material weakness, significant deficiency and other control deficiencies in our internal control over financial reporting, and we cannot yet conclude that they have been fully remedied. Failure to correct the material weakness, significant deficiency and other control deficiencies or our failure to discover and address any other control deficiencies could result in

 

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inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, effective internal control over financial reporting is important to help prevent fraud. Failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the market price of our ADSs.

Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control for purposes of identifying and reporting material weaknesses and other control deficiencies in our internal control over financial reporting as we and they will be required to do once we become a public company. In light of the number of material weakness and other control deficiencies that were identified as a result of the limited procedures performed, we believe it is possible that, had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional control deficiencies may have been identified.

Upon the closing of this offering, we will be subject to reporting obligations under the U.S. securities laws. The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring public companies to include a management report on the effectiveness of the company’s internal control over financial reporting in its annual report. In addition, an independent registered public accounting firm must issue an attestation report on the effectiveness of the company’s internal control over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending on December 31, 2011. Our management may conclude that our internal control over our financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may still issue an adverse report if it is not satisfied with our internal control, or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. The failure to establish and maintain effective internal controls over financial reporting could adversely impact the market price of our ADSs due to a loss of investor confidence in the reliability of our reporting processes. We will need to incur significant costs and use significant management and other resources in order to comply with Section 404 of the Sarbanes-Oxley Act.

We may need additional capital and any failure by us to raise additional capital on terms favorable to us, or at all, could limit our ability to grow our business and develop or enhance our service offerings to respond to market demand or competitive challenges.

We believe that our current cash, cash flow from operations and the proceeds from this offering should be sufficient to meet our anticipated cash needs for at least the next 12 months. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:

 

   

investors’ perception of, and demand for, securities of technology services outsourcing companies;

 

   

conditions of the U.S. and other capital markets in which we may seek to raise funds;

 

   

our future results of operations and financial condition;

 

   

PRC government regulation of foreign investment in China;

 

   

economic, political and other conditions in China; and

 

   

PRC government policies relating to the borrowing and remittance outside China of foreign currency.

 

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In addition, the incurrence of indebtedness by us, other than for working or operating capital purposes, is subject to prior written consent of the holders of our convertible notes who may or may not grant such consent. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to grow our business and develop or enhance our product and service offerings to respond to market demand or competitive challenges.

A significant majority of our outstanding ordinary shares is held by a small number of our existing shareholders, and these shareholders may have significantly greater influence on us and our corporate actions by nature of the size of their shareholdings relative to our public shareholders.

Our founder Tianwen Liu and our director and executive vice president Yong Feng will beneficially own approximately 17.7% and 6.0%, respectively, of our outstanding ordinary shares following this offering. AsiaVest Opportunities Fund IV and the Fidelity Entities will beneficially own approximately 19.0% and 19.8%, respectively, of our outstanding ordinary shares following this offering. These major shareholders will continue to have significant influence in determining the outcome of any corporate transactions or other matters submitted to our shareholders for approval, including mergers, consolidations and schemes of arrangement, election and removal of directors and other significant corporate actions. They may not act in the best interests of our minority shareholders. In addition, without the consent of these major shareholders, we could be prevented from entering into transactions that could be beneficial to us. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders.

Failure to adhere to regulations that govern our clients’ businesses could result in breaches of contracts with our clients. Failure to adhere to the regulations that govern our business could result in our being unable to effectively perform our services.

Our clients’ business operations are subject to certain rules and regulations in China or elsewhere. Our clients may contractually require that we perform our services in a manner that would enable them to comply with such rules and regulations. Failure to perform our services in such a manner could result in breaches of contract with our clients and, in some limited circumstances, civil fines and criminal penalties for us. In addition, we are required under various Chinese laws to obtain and maintain permits and licenses to conduct our business. If we do not maintain our licenses or other qualifications to provide our services, we may not be able to provide services to existing clients or be able to attract new clients and could lose revenues, which could have a material adverse effect on our business and results of operations.

We may incur losses resulting from business interruptions resulting from occurrence of natural disasters, health epidemics and other outbreaks or events.

Our operational facilities may be damaged in natural disasters such as earthquakes, floods, heavy rains, sand storms, tsunamis and cyclones, or other events such as fires. Such natural disasters or other events may lead to disruption of information systems and telephone service for sustained periods. Damage or destruction that interrupts our provision of outsourcing services could damage our relationships with our clients and may cause us to incur substantial additional expenses to repair or replace damaged equipment or facilities. We may also be liable to our clients for disruption in service resulting from such damage or destruction. Prolonged disruption of our services as a result of natural disasters or other events may also entitle our clients to terminate their contracts with us. We currently do not have insurance against business interruptions.

Our business could be adversely affected by the effects of H1N1, or swine flu, avian flu, severe acute respiratory syndrome, or SARS, or another epidemic or outbreak. Since 2005, there have been reports of avian

 

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flu in various parts of China and elsewhere in Asia, including a few confirmed human cases and deaths. As of August 10, 2010, there have been at least 128,000 confirmed cases of swine flu in China, according to a report issued by the PRC Ministry of Health. Any prolonged occurrence of swine flu, avian flu, SARS or other adverse public health developments in China may have a material adverse effect on our business operations. Our operations may be impacted by a number of health-related factors, including, among other things, quarantines or closures of our facilities, which could severely disrupt our operations, the sickness or death of our key officers and employees, and a general slowdown in the Chinese economy. Any of these events or other unforeseen consequences of public health problems could adversely affect our business and results of operations.

Fluctuation in the value of the Renminbi and other currencies may have a material adverse effect on the value of your investment.

Our financial statements are expressed in U.S. dollars. However, a majority of our revenues and expenses are denominated in Renminbi. Our exposure to foreign exchange risk primarily relates to the limited cash denominated in currencies other than the functional currencies of each entity and limited revenue contracts dominated in Japanese Yen in certain PRC operating entities. We do not believe that we currently have any significant direct foreign exchange risk and have not hedged exposures denominated in foreign currencies or any other derivative financial instruments. However, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and Renminbi because the primary value of our business is effectively denominated in Renminbi, while the ADSs will be traded in U.S. dollars.

The value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. The People’s Bank of China regularly intervenes in the foreign exchange market to limit fluctuations in Renminbi exchange rate and achieve certain exchange rate targets, and through such intervention kept the U.S. dollar-Renminbi exchange rate relatively stable between 6.8 and 6.9 Renminbi per U.S. dollar for almost two years from July 2008. On June 20, 2010, the People’s Bank of China announced that the PRC government would further reform the Renminbi exchange rate regime and increase the flexibility of the exchange rate. It is difficult to predict how this new policy may impact the Renminbi exchange rate.

As we may rely on dividends paid to us by our PRC subsidiaries, any significant revaluation of the Renminbi may have a material adverse effect on our revenues and financial condition, and the value of any dividends payable on our ADSs in foreign currency terms. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us. Furthermore, appreciation or depreciation in the value of the Renminbi relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations.

We incurred a net foreign exchange gain of $0.2 million and a net foreign exchange loss of $0.2 million in 2008 and 2009, respectively, and a net foreign exchange gain of $0.1 million and a net foreign exchange loss of $0.3 million in the nine-month periods ended September 30, 2009 and 2010, respectively. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign exchange losses in the future. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currencies.

Legislation in certain countries in which we have clients, particularly the United States, Japan and various European countries, may restrict companies in those countries from outsourcing work to us.

IT offshore outsourcing is a politically sensitive issue in the United States, Europe and Japan. For example, many organizations and public figures in the United States and Europe have publicly expressed concern about a

 

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perceived association between offshore outsourcing providers and the loss of jobs in their home countries. A number of U.S. states have passed legislation that restricts state government entities from outsourcing certain work to offshore service providers. Other U.S. federal and state legislation has been proposed that, if enacted, would provide tax disincentives for offshore outsourcing or require disclosure of jobs outsourced abroad. Similar legislation could be in enacted in Europe, Japan and other countries in which we have clients. Any expansion of existing laws or the enactment of new legislation restricting or discouraging offshore outsourcing by companies in the United States, Europe, Japan or other countries in which we have clients could adversely impact our business operations and financial results. In addition, from time to time there has been publicity about negative experiences associated with offshore outsourcing, such as theft and misappropriation of sensitive client data. As a result, current or prospective clients may elect to perform such services themselves or may be discouraged from transferring these services from onshore to offshore providers. Any slowdown or reversal of existing industry trends towards offshore outsourcing in response to political pressure or negative publicity would harm our ability to compete effectively with competitors that operate out of onshore facilities and adversely affect our business and financial results.

Restrictions on immigration may affect our ability to compete for and provide services to clients in the United States or other countries, which could hamper our growth and cause our revenues to decline.

The vast majority of our employees are Chinese nationals. Some of our projects require a portion of the work to be undertaken at our clients’ facilities which are sometimes located outside China. The ability of our professionals to work in the United States, Europe, Japan, Korea and other countries outside China depends on their ability to obtain the necessary visas and work permits. Historically, the process for obtaining visas for PRC nationals to certain countries, including the United States and Japan, has been lengthy and cumbersome. We have in the past experienced delays and rejections when applying for business visas to the United States for some of our personnel. Immigration laws in the United States and in other countries are subject to legislative change, as well as to variations in standards of application and enforcement due to political forces and economic conditions. Particularly given the recent global economic slowdown, it is possible that there could be a change in the existing laws or the enactment of new legislation imposing restrictions on the deployment of work visa holders at client locations, which may adversely impact our ability to do business in the jurisdictions in which we have clients. However, it is generally difficult to predict the political and economic events that could affect immigration laws, or the restrictive impact they could have on obtaining or maintaining business visas for our employees. Our reliance on visas for a number of employees makes us vulnerable to such changes and variations as it affects our ability to staff projects with professionals who are not citizens of the country where the work is to be performed. As a result, we may not be able to obtain a sufficient number of visas for our employees or we may encounter delays or additional costs in obtaining or maintaining such visas in which case we may not be able to provide services to our clients on a timely and cost-effective basis or manage our sales and delivery centers as efficiently as we otherwise could, any of which could adversely affect our business and results of operations.

Disruptions in telecommunications or significant failure in our IT systems could harm our service model, which could result in a reduction of our revenue.

A significant element of our business strategy is to continue to leverage and expand our sales and delivery centers strategically located in China. We believe that the use of a strategically located network of sales and delivery centers will provide us with cost advantages, the ability to attract highly skilled personnel in various regions of the country and the world, and the ability to service clients on a regional and global basis. Part of our service model is to maintain active voice and data communications, financial control, accounting, customer service and other data processing systems between our main offices in Beijing, our clients’ offices, and our other deliveries centers and support facilities. Our business activities may be materially disrupted in the event of a partial or complete failure of any of these IT or communication systems, which could be caused by, among other things, software malfunction, computer virus attacks, conversion errors due to system upgrading, damage from fire, earthquake, power loss, telecommunications failure, unauthorized entry or other events beyond our control. Loss of all or part of the systems for a period of time could hinder our performance or our ability to complete

 

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client projects on time which, in turn, could lead to a reduction of our revenue or otherwise have a material adverse effect on our business and business reputation. We may also be liable to our clients for breach of contract for interruptions in service.

Our computer networks may be vulnerable to security risks that could disrupt our services and adversely affect our results of operations.

Our computer networks may be vulnerable to unauthorized access, computer hackers, computer viruses and other security problems caused by unauthorized access to, or improper use of, systems by third parties or employees. A hacker who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in our operations. Although we intend to continue to implement security measures, computer attacks or disruptions may jeopardize the security of information stored in and transmitted through our computer systems. Actual or perceived concerns that our systems may be vulnerable to such attacks or disruptions may deter our clients from using our solutions or services. As a result, we may be required to expend significant resources to protect against the threat of these security breaches or to alleviate problems caused by these breaches.

Data networks are also vulnerable to attacks, unauthorized access and disruptions. For example, in a number of public networks, hackers have bypassed firewalls and misappropriated confidential information. It is possible that, despite existing safeguards, an employee could misappropriate our clients’ proprietary information or data, exposing us to a risk of loss or litigation and possible liability. Losses or liabilities that are incurred as a result of any of the foregoing could have a material adverse effect on our business.

Our insurance coverage may be inadequate to protect us against losses.

Although we maintain professional liability insurance and property insurance coverage for certain of our facilities and equipment, we do not have any loss of data or business interruption insurance coverage for our operations. If any claims for injury are brought against us, or if we experience any business disruption, litigation or natural disaster, we might incur substantial costs and diversion of resources.

We have incurred, and may continue to incur, significant share-based compensation expenses which could adversely impact our net income.

We have granted certain options under our share incentive plans and entered into certain other share-based compensation arrangements in the past, as a result of which we have recorded $4.0 million, $1.4 million and $2.4 million as share-based compensation expenses for the years ended December 31, 2007, 2008 and 2009, and $0.7 million and $5.8 million for the nine months ended September 30, 2009 and 2010, respectively.

U.S. GAAP prescribes how we account for share-based compensation which may have an adverse or negative impact on our results of operations or the price of our ADSs. U.S. GAAP requires us to recognize share-based compensation as compensation expense in the statement of operations generally based on the fair value of equity awards on the date of the grant, with compensation expense recognized over the period in which the recipient is required to provide service in exchange for the equity award. The expenses associated with share-based compensation may reduce the attractiveness of issuing share options or restricted shares, also known as non-vested shares, under our equity incentive plan. However, if we do not grant share options or restricted shares, or reduce the number of share options or restricted shares we grant, we may not be able to attract and retain key personnel. If we grant more share options or restricted shares or other share-based compensation arrangements to attract and retain key personnel, the expenses associated with share-based compensation may adversely affect our net income.

