10-Q/A 1 u97863a1e10-qa.txt ASIAINFO HOLDINGS, INC 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____ TO ____ Commission File Number 001-15713 ASIAINFO HOLDINGS, INC. (Exact name of registrant as specified in its charter) DELAWARE 752506390 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 4TH FLOOR, ZHONGDIAN INFORMATION TOWER 18 BAISHIQIAO ROAD, HAIDIAN DISTRICT BEIJING 100086, CHINA (Address of principal executive office, including zip code) +8610 6250 1658 Registrant's telephone number, including area code 4th Floor, Ligong Science & Technology Tower 11 Baishiqiao Road, Haidian District Beijing 100081, China (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] The number of shares outstanding of the Registrant's common stock as of November 12, 2000 was 40,537,940 2 ASIAINFO HOLDINGS, INC. FORM 10-Q/A FOR THE QUARTER ENDED SEPTEMBER 30, 2000 TABLE OF CONTENTS
Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited).........................................................3 a) Condensed Consolidated Statements of Operations