 

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Risks Related to Doing Business in China

Adverse changes in political, economic and other policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could materially and adversely affect the growth of our business and our competitive position.

The majority of our business operations are conducted in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. Although the PRC economy has been transitioning from a planned economy to a more market-oriented economy since the late 1970s, the PRC government continues to exercise significant control over China’s economic growth through direct allocation of resources, monetary and tax policies, and a host of other government policies such as those that encourage or restrict investment in certain industries by foreign investors, control the exchange between the Renminbi and foreign currencies, and regulate the growth of the general or specific market. While the Chinese economy has experienced significant growth in the past 30 years, growth has been uneven, both geographically and among various sectors of the economy. Furthermore, the current global economic crisis is adversely affecting economies throughout the world. As the PRC economy has become increasingly linked with the global economy, China is affected in various respects by downturns and recessions of major economies around the world. The various economic and policy measures enacted by the PRC government to forestall economic downturns or bolster China’s economic growth could materially affect our business. Any adverse change in the economic conditions in China, in policies of the PRC government or in laws and regulations in China could have a material adverse effect on the overall economic growth of China and market demand for our outsourcing services. Such developments could adversely affect our businesses, lead to reduction in demand for our services and adversely affect our competitive position.

Uncertainties with respect to the PRC legal system could have a material adverse effect on us.

The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since the late 1970s, the PRC government has been building a comprehensive system of laws and regulations governing economic matters in general. The overall effect has been to significantly enhance the protections afforded to various forms of foreign investments in China. We conduct our business primarily through our subsidiaries established in China. These subsidiaries are generally subject to laws and regulations applicable to foreign investment in China. However, since these laws and regulations are relatively new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involves uncertainties, which may limit legal protections available to us. In addition, some regulatory requirements issued by certain PRC government authorities may not be consistently applied by other government authorities (including local government authorities), thus making strict compliance with all regulatory requirements impractical, or in some circumstances impossible. For example, we may have to resort to administrative and court proceedings to enforce the legal protection that we enjoy either by law or contract. However, since PRC administrative and court authorities have discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to predict the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may impede our ability to enforce the contracts we have entered into with our business partners, clients and suppliers. In addition, such uncertainties, including any inability to enforce our contracts, together with any development or interpretation of PRC law that is adverse to us, could materially and adversely affect our business and operations. Furthermore, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other more developed countries. We cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us and other foreign investors, including you. In addition, any litigation in China may be protracted and result in substantial costs and diversion of our resources and management attention.

 

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The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under a recently adopted PRC regulation; any requirement to obtain prior CSRC approval could delay this offering and failure to obtain such approval, if required, could have a material adverse effect on our business, results of operation and reputation, as well as the trading price of our ADSs, and could also create uncertainties for this offering.

In 2006, the CSRC and five other PRC regulatory agencies jointly promulgated the Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which regulates foreign investment in PRC domestic enterprises. The M&A Rule requires offshore special purpose vehicles formed for the purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals to obtain the approval of the CSRC prior to the listing and trading of the special purpose vehicle’s securities on an overseas stock exchange.

The interpretation and application of the M&A Rule is currently unclear. However, our PRC counsel, Han Kun Law Offices, has advised us that based on its understanding of current PRC laws, rules and regulations, the M&A Rule does not require us to obtain prior CSRC approval for the listing and trading of our ADSs on the NYSE because our PRC subsidiary, iSoftStone WFOE, was established as a foreign-invested enterprise before September 8, 2006, the effective date of the M&A Rule, and iSoftStone WFOE was not established through merger or acquisition.

However, if the CSRC or another PRC regulatory agency subsequently determines that prior CSRC approval was required, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations, limit our operating privileges, delay or restrict the repatriation of the proceeds from this offering into China or the payment or distribution of dividends by our PRC subsidiaries, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur. Uncertainties or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our ADSs.

We face uncertainty regarding the PRC tax reporting obligations and consequences for certain indirect transfers of the stock of our operating company.

Pursuant to the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises issued by the PRC State Administration of Taxation on December 10, 2009, or Circular 698, where a foreign investor transfers the equity interests of a PRC resident enterprise indirectly by way of the sale of equity interests of an overseas holding company, or an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the foreign investor should report such Indirect Transfer to the competent tax authority of the PRC resident enterprise. The PRC tax authority will examine the true nature of the Indirect Transfer, and if the tax authority considers that the foreign investor has adopted an abusive arrangement in order to avoid PRC tax, they will disregard the existence of the overseas holding company and re-characterize the Indirect Transfer and as a result, gains derived from such Indirect Transfer may be subject to PRC withholding tax at the rate of up to 10%. In addition, the PRC resident enterprise is supposed to provide necessary assistance to support the enforcement of Circular 698.

At present, the PRC tax authorities will neither confirm nor deny that they would enforce Circular 698, in conjunction with other tax collection and tax withholding rules, to make claims against our PRC subsidiary as being indirectly liable for unpaid taxes, if any, arising from Indirect Transfers by shareholders who did not obtain their shares in the public offering of our shares.

 

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PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise materially and adversely affect us.

The PRC State Administration of Foreign Exchange, or SAFE, issued a public notice in 2005 known as Circular 75 that requires PRC residents, including both legal persons and natural persons, to register with an appropriate local SAFE branch before establishing or controlling any company outside of China, referred to as an offshore special purpose company, for the purpose of acquiring any assets of or equity interest in PRC companies and raising funds from overseas. When a PRC resident contributes the assets or equity interests it holds in a PRC company into the offshore special purpose company, or engages in overseas financing after contributing such assets or equity interests into the offshore special purpose company, such PRC resident must modify its SAFE registration in light of its interest in the offshore special purpose company and any change thereof. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. If these shareholders fail to comply, the PRC subsidiaries of the offshore special purpose company may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to their offshore parent company and the offshore parent company may be restricted in its ability to contribute additional capital into its PRC subsidiaries. Moreover, failure to comply with the above SAFE registration requirements could result in liabilities under PRC laws for evasion of foreign exchange restrictions.

We are committed to complying with the Circular 75 requirements and to ensuring that our shareholders who are PRC citizens or residents comply with them. We believe that all of our current PRC citizen or resident shareholders and beneficial owners have completed their required registrations with SAFE. However, we may not at all times be fully aware or informed of the identities of all our beneficial owners who are PRC citizens or residents, and we may not always be able to compel our beneficial owners to comply with the Circular 75 requirements. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC citizens or residents will at all times comply with, or in the future make or obtain any applicable registrations or approvals required by, Circular 75 or other related regulations. Failure by any such shareholders or beneficial owners to comply with Circular 75 could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

In addition, the PRC National Development and Reform Commission promulgated a rule in 2004 requiring its approval for overseas investment projects made by PRC entities. However, there exist extensive uncertainties as to the interpretation of this rule with respect to its application to a PRC individual’s overseas investment and, in practice, we are not aware of any precedents that a PRC individual’s overseas investment has been either approved by the National Development and Reform Commission or challenged by the National Development and Reform Commission based on the absence of its approval. Our current beneficial owners who are PRC individuals did not apply for the approval of the National Development and Reform Commission for their investment in us. We cannot predict how and to what extent this will affect our business operations or future strategy.

PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

In utilizing the proceeds from this public offering or any future offerings, as an offshore holding company of our PRC subsidiaries, we may make loans to our PRC subsidiaries and controlled PRC affiliate, or we may make

 

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additional capital contributions to our PRC subsidiaries. Any loans to our PRC subsidiaries or controlled PRC affiliate are subject to PRC regulations and approvals. For example, loans by us to our PRC subsidiaries in China, each of which is a foreign-invested enterprise, to finance their activities cannot exceed statutory limits and must be registered with SAFE or its local counterpart. Loans by us to our controlled PRC affiliate, Beijing iSoftStone, which is a domestic PRC entity, must be approved by the relevant government authorities and must also be registered with SAFE or its local counterpart.

We may also decide to finance our PRC subsidiaries through capital contributions. These capital contributions must be approved by the Ministry of Commerce in China or its local counterpart. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or controlled PRC affiliate or capital contributions by us to our subsidiaries or any of their respective subsidiaries. If we fail to receive such registrations or approvals, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely and materially affect our liquidity and our ability to fund and expand our business.

In 2008, SAFE promulgated Circular 142, a notice regulating the conversion by a foreign-invested enterprise of foreign currency into Renminbi by restricting how the converted Renminbi may be used. Circular 142 requires that Renminbi converted from the foreign currency-denominated capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC unless specifically provided for otherwise in its business scope. In addition, SAFE strengthened its oversight of the flow and use of Renminbi funds converted from the foreign currency-denominated capital of a foreign-invested enterprise. The use of such Renminbi may not be changed without approval from SAFE, and may not be used to repay Renminbi loans if the proceeds of such loans have not yet been used for purposes within the foreign-invested enterprise’s approved business scope.

We cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or controlled PRC affiliate or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds we receive from this offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could adversely and materially affect our liquidity and our ability to fund and expand our business.

Governmental control of currency conversion may limit our ability to use our revenues effectively and the ability of our PRC subsidiaries to obtain financing.

The PRC government imposes control on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive a majority of our revenues in Renminbi, which currently is not a freely convertible currency. Restrictions on currency conversion imposed by the PRC government may limit our ability to use revenues generated in Renminbi to fund our expenditures denominated in foreign currencies or our business activities outside China. Under China’s existing foreign exchange regulations, Renminbi may be freely converted into foreign currency for payments relating to current account transactions, which include among other things dividend payments and payments for the import of goods and services, by complying with certain procedural requirements. Our PRC subsidiaries are able to pay dividends in foreign currencies to us without prior approval from SAFE, by complying with certain procedural requirements. Our PRC subsidiaries may also retain foreign currency in their respective current account bank accounts for use in payment of international current account transactions. However, we cannot assure you that the PRC government will not take measures in the future to restrict access to foreign currencies for current account transactions.

Conversion of Renminbi into foreign currencies, and of foreign currencies into Renminbi, for payments relating to capital account transactions, which principally includes investments and loans, generally requires the

 

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approval of SAFE and other relevant PRC governmental authorities. Restrictions on the convertibility of the Renminbi for capital account transactions could affect the ability of our PRC subsidiaries to make investments overseas or to obtain foreign currency through debt or equity financing, including by means of loans or capital contributions from us. In particular, if iSoftStone WFOE borrows foreign currency from us or other foreign lenders, it must do so within approved limits that satisfy their approval documentation and PRC debt to equity ratio requirements. Further, such loans must be registered with SAFE or its local counterpart. We cannot assure you that the registration process will not delay or prevent our conversion of Renminbi for use outside of China.

The discontinuation or revocation of the preferential tax treatments and government incentives available to us could decrease our net income and materially and adversely affect our financial condition and results of operations.

Our PRC subsidiaries are incorporated in the PRC and are governed by PRC income tax laws and regulations. Prior to January 1, 2008, entities established in the PRC were generally subject to a 30% national and 3% local enterprise income tax rate. Various preferential tax treatments promulgated by national tax authorities were available to foreign-invested enterprises or high or new technology enterprises located in certain high-tech zones of China. Under the Enterprise Income Tax Law effective on January 1, 2008, the PRC has adopted a uniform enterprise income tax rate of 25% for all PRC enterprises (including foreign-invested enterprises) and revoked the previous tax exemption, reduction and preferential treatments applicable to foreign-invested enterprises. However, the Enterprise Income Tax Law also permits enterprises to continue to enjoy their existing tax incentives, adjusted by certain transitional phase-out rules, under which enterprises established before the promulgation date of the Enterprise Income Tax Law that were granted tax holidays under the then effective tax laws or regulations may continue to enjoy their tax holidays until their expiration. The Enterprise Income Tax Law also introduced a new preferential rate for high-tech enterprises. iSoftStone WFOE, as an enterprise established before the promulgation date of the Enterprise Income Tax Law, is entitled to enjoy its exemption of enterprise income tax in 2008 and 50% tax reduction in 2009, 2010 and 2011. Our local tax bureau has confirmed that the 50% reduction may be applied to the 15% preferential rate that iSoftStone WFOE enjoys as a qualified high-tech enterprise, notwithstanding a recent tax circular issued by the State Administration of Taxation that deals with whether these tax benefits are mutually exclusive. We cannot assure you that the tax authorities will not change their position. Other PRC subsidiaries of ours also enjoy a variety of tax benefits; see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Taxes and Incentives—China.” We cannot assure you that our PRC subsidiaries will continue to qualify for benefits under the Enterprise Income Tax Law or enjoy the preferential treatment under the phase-out rules, or that the local tax authorities will not, in the future, change their position and revoke any of our past preferential tax treatments, any of which could cause our effective tax rate to increase, cause our net income to decrease, and materially and adversely affect our financial condition and results of operations.

In addition, the PRC government has provided various incentives to companies in the software industry and to certain qualified technology related transactions in order to encourage developments of the software and technology related industries in China. A number of our PRC subsidiaries currently receive value-added tax, or VAT, refunds and business tax exemptions in additional to the preferential enterprise income tax treatments as described above. Incentives granted to us by PRC governmental authorities are subject to review and may be adjusted or revoked at any time in the future. The discontinuation or revocation of incentives currently available to us may materially and adversely affect our financial condition and results of operations.

We may be classified as a “resident enterprise” for PRC enterprise income tax purposes; such classification could result in unfavorable tax consequences to us and our non-PRC shareholders.

The Enterprise Income Tax Law provides that enterprises established outside of China whose “de facto management bodies” are located in China are considered PRC tax resident enterprises and will generally be subject to the uniform 25% PRC enterprise income tax rate on their global income. In addition, a tax circular issued by the State Administration of Taxation on April 22, 2009 regarding the standards used to classify certain

 

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Chinese-invested enterprises established outside of China as resident enterprises clarified that dividends and other income paid by such resident enterprises will be considered to be PRC source income, subject to PRC withholding tax, currently at a rate of 10%, when recognized by non-PRC enterprise shareholders. This recent circular also subjects such resident enterprises to various reporting requirements with the PRC tax authorities. Under the implementation rules to the Enterprise Income Tax Law, a de facto management body is defined as a body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and other assets of an enterprise. In addition, the tax circular mentioned above details that certain Chinese-invested enterprises will be classified as resident enterprises if the following are located or resident in China: senior management personnel and departments that are responsible for daily production, operation and management; financial and personnel decision making bodies; key properties, accounting books, company seal, and minutes of board meetings and shareholders’ meetings; and half or more of the senior management or directors having voting rights.

Currently, there are no detailed rules or precedents governing the procedures and specific criteria for determining de facto management bodies which are applicable to our company or our overseas subsidiary. If our company or any of our overseas subsidiaries is considered a PRC tax resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, our company or our overseas subsidiary will be subject to the uniform 25% enterprise income tax rate as to our global income as well as PRC enterprise income tax reporting obligations. Second, although under the Enterprise Income Tax Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as tax-exempted income, we cannot assure you that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, dividends payable by us to our investors and gain on the sale of our shares may become subject to PRC withholding tax. It is possible that future guidance issued with respect to the new resident enterprise classification could result in a situation in which a withholding tax of 10% for our non-PRC enterprise investors or a potential withholding tax of 20% for individual investors is imposed on dividends we pay to them and with respect to gains derived by such investors from transferring our shares or ADSs. In addition to the uncertainty in how the new resident enterprise classification could apply, it is also possible that the rules may change in the future, possibly with retroactive effect. If we are required under the Enterprise Income Tax law to withhold PRC income tax on our dividends payable to our foreign shareholders and ADS holders, or if you are required to pay PRC income tax on the transfer of our shares or ADSs under the circumstances mentioned above, the value of your investment in our shares or ADSs may be materially and adversely affected. It is unclear whether, if we are considered a PRC resident enterprise, holders of our shares or ADSs would be able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas.

We may rely on dividends paid by our subsidiaries for our cash needs, and any limitation on the ability of our subsidiaries to make payments to us could have a material adverse effect on our ability to conduct our business.

As a holding company, we conduct substantially all of our business through our consolidated subsidiaries incorporated in China. We may rely on dividends paid by these PRC subsidiaries for our cash needs, including the funds necessary to pay any dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities established in China is subject to limitations. Regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Each of our PRC subsidiaries is required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves or statutory capital reserve fund until the aggregate amount of such reserves reaches 50% of its respective registered capital. As a result, our PRC subsidiaries are restricted in their ability to transfer a portion of their net assets to us in the form of dividends. In addition, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could

 

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materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

Our current employment practices may be restricted under the PRC Labor Contract Law and our labor costs may increase as a result.

The PRC Labor Contract Law and its implementing rules impose requirements concerning contracts entered into between an employer and its employees and establishes time limits for probationary periods and for how long an employee can be placed in a fixed-term labor contract. Because the Labor Contract Law and its implementing rules have not been in effect very long and because there is lack of clarity with respect to their implementation and potential penalties and fines, it is uncertain how it will impact our current employment policies and practices. We cannot assure you that our employment policies and practices do not, or will not, violate the Labor Contract Law or its implementing rules and that we will not be subject to related penalties, fines or legal fees. If we are subject to large penalties or fees related to the Labor Contract Law or its implementing rules, our business, financial condition and results of operations may be materially and adversely affected.

In addition, according to the Labor Contract Law and its implementing rules, if we intend to enforce the non-compete provision with an employee in a labor contract or non-competition agreement, we have to compensate the employee on a monthly basis during the term of the restriction period after the termination or ending of the labor contract, which may cause extra expenses to us.

Furthermore, the Labor Contract Law and its implementation rules require certain terminations to be based upon seniority rather than merit, which significantly affects the cost of reducing workforce for employers. In the event we decide to significantly change or decrease our workforce in the PRC, the Labor Contract Law could adversely affect our ability to enact such changes in a manner that is most advantageous to our circumstances or in a timely and cost effective manner, thus our results of operations could be adversely affected.

Risks Related to Our ADSs and This Offering

There has been no public market for our ordinary shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.

We have applied to list our ADSs on the NYSE. However, prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. In addition, our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected. Moreover, a lack of liquidity for our publicly traded ADSs may cause the market price of our ADSs to decline and may make it difficult for you to resell our ADSs.

The initial public offering price for our ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for our ADSs after this initial public offering. We cannot assure you that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price. You may lose part or all of your investment in our ADSs.

The market price for our ADSs may be volatile.

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 and changes or revisions of our expected results;

 

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changes in financial estimates by securities research analysts;

 

   

changes in the economic performance or market valuations of other IT services companies;

 

   

announcements by us or our competitors of new services, acquisitions, strategic partnerships, joint ventures or capital commitments;

 

   

technological breakthroughs in the services outsourcing industry;

 

   

potential litigation or administrative investigations;

 

   

addition or departure of our senior management and other key personnel;

 

   

fluctuations of exchange rates between the RMB and U.S. dollar or other foreign currencies;

 

   

release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares or ADSs;

 

   

sales or perceived sales of additional ordinary shares or ADSs; and

 

   

general market conditions or other developments affecting us, or our industry or the global economy.

In addition, the performance, and fluctuation in market prices, of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes of our ADSs. Volatility in global capital markets, such as the recent global financial crisis, could also have an adverse effect on the market price of our ADSs. Furthermore, the securities market has 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 have a material adverse effect on the market price of our ADSs. In the past, following periods of volatility in the market price of a company’s securities, shareholders have often instituted securities class action litigation against that company. If we were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense and, whether or not adversely determined, could have a material adverse effect on our business, financial condition, results of operations and prospects.

Because the initial public offering price is substantially higher than our net tangible book value per share, you will incur immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately $8.52 per ADS, representing the difference between the mid-point of the estimated range of the initial offering price and our net tangible book value per ADS as of September 30, 2010 after giving effect to this offering. In addition, you may experience further dilution to the extent that our ordinary shares are issued upon the exercise of stock options or the conversion of the remainder of our outstanding convertible notes. See “Dilution” for a more complete description.

Substantial future sales or perceived sales of our ADSs or ordinary shares in the public market could cause the price of our ADSs to decline.

Sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon the closing of this offering, we will have 509,693,868 ordinary shares outstanding (or 525,943,868 ordinary shares if the underwriters exercise their option to purchase additional ADSs in full), including 108,333,340 ordinary shares represented by 10,833,334 ADSs (or 12,458,334 ADSs if the underwriters exercise the option to purchase additional ADSs in full) sold in this offering. This number of outstanding ordinary shares also includes 16,666,667 ordinary shares issued to Bayfront, an affiliate of Temasek, in connection with its investment in our ordinary shares, assuming a price per ADS of US$12.00, the mid-point of the estimated range of the initial public offering price. See “Underwriting—Concurrent Private Placement.” All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. The remaining

 

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ordinary shares outstanding after this offering and the ordinary shares issuable upon conversion of our outstanding convertible notes, will be available for sale, upon the expiration of the 180-day lock-up period beginning from the date of this prospectus, subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. Any or all of these shares may be released prior to expiration of the applicable lock-up period at the discretion of the underwriters. To the extent shares are released before the expiration of the applicable lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

In addition, certain holders of our outstanding ordinary shares and holders of ordinary shares issuable upon conversion of our outstanding convertible notes have the right to cause us to register the sale of their shares under the Securities Act, subject to a 180-day lock-up period in connection with this offering. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. If any of our existing shareholders sell a substantial amount of ordinary shares, or if it is perceived that they will be sold, in the public market, the market price of our ADSs could decline.

You may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials in time to be able to exercise your right to vote.

Except as described in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote. Upon our written request, the depositary will mail to you a shareholder meeting notice which contains, among other things, a statement as to the manner in which your voting instructions may be given. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but you may not receive the voting materials in time to ensure that you can instruct the depositary to vote your ADSs. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ADSs are not voted as you requested. In addition, in your capacity as an ADS holder, you will not be able to call a shareholders’ meeting.

You may not receive distributions on our ordinary shares or any value for them if such distribution is illegal or if any required government approval cannot be obtained in order to make such distribution available to you.

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of 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. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive 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 cause a material decline in the value of our ADSs.

 

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You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act, or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

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

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

You may have difficulty in effecting service of legal process and enforcing court judgments obtained against us or any of our directors or management.

We are incorporated in the Cayman Islands and conduct substantially all of our operations in China through our subsidiaries in China. Most of our officers and directors reside outside of the United States and some or all of the assets of those persons are located outside of the United States. It may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws of the United States or otherwise. Even if you are successful in bringing an action of this kind in the United States, the respective laws of the Cayman Islands and China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. Our PRC counsel has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts, and therefore PRC courts have discretion not to enforce judgments of U.S. courts.

We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2010 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, 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 of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

 

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As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

Anti-takeover provisions in our organizational documents may discourage our acquisition by a third party, which could limit your opportunity to sell your shares at a premium.

Our fourth amended and restated memorandum of association and fifth amended and restated articles of association, which will take effect upon the closing of this offering, include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change of control transactions, including, among other things, the following:

 

   

provisions that authorize our board of directors, without action by our shareholders, to issue preferred shares and to issue additional ordinary shares, including ordinary shares represented by ADSs;

 

   

provisions that restrict or limit the ability of our shareholders to replace our directors or increase the size of our board. Our directors are not subject to a term of office (unless a term is set by our board and approved by our shareholders) and their removal requires approval by a supermajority of at least two-thirds of our shareholders at a shareholders meeting or by at least two-thirds of our board of directors. The number of director nominees that our shareholders can propose in any one calendar year is limited to, in the case of a shareholders meeting convened by the company, the lesser of that number of directors that are up for election (which may be none) or 25% of the size of the board, or, in the case of a shareholders meeting properly called by shareholders, 25% of the size of the board. The size of our board is determined by our board of directors; and

 

   

provisions that impose advance notice, minimum shareholding periods and ownership thresholds and other requirements on the ability of our shareholders to call meetings or to propose special matters for consideration at shareholder meetings.

These provisions could have the effect of depriving you of an opportunity to sell your ADSs at a premium over prevailing market prices by discouraging third parties from seeking to acquire control of us in a tender offer or similar transactions.

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

We have not determined a specific use for a portion of the net proceeds of this offering. Our management will have considerable discretion in the application of these 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. 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 profitability or increase our ADS price. The net proceeds from this offering may also be placed in investments that do not produce income or that may lose value.

We are exempt from certain corporate governance requirements of the NYSE.

We are exempt from certain corporate governance requirements of the NYSE by virtue of being a foreign private issuer. We are required to provide a brief description of the significant differences between our corporate governance practices and the corporate governance practices required to be followed by U.S. domestic companies under the NYSE rules. The standards applicable to us are considerably different than the standards applied to U.S. domestic issuers. The significantly different standards applicable to us do not require us to:

 

   

have a majority of the board be independent;

 

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have a minimum of three members or a person with accounting or related financial management expertise in our audit committee;

 

   

have a compensation committee or a nominating and corporate governance committee;

 

   

provide an annual certification by our chief executive officer that he or she is not aware of any non-compliance with any corporate governance rules of the NYSE;

 

   

have regularly scheduled executive sessions with only non-management directors;

 

   

have at least one executive session of solely independent directors each year;

 

   

seek shareholder approval for (i) the implementation and material revisions of the terms of share incentive plans, (ii) the issuance of more than 1% of our outstanding ordinary shares or more than 1% of our outstanding voting power to a related party, (iii) the issuance of more than 20% of our outstanding ordinary shares, and (iv) an issuance that would result in a change of control;

 

   

adopt and disclose corporate governance guidelines; or

 

   

adopt and disclose a code of business conduct and ethics for directors, officers and employees.

We do not intend to rely on any of the exemptions provided by the NYSE to foreign private issuers, except that we will not provide an annual certification by our chief executive officer that he or she is not aware of any non-compliance with any corporate governance rules of the NYSE, and we will not seek shareholder approval for (i) the issuance of more than 1% of our outstanding ordinary shares or more than 1% of our outstanding voting power to a related party, (ii) the issuance of more than 20% of our outstanding ordinary shares, and (iii) an issuance that would result in a change of control. As a result, you may not be provided with the benefits of certain corporate governance requirements of the NYSE.

We may be classified as a passive foreign investment company, or PFIC, which could result in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.

Depending upon the value of our ordinary shares and ADSs and the nature and composition of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. Based on assumptions as to our projections of the value of our outstanding ordinary shares and ADSs during the year and our use of the proceeds from the initial public offering of our ADSs and of the other cash that we will hold and generate in the ordinary course of our business throughout taxable year 2010, we do not expect to be a PFIC for the taxable year 2010. However, there can be no assurance that we will not be a PFIC for the taxable year 2010 or any future taxable year as PFIC status is tested each taxable year and depends on the composition of our assets and income in such taxable year. Our PFIC status for the current taxable year 2010 will not be determinable until the close of the taxable year ending December 31, 2010.

We will be classified as a PFIC for any taxable year if either (i) at least 75% of our gross income for the taxable year is passive income or (ii) at least 50% of the value of our assets (based on a quarterly value of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. In determining the average percentage value of our gross assets, the aggregate value of our assets will generally be deemed to be equal to our market capitalization (determined by the sum of the aggregate value of our outstanding equity) plus our liabilities. Therefore, a drop in the market price of our ADSs and ordinary shares would cause a reduction in the value of our non-passive assets for purposes of the asset test. Accordingly, we would likely become a PFIC if our market capitalization were to decrease significantly while we hold substantial cash.

If we are classified as a PFIC in any taxable year in which you hold our ADSs or ordinary shares, and you are a U.S. Holder (as defined in “Taxation—United States Federal Income Taxation”), you would generally be subject to additional taxes and interest charges on certain “excess” distributions we make and on any gain recognized on the disposition or deemed disposition of your ADSs or ordinary shares in a later year, even if we

 

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are not a PFIC in that year. Moreover, if we are classified as a PFIC in any taxable year in which you hold our ADSs or ordinary shares, you would not be able to benefit from any preferential tax rate with respect to any dividend distribution that you may receive from us in that year or in the following year. Finally, you would also be subject to special U.S. tax reporting requirements. For more information on the U.S. tax consequences to you that would result from our classification as a PFIC, see “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

Compliance with rules and requirements applicable to public companies may cause us to incur increased costs, which may negatively affect our results of operations.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and NYSE, have required changes in corporate governance practices of public companies. We expect these rules and regulations to increase our legal, accounting and financial compliance costs and to make certain corporate activities more time-consuming and costly. Complying with these rules and requirements may be especially difficult and costly for us because we may have difficulty locating sufficient personnel in China with experience and expertise relating to U.S. GAAP and U.S. public company reporting requirements, and such personnel may command high salaries relative to what similarly experienced personnel would command in the United States. If we cannot employ sufficient personnel to ensure compliance with these rules and regulations, we may need to rely more on outside legal, accounting and financial experts, which may be very costly. In addition, we will incur additional costs associated with our public company reporting requirements. We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements based on our current expectations, assumptions, estimates and projections about us and our industry. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In some cases, these forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. The forward-looking statements included in this prospectus relate to, among others:

 

   

our goals, strategies and expansion plans;

 

   

our future growth, business development, financial condition and results of operations;

 

   

projected revenues, profits, earnings and other estimated financial information;

 

   

our ability to acquire businesses and enter into strategic alliances complementary to our business and integrate these into our business;

 

   

competition in the PRC IT services industry and the global IT services industry generally;

 

   

our plans to recruit more employees;

 

   

our plans to invest in research and development to enhance our service lines and industry vertical knowledge and domain expertise;

 

   

our ability to attract and retain clients;

 

   

fluctuations in the general economic and business conditions in the PRC, the United States, Japan, Korea, Europe and other jurisdictions where we or our clients conduct business;

 

   

PRC governmental policies and rules and regulations relating to the IT services industry and other areas relevant to our business activities; and

 

   

those other risks identified in the section of this prospectus entitled “Risk Factors.”

This prospectus also contains data relating to the PRC IT services industry and the global IT services industry generally, and we have derived such data from various government and private publications. These market data include projections based on a number of assumptions. In addition, any data that is available may not be current. Moreover, the PRC IT services industry and the global IT services industry generally may not grow at the rates projected by market data, or at all. The failure of these markets to grow at the projected rates may have a material adverse effect on our business, financial condition, results of operations and the trading price of our ADSs. In particular, the relatively new and rapidly changing nature of the IT services market in China subject any projections or estimates relating to the growth prospects or future conditions of our sector to significant uncertainties. Furthermore, if any one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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CORPORATE HISTORY AND STRUCTURE

Corporate History

We commenced operations in October 2001 through Beijing iSoftStone Technologies Ltd., or Beijing iSoftStone, a limited liability company established in China and majority owned by our founder Tianwen Liu. To enable us to raise equity capital from investors outside of China, in November 2005, we reorganized our corporate structure by establishing our current Cayman Islands holding company, iSoftStone Holdings Limited, or iSoftStone Holdings, and transferred substantially all the IT services business and related assets and liabilities of Beijing iSoftStone into iSoftStone Information Technology (Group) Co., Ltd., or iSoftStone WFOE, a wholly owned subsidiary of iSoftStone Holdings, in exchange for issuance of ordinary shares of iSoftStone Holdings to our founder Tianwen Liu and other shareholders of Beijing iSoftStone. Concurrently, because certain businesses cannot be conducted by foreign invested enterprises, iSoftStone WFOE entered into a series of contractual arrangements with Beijing iSoftStone and its shareholders.

Since November 2005, in addition to our organic growth, we have also expanded our operations through a series of strategic acquisitions including principally the following:

 

   

In November 2005, iSoftStone WFOE acquired the IT services business and related assets of United Innovation Ltd., a limited liability company established in January 2002 in Beijing and founded by Yong Feng, our executive vice president. We liquidated United Innovation Ltd. in January 2008, after we integrated its business into another operating entity of ours.

 

   

In December 2006, we acquired 100% of the equity interest in Guangzhou Ruandongzhiruan Computer Technology Co., Ltd., or Guangzhou Ruandongzhiruan. This acquisition provided us with the skilled personnel and capabilities to provide IT services for clients in the insurance industry. We have paid cash consideration of $1.6 million, and may need to pay additional consideration of $0.2 million for this acquisition, which has been already accrued. To streamline our corporate structure, we liquidated Guangzhou Ruandongzhiruan in September 2010 after we integrated its business into another operating entity of ours.

 

   

In December 2006, we acquired 75% of the equity interest in Beijing Kebao System Engineering Co., Ltd., or Beijing Kebao, pioneer in providing IT services to Japanese clients. In September 2007, we acquired the remaining 25% equity interest in Beijing Kebao. The acquisitions brought us a group of experienced talents and enabled us to rapidly expand our Japan related business and delivery capabilities. We have paid cash consideration of $0.9 million in total for the 100% equity interest and agreed to issue 674,109 of our ordinary shares to the sellers who became our employees. These 674,109 ordinary shares have been accounted for as share-based compensation because the shares were subject to return if the sellers terminated their employment with us within a specified period of time. To streamline our corporate structure, Beijing Kebao’s wholly owned subsidiary in Japan, iSoftStone Information, merged into our existing subsidiary iSoftStone Japan Limited in August 2008 and we liquidated Beijing Kebao in July 2010 after we integrated its business into ours.

 

   

In July 2007, iSoftStone WFOE acquired the operating assets and liabilities of Wuxi Huayang Software Co., Ltd., or Wuxi Huayang, including the remaining 49% equity interest in iSoftStone Information System Service Co., Ltd., after the completion of which iSoftStone Information System Service Co., Ltd. became our wholly owned subsidiary. With this acquisition, we quickly expanded into, and established a low cost data center, training center and sales and delivery center that serves both Greater China and Global clients, in Wuxi, a key tier two city in China. We have paid cash consideration of $1.9 million for such acquisition and agreed to pay additional consideration in cash contingent on the financial performance of iSoftStone Information System Service Co., Ltd. for the three years ended June 30, 2010, which is currently to be determined.

 

   

In January 2008, we acquired Shanghai Jiefeng Computer Science Co., Ltd., or Shanghai Jiefeng, which is a long-time Microsoft business partner and has strong expertise in Microsoft .Net based

 

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technologies. This acquisition brought us proprietary Microsoft .Net based technologies and strengthened our capability to provide Microsoft .Net based application development services to clients. We paid cash consideration of $2.7 million and issued 1,004,500 of our ordinary shares for this acquisition.

 

   

In February 2008, we acquired Akona Systems, Inc., or Akona, a Washington corporation primarily focusing on IT consulting services in the U.S. This acquisition provided us with front-end consulting capabilities in the United States and Europe and expanded our client relationship with Microsoft. We paid cash consideration of $8.8 million and issued 12,087,777 of our ordinary shares for this acquisition. In September 2008, Akona was merged into our wholly owned subsidiary iSoftStone Inc.

 

   

In March 2009, we acquired Shenzhen Star Ronghe Science and Technology Co., Ltd., or Shenzhen Star, which is a long-time service provider for Huawei. This acquisition enhanced our client relationship with Huawei and helped us to become one of Huawei’s major IT services providers. We have paid cash consideration of $0.8 million in 2010 and agreed to pay a contingent consideration of up to $0.7 million in cash for this acquisition, based on certain performance targets for the 12-month period ended February 28, 2010. How much contingent consideration is to be paid has yet to be determined.

 

   

In March 2009, we acquired the IT services business of MDCL-Frontline (China) Ltd., or MDCL, a top-class provider of Chinese software and professional services, and its affiliates in Beijing, Shanghai, Hong Kong and Taiwan. Through this acquisition, we acquired a group of high quality personnel and increased our presence in the Greater China region, especially in Hong Kong and Taiwan. We paid cash consideration of $0.7 million in 2009. In addition, we paid cash consideration of $0.2 million and issued 242,059 of our ordinary shares in 2010 based on certain performance conditions of the acquired business, and agreed to pay a further consideration of up to $0.3 million in cash contingent to the future performance of the acquired business. We also agreed to issue 36,209 ordinary shares and an additional $67,898 worth of our ordinary shares issuable at the fair value of our ordinary shares upon vesting to the sellers who became our employees, which was accounted for as share-based compensation because the shares were subject to return if the sellers terminated their employment with us within a specified period of time.

 

   

In October 2010, we acquired Ascend Technologies, Inc., or Ascend, which has offices in Boston and New York City and provides IT consulting services to global banking and financial services (including insurance) clients. Among other benefits, this acquisition expands our geographic presence and service capabilities to better serve global BFSI clients and deepens our BFSI domain expertise. The transaction consideration contains a contingent consideration arrangement based primarily on the performance of the acquired business for the period from October 1, 2010 to September 30, 2011 with a total consideration floor of $3.5 million and cap of $6.5 million. Pursuant to the agreements, we have paid $1.4 million cash consideration to date. In addition, we will issue a number of ordinary shares to be determined by dividing $963,902 by a per ordinary share price equal to 90% of the per share equivalent price in this offering, provided that this offering is completed prior to December 24, 2010. Otherwise, $963,902 will be paid in cash. The transaction consideration of the acquisition of Ascend also contains a contingent cash consideration arrangement based primarily on performance of the acquired business for the period from October 1, 2010 to September 30, 2011 at a minimum of $0.9 million and maximum of $3.9 million, which will be payable in cash in installments over two years. We are further required to pay cash of $0.2 million to certain employees if they continue to be employed by us until December 31, 2011, which will be recognized as our compensation costs.

 

   

In November 2010, we acquired Shanghai Kangshi Information Systems Company Limited, or Shanghai Kangshi, enhancing our capability to provide business intelligence services to our Greater China and Global clients. The total cash consideration of $6.3 million is payable in installments, with $2.2 million, $3.5 million and $0.6 million payable in 2010, 2011 and 2012, respectively. In addition,

 

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we will issue a number of additional ordinary shares to be determined by dividing $1,198,215 by a per ordinary share price equal to 95% of the per share equivalent of the initial offering price, promptly following the earlier to occur of the completion of this offering and February 28, 2011. A portion of these shares will be subject to our repurchase right at a nominal price if the performance of the acquired business for each of 2010, 2011 and 2012 fails that year’s performance target.

For more information relating to the above acquisitions, please see our audited consolidated financial statements included elsewhere in this prospectus.

We conduct our business primarily though the following subsidiaries:

 

   

iSoftStone WFOE, which is our primary operating entity and hosts our headquarter in Beijing, China. iSoftStone WFOE operates our China-based delivery platform and holds our China-based subsidiaries, including our three key regional centers: iSoftStone Information Technology Co., Ltd. located in Tianjin, iSoftStone Information System Service Co., Ltd. located in Wuxi, and Guangzhou iSoftStone Information Technology Co., Ltd. located in Guangzhou.

 

   

iSoftStone Inc., our wholly owned subsidiary incorporated in the State of Delaware. iSoftStone Inc. integrates the business of Akona that we acquired in 2008, and provides a wide range of services to our clients in the United States, especially our key client Microsoft, ranging from consulting, application development to R&D services.

 

   

iSoftStone Japan Limited, our wholly owned subsidiary incorporated in Japan that primarily provides IT service, consulting and software R&D services to our clients.

 

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Corporate Ownership Structure

The following diagram illustrates our current corporate structure and the place of formation and the ownership of our major subsidiaries and affiliated entity as of the date of this prospectus. All of our subsidiaries are 100% owned or controlled by us except for Beijing Guodian Ruantong Technology Co., Ltd., in which we have a 60% equity interest, and Beijing iSoftStone Jiewen Information Technology Co., Ltd., in which we have a 67% equity interest.

LOGO

 

(1) Include a series of contractual arrangements among iSoftStone WFOE, Beijing iSoftStone, and certain shareholders of Beijing iSoftStone, including an exclusive outsourcing agreement, an exclusive technology consulting and management service agreement, a trademark and software licensing agreement, an equity pledge agreement, and an irrevocable proxy. For a more detailed discussion of these contractual arrangements, see “Related Party Transactions—Contractual Arrangements with Beijing iSoftStone.”

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering and from the investment by Bayfront, an affiliate of Temasek, in our ordinary shares of approximately $97.3 million, or $115.4 million if the underwriters exercise their option to purchase additional ADSs in full, after deducting underwriting discounts, commissions and the estimated offering expenses payable by us (without giving effect to any placement fees payable by us in connection with the concurrent private placement with Bayfront) and based upon an assumed initial offering price of $12.00 per ADS (the mid-point of the estimated public offering price range shown on the front cover of this prospectus). See “Underwriting—Concurrent Private Placement.” Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, a $1.00 increase (decrease) in the assumed initial public offering price of $12.00 per ADS would increase (decrease) the net proceeds to us from this offering by $6.8 million, after deducting the estimated underwriting discounts and commissions and estimated aggregate offering expenses payable by us.

We intend to use $36.8 million of our net proceeds from this offering to repay outstanding bank borrowings, and use the remainder for other general corporate purposes, such as working capital, facilities acquisitions and funding potential acquisitions of, or investments in, other businesses or technologies that we believe will complement our current business and expansion strategies. The outstanding bank borrowings that will be repaid by net proceeds from this offering have fixed annual interest rates ranging from 5.31% to 5.58% and maturity dates ranging from December 28, 2010 to November 19, 2011. The proceeds from such bank borrowings were primarily used to finance our operations.

In addition, the purposes of this offering also include the retention of employees by providing them with equity incentives and the creation of a public market for our ordinary shares represented by the ADSs for the benefit of our shareholders.

The foregoing represents our current intentions with respect of the use and allocation of the net proceeds from this offering based upon our present plans and business conditions. The amounts and timing of any expenditure will vary depending on the amount of cash generated by our operations, competitive developments and the rate of growth, if any, of our business. Accordingly, our management will have significant flexibility and discretion in applying the net proceeds from the offering. Unforeseen events or changed business conditions may result in application of the proceeds from this offering in a manner other than as described in this prospectus.

It is possible that we may become a passive foreign investment company for U.S. federal income tax purposes, which could result in negative tax consequences for you. See “Risk Factors—Risks Related to Our ADSs and This Offering—We may be classified as a passive foreign investment company, or PFIC, which could result in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.” and “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

In utilizing the proceeds from this offering, as an offshore holding company, we are permitted under PRC laws, rules and regulations to provide funding to our PRC subsidiaries through loans or capital contributions and to other entities through loans only. Subject to the satisfaction of applicable government registration and approval requirements, we may extend loans or make additional capital contributions to our PRC subsidiaries to fund their capital expenditures or working capital. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, or at all. See “Risk Factors—Risks Related to Doing Business in China—PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

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

 

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DIVIDEND POLICY

We have never declared or paid dividends, nor do we have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

Cash dividends, if any, will be at the discretion of our board of directors, and will depend upon our future results of operations and earnings, capital requirements and surplus, general financial conditions, shareholders’ interests, contractual restrictions and other factors our board of directors may deem relevant. We can pay dividends only out of profits or other distributable reserves. Cash dividends on our ordinary shares will be paid in U.S. dollars.

We are a holding company incorporated in the Cayman Islands. In order to pay dividends, if any, to our shareholders, we rely on dividends from our PRC subsidiaries. Each of our PRC subsidiaries may pay dividends only out of its accumulated distributable profits, if any, determined in accordance with its articles of association and the accounting standards and regulations in the PRC. The results of operations reflected in our financial statements prepared in accordance with U.S. GAAP differ from those reflected in the statutory financial statements of our PRC subsidiaries. Moreover, pursuant to applicable PRC laws and regulations, 10% of the after-tax profits of each of our PRC subsidiaries are required to be set aside in a statutory surplus reserve fund each year until the reserve balance reaches 50% of such PRC subsidiary’s registered capital. Allocations to these statutory reserves may only be used for specific purposes and are not distributable to us in the form of loans, advances or cash dividends. Furthermore, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us.

The Enterprise Income Tax Law and its implementing rules provide that an income tax rate of 10% will be applicable to dividends payable to non-PRC resident enterprise shareholders to the extent such dividends are derived from sources within the PRC. If we are determined to be a PRC resident enterprise by the PRC tax authorities, it is unclear whether dividends declared and distributed by us to our non-PRC resident enterprise shareholders will be deemed to be derived from sources within the PRC under the Enterprise Income Tax Law and its implementing rules and therefore be subject to the 10% withholding tax (or potentially a 20% income tax withholding will be imposed on dividends received from us by our non-PRC individual shareholders under the applicable PRC tax laws). See “Taxation—People’s Republic of China Taxation.”

If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.”

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2010 presented on:

 

   

an actual basis;

 

   

a pro forma basis, to give effect to (1) the automatic conversion of all of our outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares upon the closing of this offering, and (2) the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million into 19,913,824 ordinary shares upon the closing of this offering based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus;

 

   

a pro forma as adjusted basis, to give effect to (1) the automatic conversion of all of our outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares upon the closing of this offering, (2) the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million into 19,913,824 ordinary shares upon the closing of this offering based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus, (3) the issuance and sale of 73,222,230 ordinary shares in the form of ADSs in this offering and 16,666,667 ordinary shares to Bayfront, an affiliate of Temasek, assuming an initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus, after deducting underwriting discounts, commissions and estimated offering expenses payable by us (without giving effect to any placement fees payable by us in connection with the concurrent private placement with Bayfront) and assuming no exercise of the underwriters’ option to purchase additional ADSs and no other change to the number of ADS sold by us as set forth on the cover page of this prospectus, and (4) the use of proceeds from this offering to repay our outstanding bank borrowings, which had a $31.4 million balance as of September 30, 2010.

You should read this table in conjunction with “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of September 30, 2010  
     Actual     Pro forma     Pro forma as adjusted  
     (in thousands, except share data)  

Short term bank borrowings

   $ 31,390      $ 31,390        —     

Convertible notes

     41,203        21,686        21,686   

Series B convertible redeemable preference shares

     54,164        —          —     

Shareholders’ equity:

      

Ordinary shares, par value $0.0001 per share; 450,065,400 shares authorized; 135,644,912 shares issued and outstanding, actual; 399,811,147 shares issued and outstanding, pro forma;              shares issued and outstanding, pro forma as adjusted

     14        42        51   

Series A convertible preference shares, par value $0.0001 per share; 95,286,195 shares authorized; 95,286,195 shares issued and outstanding

     14,150        —          —     

Treasury shares

     (2,000     (2,000     (2,000

Shares to be issued

     230        230        230   

Additional paid-in capital(1)

     24,616        112,419        209,671   

Statutory reserves

     4,133        4,133        4,133   

Accumulated other comprehensive income

     5,622        5,622        5,622   

Accumulated deficit

     (23,668     (23,668     (23,668
                        

Total iSoftStone Holdings Limited shareholders’ equity

     23,097        96,778        194,039   

Noncontrolling interest

     668        668        668   
                        

Total equity(1)

     23,765        97,446        194,707   
                        

Total capitalization(1)

   $ 150,522      $ 150,522        216,393   
                        

 

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(1)

A $1.00 increase (decrease) in the assumed initial public offering price of $12.00 per ADS would increase (decrease) each of additional paid-in capital, total equity and total capitalization by $6.8 million on a pro forma as adjusted basis, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us (without giving effect to any placement fees payable by us in connection with the concurrent private placement with Bayfront) and assuming no exercise of the underwriter’s option to purchase additional ADSs.

The table above excludes:

 

   

85,121,280 ordinary shares issuable upon the exercise of options issued under our equity incentive plans that are outstanding as of the date of this prospectus;

 

   

7,412,746 additional ordinary shares available for future grant under our equity incentive plans as of the date of this prospectus;

 

   

ordinary shares issuable upon the conversion of our convertible notes with an aggregate principal amount of $20 million outstanding at the date of this prospectus. Within 12 months of the closing of this offering, these convertible notes are convertible into our ordinary shares at a significant discount to the offering price or redeemable for cash at the holders’ option. See “Related Party Transactions—Private Placements—Convertible Notes Financing”;

 

   

acquisition consideration (A) relating to our October 2010 acquisition of Ascend Technologies, Inc. of a number of ordinary shares to be determined by dividing $963,902 by a per share issue price equal to 90% of the per share equivalent price in this offering if this offering is closed prior to December 24, 2010, or 892,502 ordinary shares assuming an initial public offering price of $12.00 per ADS (the mid-point of the estimated range of the offering price), and (B) relating to our November 2010 acquisition of Shanghai Kangshi Information Systems Company Limited of a number of ordinary shares to be determined by dividing $1,198,215 by a per ordinary share price equal to 95% of the per share equivalent of the initial offering price, or 1,051,066 ordinary shares assuming an initial public offering price of $12.00 per ADS (the mid-point of the estimated range of the offering price); and

 

   

up to 1,361,058 ordinary shares and an additional $67,898 worth of ordinary shares issuable, conditionally or unconditionally, pursuant to certain share-based compensation arrangements in connection with certain acquisitions that we made prior to the date of the prospectus. For more information relating to such acquisitions, see “Corporate History and Structure—Corporate History” and “Related Party Transactions—Acquisition Related Shares Issuance.”

As of the date of this prospectus, there has been no material change to our capitalization as set forth above.

 

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DILUTION

If you invest in our ADSs, you will experience dilution to the extent of the difference between the initial public offering price per ADS you pay in this offering and the pro forma net tangible book value per ADS immediately after this offering.

Our net tangible book value as of September 30, 2010 was approximately $23.1 million, or $0.05 per ordinary share outstanding at that date and $0.51 per ADS, based on 137,581,854 ordinary shares (representing 135,644,912 ordinary shares outstanding as of that date plus 1,936,942 ordinary shares issuable unconditionally as of that date). Net tangible book value per ordinary share is determined by dividing our net tangible book value by the number of outstanding ordinary shares. Our net tangible book value is determined by subtracting the value of our acquired net intangible assets, goodwill, total liabilities, noncontrolling interest and our Series B convertible redeemable preference shares from our total assets. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the conversion of all outstanding preference shares and certain outstanding convertible notes as described in following paragraph into ordinary shares upon the closing of this offering and the additional proceeds we receive from this offering, from the assumed public offering price per ordinary share, which is the mid-point of the estimated initial public offering price range shown on the front cover of this prospectus and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

Without taking into account any other changes in such net tangible book value after September 30, 2010, other than to give effect to (1) the automatic conversion of all of our outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares upon the closing of this offering, (2) the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million into 19,913,824 ordinary shares upon the closing of this offering based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus, and (3) the issuance and sale of 73,222,230 ordinary shares in the form of ADSs in this offering and 16,666,667 ordinary shares to Bayfront, an affiliate of Temasek, assuming an initial public offering price of $12.00 per ADS, which is the mid-point of the estimated public offering price range shown on the front cover of this prospectus and, after deducting underwriting discounts and commissions and estimated offering expenses payable by us (without giving effect to any placement fees payable by us in connection with the concurrent private placement with Bayfront) and assuming no exercise of the underwriters’ option to purchase additional ADSs and no other change to the number of ADS sold by us as set forth on the cover page of this prospectus, our pro forma net tangible book value as of September 30, 2010 would have been $178.0 million, $0.35 per outstanding ordinary share, including ordinary shares underlying our outstanding ADSs, and $3.48 per ADS. This represents an immediate increase in pro forma net tangible book value of $0.16 per ordinary share, or $1.56 per ADS, to existing shareholders and an immediate dilution in pro forma net tangible book value of $0.85 per ordinary share, or $8.52 per ADS, to new investors in this offering. The following table illustrates such per ordinary share dilution:

 

     Per Share      Per ADS  

Net tangible book value as of September 30, 2010

   $ 0.05       $ 0.51   

Increase in the net tangible book value per share attributable to the conversion of our
series A and B preference shares and Convertible notes with an aggregate principal amount of $18 million

   $ 0.14       $ 1.41   
                 

Pro forma net tangible book value after giving effect to the conversion of our
series A and B preference shares and convertible notes with an aggregate
principal amount of $18 million

   $ 0.19       $ 1.92   

Increase in pro forma net tangible book value attributable to price paid by new investors

   $ 0.16       $ 1.56   
                 

Pro forma net tangible book value after giving effect to the conversion of our series A and B preference shares, conversion of convertible notes with an aggregate principal amount of $18 million, this offering and issuance of 16,666,667 ordinary shares to Bayfront, an affiliate of Temasek

   $ 0.35       $ 3.48   

Dilution in net tangible book value to new investors in this offering

   $ 0.85       $ 8.52   
                 

Assumed initial public offering price

   $ 1.20       $ 12.00   
                 

 

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A $1.00 increase (decrease) in the assumed initial public offering price of $12.00 per ADS would increase (decrease) our pro forma net tangible book value after giving effect to the offering by $6.8 million, the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by $0.02 per ordinary share and $0.15 per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by $0.08 per ordinary share and $0.85 per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us (without giving effect to any placement fees payable by us in connection with the concurrent private placement with Bayfront). The pro forma information discussed above is illustrative only. Our net tangible book value following the closing of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

The following table summarizes on a pro forma basis the differences as of September 30, 2010 between the existing shareholders, including holders of our Series A and B preference shares and the new investors (including Bayfront, an affiliate of Temasek) with respect to the number of ordinary shares purchased from us, the total consideration paid and the average price per ordinary share paid before deducting the underwriting discounts and commissions and estimated offering expenses payable by us. The total ordinary shares do not include ADSs issuable upon the exercise of options granted under our share incentive plans or ADSs issuable upon the exercise of the option to purchase additional ADSs granted to the underwriters. The information in the following table is illustrative only and the total consideration paid and the average price per ordinary share equivalent and per ADS equivalent is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

 

     Ordinary shares
purchased
    Total
consideration
    Average price per
ordinary share
equivalent
     Average price per
ADS equivalent
 
     Number      Percent     Amount      Percent       

Existing shareholders(1)

     421,661,913         82.4     90,474,214         45.6     0.21         2.15   

New investors

     89,888,897         17.6     107,866,676         54.4     1.20         12.00   
                                                   

Total

     511,550,810         100     198,340,890         100     0.39         3.88   
                                                   

 

(1) Reflects (a) the automatic conversion of all of our outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares upon the closing of this offering, and (b) the issuance of 19,913,824 ordinary shares upon the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million upon the closing of this offering, based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus.

The dilution to new investors will be $0.83 per ordinary shares and $8.28 per ADS, if the underwriters exercise in full their option to purchase additional ADSs.

The dilution to new investors does not give effect to the potential conversion of our outstanding convertible notes with an aggregate principal amount of $20 million. Upon the closing of this offering and within the 12 months thereafter, the holders of the convertible notes have the right, but not the obligation, to (i) convert the outstanding principal amounts of notes and any accrued and unpaid interest thereon into ordinary shares with the conversion price equal to the discount to the offering price in this offering providing the note holders, on the date of the closing of this offering, an internal rate of return of 35%, subject to anti-dilution adjustment, or (ii) have us redeem for cash all of the outstanding principal amount of the convertible notes at a price that would provide the note holders, at the time of payment, an internal rate of return of 18%, plus any accrued and unpaid interest.

 

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EXCHANGE RATE INFORMATION

A substantial majority of our business are conducted in Renminbi. We make no representation that any amounts in Renminbi or U.S. dollar could be or could have been converted into each other at any particular rate or at all. The PRC government imposes controls over its foreign exchange in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated. These rates are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

     Noon Buying Rate  

Period

   Period End      Average(1)      Low      High  
     (RMB per $1.00)  

2005

     8.0702         8.1826         8.2765         8.0702   

2006

     7.8041         7.9579         8.0702         7.8041   

2007

     7.2946         7.5806         7.8127         7.2946   

2008

     6.8225         6.9193         7.2946         6.7800   

2009

     6.8259         6.8295         6.8470         6.8176   

2010

           

Nine months ended September 30, 2010

     6.6905         6.8060         6.8330         6.6869   

May

     6.8305         6.8275         6.8310         6.8245   

June

     6.7815         6.8184         6.8323         6.7815   

July

     6.7735         6.7762         6.7807         6.7709   

August

     6.8069         6.7873         6.8069         6.7670   

September

     6.6905         6.7396         6.8102         6.6869   

October

     6.6705         6.6675         6.6912         6.6397   

November (through November 26, 2010)

     6.6675         6.6526         6.6906         6.6233   

 

Source: Federal Reserve Bank of New York
(1) Averages for a period are calculated by using the average of the exchange rates on the end of each month during the period. Monthly averages are calculated by using the average of the daily rates during the relevant period.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated statements of operations data for the years ended December 31, 2007, 2008 and 2009 and the selected consolidated balance sheet data as of December 31, 2008 and 2009 have been derived from our audited consolidated financial statements included elsewhere in this prospectus, which have been audited by Deloitte Touche Tomatsu CPA Ltd., an independent registered public accounting firm. The report of Deloitte Touche Tomatsu CPA Ltd. on our audited financial statements is included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2007 have been derived from our audited consolidated financial statements not included elsewhere in this prospectus. Our audited consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate our expected results for any future periods. Our selected consolidated statements of operations data for each of the nine month periods ended September 30, 2009 and 2010 and selected consolidated balance sheet data as of September 30, 2010 have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. We have prepared this unaudited consolidated financial information on the same basis as our audited consolidated financial statements. This unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Results for the nine months ended September 30, 2010 are not necessarily indicative of results that may be expected for the full year. You should read the selected consolidated financial data in conjunction with those financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

We have not included financial information for the years ended December 31, 2005 and 2006, as such information is not available on a basis that is consistent with the consolidated financial information for the years ended December 31, 2007, 2008 and 2009, and cannot be provided on a U.S. GAAP basis without unreasonable effort or expense.

 

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Selected Consolidated Statements of Operations Data

 

     For the year ended December 31,     For the nine months ended September 30,  
         2007             2008             2009             2009             2010      
     (dollars in thousands, except share and
per share data or as otherwise noted)
 

Net revenues

   $ 36,417      $ 82,464      $ 134,387      $ 90,032      $ 135,198   

Cost of revenues(1)(2)

     (24,399     (55,083     (88,391     (59,585     (87,334
                                        

Gross profit

     12,018        27,381        45,996        30,447        47,864   
                                        

Operating expenses:

          

General and administrative expenses(1)

     (12,762     (16,344     (26,654     (17,482     (32,965

Selling and marketing expenses(1)(2)

     (6,150     (11,264     (13,205     (9,487     (11,485

Research and development expenses(1)

     (4,498     (1,057     (1,222     (643     (2,517
                                        

Total operating expenses

     (23,410     (28,665     (41,081     (27,612     (46,967
                                        

Changes in fair value of contingent consideration in connection with business combination

     —          —          (3     —          231   

Change in fair value of return rate reset feature of convertible notes

     —          —          —          —          (1,028

Other income, net

     56        800        981        789        25   

Government subsidies

     2,822        862        2,999        1,929        2,910   

Gain on sale of equity of a subsidiary

     —          —          —          —          1,079   
                                        

(Loss) income from operations

     (8,514     378        8,892        5,533        4,114   
                                        

Interest income

     90        228        138        110        98   

Interest expense

     (71     (363     (878     (522     (3,581

Change in fair value of warrants

     (1,419     (676     —          —          —     

Gain on bargain purchase of a business

     —          —          66        66        —     
                                        

(Loss) income before provision for income taxes and loss in equity method investments, net of income taxes

     (9,914     (433     8,218        5,207        631   

Income taxes (expenses) benefit

     (373     492        823        518        (171
                                        

(Loss) income after income taxes before loss in equity method investments, net of income taxes

     (10,287     59        9,041        5,725        460   

Loss in equity method investments, net of income taxes

     (21     (62     (13     (11     (188
                                        

Net (loss) income(5)

     (10,308     (3     9,028        5,714        272   

Less: Net loss attributable to noncontrolling interest

     114        101        21        14        514   
                                        

Net (loss) income attributable to iSoftStone Holdings Limited

   $ (10,194   $ 98      $ 9,049      $ 5,728      $ 786   
                                        

 

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     For the year ended December 31,      For the nine months ended September 30,  
     2007     2008     2009              2009                      2010          
     (dollars in thousands, except share and per share data or as otherwise noted)  

Net (loss) income per share attributable to ordinary shareholders of iSoftStone Holdings Limited:

            

Basic

   $ (0.10   $ (0.03   $ 0.01       $ 0.01       $ (0.02

Diluted

   $ (0.10   $ (0.03   $ 0.01       $ 0.01       $ (0.02
                                          

Weighted average shares used in calculating net (loss) income per ordinary share

            

Basic

     38,827,820        122,681,330        125,106,274         123,388,300         133,652,540   

Diluted

     38,827,820        122,681,330        131,892,325         129,641,280         133,652,540   
                                          

Pro forma net loss per share for the use of proceeds to repay bank borrowings(3):

            

Basic (unaudited)

             $ (0.01

Diluted (unaudited)

             $ (0.01 ) 
                  

Weighted average shares used in computation of pro forma net loss per ordinary share

            

Basic (unaudited)

             $ 158,330,040   

Diluted (unaudited)

             $ 158,330,040   
                  

Pro forma net income per share for the conversion of preference shares and convertible notes(4)

       $ 0.02          $ 0.01   

Weighted average shares used in computation of pro forma net income per ordinary share

         389,662,755            415,007,811   

 

(1) Includes share-based compensation charges totaling $4.0 million, $1.4 million and $2.4 million in 2007, 2008 and 2009, and $0.7 million and $5.8 million in the nine months ended September 30, 2009 and 2010, respectively, allocated as follows:

 

     For the year ended December 31,      For the nine months ended September 30,  
         2007              2008              2009              2009              2010      
     (dollars in thousands)  

Cost of revenues

   $ 56       $ 85       $ 159       $ 69       $ 106   

Operating expenses:

              

General and administrative expenses

     3,895         1,258         2,074         618         5,508   

Selling and marketing expenses

     18         44         110         39         198   

Research and development expenses

     1         1         7         1         5   
                                            

Total share-based compensation expenses

   $ 3,970       $ 1,388       $ 2,350       $ 727       $ 5,817   
                                            

 

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(2) Includes acquisition-related amortization of intangible assets totaling $0.6 million, $2.6 million and $2.0 million in 2007, 2008 and 2009, and $1.5 million and $1.2 million in the nine months ended September 30, 2009 and 2010, respectively, allocated as follows:

 

    For the year ended December 31,     For the nine months ended September 30,  
            2007                     2008                     2009                     2009                     2010          
    (dollars in thousands)  

Cost of revenues

  $ 166      $ 447      $ 87      $ 67      $ 87   

Operating expenses:

         

Selling and marketing expenses

    416        2,202        1,928        1,443        1,071   
                                       

Total amortization of intangible assets expenses

  $ 582      $ 2,649      $ 2,015      $ 1,510      $ 1,158   
                                       

 

(3) This pro forma basic and diluted net loss per ordinary share for the nine months ended September 30, 2010 were computed by dividing adjusted net loss attributable to our shareholders by the sum of (1) the weighted average number of ordinary shares outstanding for the nine months ended September 30, 2010 and (2) the number of ordinary shares whose proceeds, calculated using the share price at the mid-point of the price range shown on the front of this preliminary prospectus, would have been necessary to repay our average bank borrowings of $29.6 million for the nine months ended September 30, 2010, which was calculated by averaging the $27.8 million balance as of January 1, 2010 and the $31.4 million balance as of September 30, 2010, assuming those borrowings had been outstanding for the nine months period ended September 30, 2010. Net loss attributable to our shareholders has been adjusted by the actual interest cost (net of tax) of the borrowings recognized in our consolidated statement of operations for the nine months ended September 30, 2010.

The reconciliation of net loss used for computing the pro forma earnings per share for the nine-month period ended September 30, 2010 is as follows:

 

     Amount  

Net loss attributable to iSoftStone shareholders allocated for computing net loss per ordinary share-basic and diluted

   $ (2,068

Add: Interest expenses attributable to bank borrowings, net of tax

     816   
        

Net loss used in computing pro forma net loss per ordinary share-basic and diluted

   $ (1,252
        

The reconciliation of weighted average number of ordinary shares used for computing the pro forma earnings per share for the period ended September 30, 2010, are as follows:

 

     Number of shares  
     Basic      Diluted  
     (Unaudited)      (Unaudited)  

Weighted average number of shares used in calculating net loss per ordinary share

     133,652,540         133,652,540   

Add: the number of shares whose proceeds would be necessary to pay the bank borrowings of $29.6 million

     24,677,500         24,677,500   
                 

Weighted average ordinary shares used in computing pro forma net loss per ordinary share

     158,330,040         158,330,040   
                 

 

(4)

This pro forma net income per ordinary share reflects (a) the automatic conversion of all of the outstanding series A preference shares and series B preference shares into 264,166,235 ordinary shares using a conversion ratio of one for one upon the closing of this offering, as if it had occurred as of January 1, 2009, and (b) the conversion, pursuant to binding

 

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conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million into 19,913,824 of our ordinary shares upon the closing of this offering based on an assumed initial public offering price of $12.00 per ADS, as if it had occurred as of September 30, 2010.

 

(5) To supplement our net income presented in accordance with U.S. GAAP, we use the non-GAAP financial measure of net income, which is adjusted from results based on U.S. GAAP to exclude share-based compensation, interest expense of convertible notes, changes in fair value of certain liabilities carried at fair value, amortization of intangible assets from acquisitions and gain on bargain purchase of a business. This non-GAAP financial measure is provided as additional information to help our investors compare business trends among different reporting periods on a consistent basis and to enhance investors’ overall understanding of the historical and current financial performance of our continuing operations and our prospects for the future. This non-GAAP financial measure should be considered in addition to results prepared in accordance with U.S. GAAP, but should not be considered a substitute for or superior to U.S. GAAP results. In addition, our calculation of this non-GAAP financial measure may be different from the calculation used by other companies, and therefore comparability may be limited.

The following table sets forth the reconciliation of our non-GAAP net income (loss) to our U.S. GAAP net income (loss):

 

     For the Year Ended
December 31,
    For the Nine
Months Ended
September 30,
 
     2007     2008     2009     2009     2010  
     (U.S. dollars in thousands)  

Net income (loss) (U.S. GAAP)

     (10,308     (3     9,028        5,714        272   

Share-based compensation

     3,970        1,388        2,350        727        5,817   

Amortization of intangible assets from acquisitions

     582        2,649        2,015        1,510        1,158   

Interest expense of convertible notes

     —          —          63        —          2,677   

Changes in fair value of contingent consideration in connection with business combinations

     —          —          3        —          (231

Changes in fair value of the return rate reset feature of convertible notes

     —          —          —          —          1,028   

Changes in fair value of warrants

     1,419        676        —          —          —     

Gain on bargain purchase of a business

     —            (66     (66     —     
                                        

Total non-GAAP adjustments

     5,971        4,713        4,365        2,171        10,449   
                                        

Net income (loss) (non-GAAP)

     (4,337     4,710        13,393        7,885        10,721   
                                        

 

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Selected Consolidated Balance Sheet Data

 

     December 31,
2007
    December 31,
2008
    December 31,
2009
    September 30,
2010
     September 30,
2010
 
                              Pro forma(1)  
    

(dollars in thousands)

 

Cash

   $ 12,963      $ 33,776      $ 55,138      $ 40,414       $ 40,414   

Accounts receivable, net of allowance for doubtful accounts of $292,000, $309,000, $423,000 and $1,968,000 as of December 31, 2007, 2008, 2009 and September 30, 2010 respectively

     12,572        28,350        69,094        97,443         97,443   

Total assets

     38,961        82,841        162,179        193,252         193,252   

Total liabilities

     17,030        27,158        90,935        115,323         95,806   

Series B convertible redeemable preference shares:

     18,130        49,459        52,159        54,164         —     

Total iSoftStone Holdings Limited shareholders’ equity

     3,676 (2)      6,221 (2)      18,590 (2)      23,097         96,778   

Non-controlling interest

     125        3        495        668         668   
                                         

Total equity

     3,801        6,224        19,085        23,765         97,446   
                                         

Total liabilities, series B convertible redeemable preference shares and equity

   $ 38,961      $ 82,841      $ 162,179      $ 193,252       $ 193,252   

 

(1) The pro forma balance sheet information as of September 30, 2010 assumes (a) the automatic conversion of all of our outstanding series A convertible preference shares and series B convertible redeemable preference shares into our ordinary shares using a conversion ratio of one for one upon the closing of this offering, and (b) the conversion, pursuant to binding conversion agreements entered into in November 2010, of convertible notes with an aggregate principal amount of $18 million into 19,913,824 ordinary shares upon the closing of this offering based on an assumed initial public offering price of $12.00 per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus.
(2) Including series A convertible preference shares with carrying amount of $14.2 million for each of the periods ended December 31, 2007, 2008, 2009 and September 30, 2010.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We are a leading China-based IT services provider, serving both Greater China and Global clients. Revenues from our Greater China clients include all revenues from companies headquartered in Greater China, and revenues from Global clients include all revenues from companies headquartered outside of Greater China, including revenues from the Greater China-based operations of these overseas clients. Net revenues from our Greater China and Global client groups accounted for 57.6% and 42.4% of our net revenues in 2009, and 55.6% and 44.4% of our net revenues in the nine months ended September 30, 2010, respectively.

Our integrated suite of IT services and solutions includes IT Services (including application development and maintenance services, or ADM, R&D services and infrastructure and software services), Consulting & Solutions and BPO services. Our IT Services, Consulting & Solutions and BPO service lines accounted for 64.1%, 33.1% and 2.8% of our net revenues in 2009, and 67.2%, 29.4% and 3.4% of our net revenues in the nine months ended September 30, 2010, respectively.

To date, we have focused on serving clients in four target industry verticals, each with large and growing demand for IT services and solutions: technology; communications; banking, financial services and insurance, or BFSI; and energy, transportation and public sector. Our technology, communications, BFSI, and energy, transportation and public sector industry verticals accounted for 40.0%, 32.6%, 14.3% and 10.0% of our net revenues in 2009, and 34.4%, 38.9%, 14.7% and 7.0% of our net revenues in the nine months ended September 30, 2010, respectively.

We believe we have built one of the largest sales and service delivery platforms for IT services and solutions in China. We have grown from six sales and delivery centers as of January 1, 2007 to 19 sales and delivery centers as of the date of this prospectus, of which 12 are located in China, spanning tier one cities, such as Beijing, Shanghai and Shenzhen, as well as key tier two and three cities, such as Dalian, Nanjing, Tianjin, Wuhan and Wuxi. We also have operations in the United States, Europe and Japan that are close to the main offices of key Global clients.

We believe resource management and planning is critically important to supporting our growth, and we are committed to effectively recruiting, training, developing and retaining our human capital. Our total number of employees has grown from 1,527 employees as of January 1, 2007 to 9,172 employees as of September 30, 2010. We have established three major training centers, in Guangzhou, Tianjin and Wuxi. The training institute in Wuxi that we helped establish and fund in cooperation with the Wuxi City government, the iCarnegie-iSoftStone training institute, in which we have an equity investment, utilizes the technical curriculum and professional certifications developed and maintained by Carnegie Mellon University, with an annual training capacity of up to 10,000 students. Our “Top 300” leadership development program is focused on identifying, training, promoting and relocating, as appropriate, qualified candidates to meet our middle and senior management needs.

Since inception, our net revenues have grown primarily through our organic business development efforts and strategic acquisitions. Historically, acquisitions have allowed us to acquire additional expertise and capabilities and expand our client base and presence in key client locations, such as the United States and Japan. Recent strategic acquisitions include: our January 2008 acquisition of the IT services business of Shanghai Jiefeng, a long-time Microsoft business partner, which increased our IT Services business with Microsoft; our

 

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February 2008 acquisition of Akona, which provided us consulting capabilities in the United States and further expanded our client relationship with Microsoft for Consulting & Solutions and IT Services; and our March 2009 acquisition of the IT services business of Shenzhen Star, which enhanced our client relationship with Huawei and significantly increased the growth of our R&D services line.

In 2007, 2008 and 2009, our net revenues were $36.4 million, $82.5 million and $134.4 million, respectively, representing a CAGR of 92.1%, and in the nine months ended September 30, 2009 and 2010, our net revenues were $90.0 million and $135.2 million, an increase of 50.2%. In 2007, 2008 and 2009, our net income (loss) increased from a net loss of $10.3 million, to a net loss of $3,000 and then to net income of $9.0 million, and in the nine months ended September 30, 2009 and 2010, our net income decreased from $5.7 million to $0.3 million primarily due to share-based compensation charges on options granted to directors, employees and consultants. Our non-GAAP net income (loss) for 2007, 2008 and 2009, which excludes share-based compensation, interest expense of convertible notes, changes in fair value of certain liabilities carried at fair value, amortization of intangible assets from acquisitions and gain on bargain purchase of a business from net income (loss), were $(4.3) million, $4.7 million and $13.4 million, respectively. For the nine months ended September 30, 2009 and 2010, our non-GAAP net income were $7.9 million and $10.7 million, respectively. For a reconciliation of our non-GAAP net income (loss) to our U.S. GAAP net income (loss), see footnote (3) on page 13 of this prospectus.

Factors Affecting Our Results of Operations

We believe that the most significant macro-level factors affecting our results of operations include:

 

   

health of the global economy and the growth and development of China’s economy;

 

   

the overall growth of China’s IT services industry;

 

   

IT spending by Greater China and Global clients;

 

   

competition and related pricing pressure from other IT services providers in China, India and other global delivery locations;

 

   

wage inflation, particularly in China where most of our employees are based; and

 

   

changes in exchange rates, especially changes in the exchange rate between the Renminbi and the U.S. dollar.

Our results of operations are also expected to benefit from PRC government policies and regulations designed to foster the IT services industry in China. These policies and benefits are reflected in, among other things:

 

   

China’s IT services industry designation as a priority industry under the PRC government’s current and upcoming Five-Year Plans, the central government’s strategic roadmap for economic development;

 

   

strong central, provincial and local government support for China-based IT services providers in the form of grants, subsidies, incentive and other awards for training, technology development, research and development and other infrastructure development;

 

   

favorable tax treatment and policies, including the tax policy announced in July 2010 exempting certain companies located in 21 jurisdictions, including Beijing, Shanghai, Guangzhou and Shenzhen, from paying a 5% business tax on income derived from contracts signed with offshore entities for providing information technology outsourcing, business processing outsourcing and knowledge process outsourcing services; and

 

   

actions by the Chinese government to encourage state-owned enterprises to outsource more IT and non-core operational functions to enhance their competitiveness and efficiency.

Early on, we sought to identify and benefit from the various government incentives, subsidies and other efforts designed to promote growth of the IT services industry in China. In 2007, 2008, 2009 and the nine months

 

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ended September 30, 2009 and 2010, we recognized government subsidies as a reduction to cost of revenue and expenses, primarily cost of revenues, of nil, $1.7 million, $2.1 million, $1.5 million and $5.8 million, respectively, and recognized government subsidies as other income of $2.8 million, $0.9 million, $3.0 million, $1.9 million and $2.9 million, respectively.

Our results of operations in any given period are more directly affected by company specific factors, including:

 

   

Revenue mix by service line. Our IT Services, Consulting & Solutions and BPO service lines accounted for 64.1%, 33.1% and 2.8% of our net revenues in 2009, and 67.2%, 29.4% and 3.4% of our net revenues in the nine months ended September 30, 2010, respectively. Our Consulting & Solutions service line has generally enjoyed higher margins, followed by our IT Services then BPO service lines. As the mix of services we deliver in any period will vary, we expect our margins will vary accordingly.

 

   

Our ability to deepen and expand our suite of service offerings while maintaining our high standard of quality. The breadth and depth of our service offerings impacts our ability to grow revenues from new and existing clients. Through research and development, targeted hiring and strategic acquisitions, we have proactively invested in broadening our existing service lines, including those for serving our specific industry verticals. Our future growth and success depend significantly on our ability to anticipate the needs of our clients and rapidly develop and maintain these capabilities, including relevant industry vertical domain knowledge and technological capabilities required to meet those needs, while maintaining our high standard of quality.

 

   

Diversity of our client base. In recent years, as we have expanded significantly in the IT services industry, we have diversified our client base of both Greater China and Global clients. In the twelve months ended September 30, 2010, our clients included 71 Fortune 500 companies, of which 23 were Greater China clients and 48 were Global clients. While we are seeking out new clients in each of our target industry verticals, we will continue to enhance our strategic relationships with our existing clients. Our ten largest clients accounted for 44.9%, 49.7%, 56.7%, 59.0% and 55.8% of our net revenues in 2007, 2008, 2009 and the nine months ended September 30, 2009 and 2010, respectively. The gain or loss of any significant client, or any significant change in the business volume from a significant client, will affect our results of operations.

 

   

Pricing of our services. For time-and-expense contracts, our billing rates are a key factor impacting our gross margins and profitability. Billing rates vary by service offering and location of service delivery, and aggregate billings per engagement are driven by a number of factors, including the mix of delivery method (onsite/onshore or offsite/offshore) and the mix of experience levels of personnel on a particular project. Some larger clients receive reduced pricing through reduced billing rates. As a client relationship matures and deepens, we seek to maximize our billings and profitability by expanding the scope of services offered to the client and optimizing the mix of professionals providing services to that client. We are entering into a growing portion of our contracts on a fixed-price basis. Our ability to profitably price these contracts requires that we accurately assess the time and resources required for completing projects. Underestimating the required time and resources may result in cost overruns or mismatches in project staffing, thereby yielding lower profit margins than anticipated. Conversely, overestimating our costs may result in our submitting uncompetitive bids and inability to win business.

 

   

Effective retention and management of employees. Our ability to effectively retain and manage our employees will have an effect on our gross margin and our results of operations. We manage employee headcount and utilization based on ongoing assessments of our project pipeline and requirements for professional capabilities. An unanticipated termination of a significant project could also cause us to experience lower employee utilization resulting from a higher than expected number of idle employees. Our ability to effectively utilize our employees is typically improved by longer-term engagements due to increasing predictability of client needs over the course of the engagement. Furthermore although our headcount has grown significantly, we have experienced what we believe to be relatively low attrition rates of 13.9%, 17.7%, 12.8% and 14.3% in 2007, 2008, 2009 and the nine months ended

 

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September 30, 2010, respectively, largely by offering an attractive working environment, ongoing training and diverse career development opportunities. A significant increase in our attrition rate could decrease our productivity and, in turn, our profitability.

 

   

Investments in our delivery platform. We have grown from six sales and delivery centers as of January 1, 2007 to 19 sales and delivery centers as of the date of this prospectus, of which 12 are located in China, spanning tier one cities such as Beijing, Shanghai and Shenzhen, as well as key tier two and three cities such as Dalian, Nanjing, Tianjin, Wuhan and Wuxi, and we have operations in the United States, Europe and Japan that are close to the main offices of key Global clients. Our integrated global delivery platform allows us to deliver our services through a blend of onsite/onshore and offsite/offshore methods. Early on, we recognized the benefits of expanding into China’s tier two and three cities, including more favorable blended labor costs and the ability to attract and retain required talent in increasing scale. For example, by 2006 we had established sales and delivery centers in Dalian and Wuhan. Our ability to effectively utilize this robust delivery platform will significantly affect our results of operations in the future.

 

   

Investments in training and R&D. To develop deeper industry knowledge and deeper understanding of our clients’ needs and more quickly and cost-effectively address our clients’ requirements while maintaining the high quality standard of our services, we continually invest in training and research and development. In 2008, we established dedicated training centers alongside our sales and delivery centers in Wuxi and Tianjin, and we have since added a training center in Guangzhou. The training institute in Wuxi that we helped establish and fund in cooperation with the Wuxi City government, the iCarnegie-iSoftStone training institute, in which we have an equity investment, utilizes the technical curriculum and professional certifications developed and maintained by Carnegie Mellon University, with an annual training capacity of up to 10,000 students. We expect to open another training center in Dalian in the fourth quarter of 2010. In addition, we continuously invest in R&D to enhance our domain knowledge and improve our competitiveness. Among other activities, we established four iSoftStone R&D institutes in Beijing, Tianjin, Wuhan and Wuxi and have leveraged our R&D efforts to build a library of industry-specific proprietary software modules (currently over 50 modules) for our use in the delivery of our services. We expect that our ability to effectively utilize our training and R&D capabilities will significantly affect our results of operations in the future.

 

   

Impact of strategic alliances and business acquisitions. We have pursued and may continue to pursue strategic alliance and acquisition opportunities to expand our geographic presence, establish or deepen client relationships, increase our service offerings and capabilities and enhance our industry and technical expertise. Our acquisitions of Beijing Kebao in 2007 and Akona in 2008, for example, enabled us to rapidly enter into the Japanese market and expand our U.S. presence. Our ability to successfully identify, execute, integrate and manage new alliances and acquisitions can have a significant effect on our results of operations. We often enter into strategic alliances with Global technology clients as they are expanding into the China market. Examples of these strategic alliances include our alliance with Sungard where we are assisting in the deployment and implementation of Sungard’s iWorks solution at domestic China insurance clients.

 

   

Seasonality. Our business is also affected by seasonal trends. In particular, our net revenues are typically progressively higher in the second, third and fourth quarters of each year compared to the first quarter of each year due to seasonal trends, such as: (i) a general slowdown in business activities and a reduced number of working days for our professionals during the first quarter of each year as a result of the Chinese New Year holiday period, and (ii) our customers in general tend to spend their IT budgets in the second half of the year and in particular the fourth quarter. Other factors that may cause our quarterly operating results to fluctuate include, among others, changes in general economic conditions in China and the impact of unforeseen events. We believe that our net revenues will continue to be affected in the future by seasonal trends. As a result, you may not be able to rely on period to period comparisons of our operating results as an indication of our future performance, and we believe it is more meaningful to evaluate our business on an annual basis.

 

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Certain Income Statement Line Items

Net Revenues

Our net revenues represent our total revenues from operations, less business taxes. We are subject to business taxes at a rate of 5% of total revenues for certain types of contracts.

In recent years, we have experienced rapid growth and significantly expanded our business. Our net revenues increased from $36.4 million in 2007 to $82.5 million in 2008 and $134.4 million in 2009, or 126.4% and 63.0% growth, respectively, and from $90.0 million in the nine months ended September 30, 2009 to $135.2 million in the nine months ended September 30, 2010. We discuss below the breakdown of our net revenues by service lines, geographic markets, client industry, major clients and pricing method.

Net Revenues by Service Lines

We derive net revenues by providing an integrated suite of IT services and solutions, including: (i) IT Services, which primarily includes application development and maintenance, or ADM, as well as R&D services and infrastructure and software services; (ii) Consulting & Solutions; and (iii) BPO services. The following table sets forth our net revenues by service line for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
 
    (dollars in millions, except for percentages)  

IT Services

  $ 27.5        75.5   $ 55.1        66.9   $ 86.1        64.1   $ 58.6        65.1   $ 90.7        67.2

Consulting & Solutions

    8.9        24.5        26.9        32.5        44.5        33.1        30.7        34.1        39.8        29.4   

BPO Services

    —          —          0.5        0.6        3.8        2.8        0.7        0.8        4.7        3.4   
                                                                               

Total net revenues

  $ 36.4        100.0   $ 82.5        100.0   $ 134.4        100.0   $ 90.0        100.0   $ 135.2        100.0
                                                                               

IT Services. Historically, IT Services has represented the substantial majority of our net revenues. Our net revenues from IT Services increased significantly in absolute terms as a result of our continued ability to increase the number and scope of our engagements with our major IT Services clients and the strong demand for outsourced technology services. The following table sets forth the major components of our IT Services net revenues for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Net
Revenues
    % of IT
Services
Net
Revenues
    Net
Revenues
    % of IT
Services
Net
Revenues
    Net
Revenues
    % of IT
Services
Net
Revenues
    Net
Revenues
    % of IT
Services
Net
Revenues
    Net
Revenues
    % of IT
Services
Net
Revenues
 
    (dollars in millions, except for percentages)  

ADM Services

  $ 19.1        69.5   $ 21.2        38.5   $ 42.8        49.7   $ 30.0        51.3   $ 42.2        46.6

R&D Services

    8.2        29.8        32.6        59.2        41.3        47.9        27.0        46.0        45.5        50.1   

Infrastructure and Software Services

    0.2        0.7        1.3        2.3        2.0        2.4        1.6        2.7        3.0        3.3   
                                                                               

Total IT Services net revenues

  $ 27.5        100.0   $ 55.1        100.0   $ 86.1        100.0   $ 58.6        100.0   $ 90.7        100.0
                                                                               

Key drivers for growth in particular IT Services components include:

 

   

Greater China clients’ increasing adoption of technology outsourcing and desire to engage with China-based companies as their providers;

 

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Global clients’ increasing acceptance of China as a primary or complementary location for delivery of IT services;

 

   

a growing willingness by independent software vendors and hardware original equipment manufacturers, or OEMs, to outsource product development;

 

   

a growing willingness of our existing clients to engage us to provide additional services which they may not have purchased from us or others previously; and

 

   

strategic acquisitions, such as our acquisition in March 2009 of the IT services business of Shenzhen Star, enhancing our client relationship with Huawei and significantly increasing the growth of our R&D service line.

Consulting & Solutions. We have provided Consulting & Solutions services since our inception. Our industry expertise and technical know-how in targeted industry verticals have enabled us to grow our Consulting & Solutions revenues by delivering solutions designed to improve a client’s technology functionality, business performance and overall competitiveness. Our Consulting & Solutions engagements are often strategic in nature and involve frequent contact with c-level executives. Consulting & Solutions engagements also help us identify and secure additional opportunities to offer clients complementary IT Services. Key investments in this service line include development of industry-specific solutions and strategic hires and acquisitions to obtain critical domain expertise.

BPO Services. We began investing in our BPO service line and recognized our first BPO services revenues in 2008. Our BPO service line leverages our industry expertise, allowing clients to achieve operational efficiencies and cost savings by outsourcing non-core business processes to us. By providing BPO services, we gain knowledge of each client’s unique business, often resulting in opportunities for us to cross-sell additional services.

While we expect IT Services to continue to grow and account for the majority of our net revenues in the foreseeable future, we also expect continued growth in our Consulting & Solutions and BPO net revenues in absolute terms, and we expect our BPO service line to account for an increasing percentage of our net revenues as we expand this service line.

Net Revenues by Geographic Markets

We classify our net revenues into the following geographic markets: Greater China (which includes China, Taiwan, Hong Kong and Macau) and Global (which includes the United States, Europe, Japan and others), which accounted for 57.6% and 42.4% of our net revenues in 2009 and 55.6% and 44.4% of our net revenues in the nine months ended September 30, 2010, respectively. We record our net revenues based on the headquarters of our clients irrespective of the location of the specific client entity which we serve or the locations at which our services are delivered or the invoice is rendered. The following table sets forth our net revenues by geographic markets for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
 
    (dollars in millions, except for percentages)  

Greater China

  $ 18.3        50.3   $ 32.4        39.3   $ 77.4        57.6   $ 49.8        55.3   $ 75.2        55.6

Global:

                   

United States

    10.0        27.5        30.2        36.5        37.1        27.6        25.9        28.8        38.3        28.3   

Europe

    1.3        3.5        3.9        4.8        6.7        5.0        4.9        5.4        7.7        5.7   

Japan

    5.0        13.6        14.2        17.2        12.7        9.4        9.0        10.0        13.9        10.3   

Others

    1.8        5.1        1.8        2.2        0.5        0.4        0.4        0.5        0.1        0.1   
                                                                               

Global total

    18.1        49.7        50.1        60.7        57.0        42.4        40.2        44.7        60.0        44.4   
                                                                               

Total net revenues

  $ 36.4        100.0   $ 82.5        100.0   $ 134.4        100.0   $ 90.0        100.0   $ 135.2        100.0
                                                                               

 

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The table above reflects, among other things, the strength of our Greater China business during the recent economic crisis. Also, despite the significant slowing of IT spending in the United States and Europe, we were able to grow our net revenues in those markets, both organically and through key hiring and strategic acquisitions. In Japan, we experienced a modest decline in net revenues from 2008 to 2009, then a modest rebound in the nine months ended September 30, 2010 compared to the same period 2009.

We strive to maintain a balanced business mix from both Greater China and Global clients. We expect Greater China clients to continue outsourcing to third-party IT services providers to achieve the benefits associated with outsourcing, such as the ability to focus on their core businesses, leverage best-in-class systems knowledge and benefit from operational efficiencies over time. Similarly, we expect that Global clients will increase their focus on China as a long-term growth market for their own products and services and continue to develop long-term relationships with China-based IT services providers as they continue to diversify the key locations to which they send outsourced work.

Net Revenues by Client Industry

To date, we have focused on serving clients, both globally and in China, in four target industry verticals, each with large and growing demand for IT services and solutions: technology; communications; BFSI; and energy, transportation and public sector. The following table sets forth our net revenues by client industry for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
 
    (dollars in millions, except for percentages)  

Technology

  $ 14.9        40.9   $ 40.2        48.7   $ 53.8        40.0   $ 37.8        42.0   $ 46.5        34.4

Communications

    9.3        25.6        19.8        24.1        43.8        32.6        29.1        32.4        52.6        38.9   

BFSI

    7.1        19.5        13.1        15.9        19.2        14.3        10.8        12.0        19.9        14.7   

Energy, transportation and public sector

    3.6        9.8        6.4        7.7        13.5        10.0        9.7        10.7        9.5        7.0   

Other

    1.5        4.2        3.0        3.6        4.1        3.1        2.6        2.9        6.7        5.0   
                                                                               

Total net revenues

  $ 36.4        100.0   $ 82.5        100.0   $ 134.4        100.0   $ 90.0        100.0   $ 135.2        100.0
                                                                               

Historically, we have primarily focused on clients in the technology industry and communications industry, which includes both telecom operators and communications equipment vendors. Our growth in net revenues from these industries has been driven primarily by the increase in demand for outsourced technology services. In the future, we expect to focus increasingly on serving clients in a broader range of industries, including greater focus on BFSI and energy, transportation and public sector.

 

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Net Revenues by Major Clients

We have grown with our clients by increasingly expanding the scope and size of our engagements, and we have grown our key client base both by our internal business development efforts and through strategic acquisitions. From 2007 to 2009, we increased the number of clients generating over $1.0 million in annual net revenues from eight in 2007 to 13 in 2008 and 20 in 2009, and we increased the number of clients generating over $3.0 million in annual net revenues from one in 2007 to four in 2008 and six in 2009. In the twelve months ended September 30, 2010, we had 28 clients generating at least $1.0 million of net revenues during the period, and we had seven clients generating at least $3.0 million of net revenues during the period. The following table sets forth total net revenues contributed by our top five and top ten clients for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
 
    (dollars in millions, except for percentages)  

Top five

  $ 11.6        31.9   $ 32.5        39.4   $ 62.0        46.2   $ 43.1        47.9   $ 64.2        47.5

Top ten

  $ 16.4        44.9   $ 41.0        49.7   $ 76.3        56.7   $ 53.2        59.0   $ 75.5        55.8

In 2007, IBM contributed more than 10% of our net revenues; in 2008, Microsoft contributed more than 10% of our net revenues; and in 2009 and the nine months ended September 30, 2010, Huawei and Microsoft each contributed more than 10% of our net revenues, together accounting for 34.4% and 38.1% of our total net revenues, respectively.

The volume of work we perform for specific clients is likely to vary from year to year, as we are typically not their exclusive external IT services provider, and a major client in one year may not contribute the same amount or percentage of our net revenues in a subsequent year.

Net Revenues by Pricing Method

We provide our services on a time-and-expense basis, a fixed-price basis or, with respect to our BPO services, on the basis of volume of work processed for our clients. Our engagement models depend on the type of services provided to a client, the mix and locations of professionals involved, and the business outcomes our clients are looking to achieve. Historically, we provided more of our net revenues on a time-and-expense basis, but over time we have begun to derive a greater portion of net revenues on a fixed-price basis, which our Consulting & Solutions clients in China typically prefer. The following table sets forth our net revenues by pricing method for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
    Net
Revenues
    % of Net
Revenues
 
    (dollars in millions, except for percentages)  

Time-and-expense basis

  $ 22.6        62.1   $ 42.8        51.9   $ 74.0        55.1   $ 53.2        59.2   $ 56.8        42.0

Fixed-price basis

    13.8        37.9        39.2        47.5        57.7        42.9        36.8        40.8        76.6        56.7   

Volume basis (BPO)

    —          —          0.5        0.6        2.7        2.0        —          —          1.8        1.3   
                                                                               

Total net revenues

  $ 36.4        100.0   $ 82.5        100.0   $ 134.4        100.0   $ 90.0        100.0   $ 135.2        100.0
                                                                               

 

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Cost of Revenues, Gross Profit and Gross Margin

The following table sets forth our net revenues, cost of revenues, a breakdown of the principal components of our cost of revenues, gross profit and gross margin for the periods presented:

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2007     2008     2009     2009     2010  
    Total     % of Net
Revenues
    Total     % of Net
Revenues
    Total     % of Net
Revenues
    Total     % of Net
Revenues
    Total     % of Net
Revenues
 
    (dollars in millions, except for percentages)  

Net revenues

  $ 36.4        100.0   $ 82.5        100.0   $ 134.4        100.0   $ 90.0        100.0   $ 135.2        100.0

Cost of revenues:

                   

Salary and compensation expenses

    16.7        45.8        37.5        45.5        67.1        50.0        47.2        52.4        67.4        49.9   

Subcontracting costs

    4.9        13.3        12.8        15.5        13.5        10.0        7.3        8.1        11.4        8.4   

Rental expenses

    1.2        3.2        1.5        1.8        2.8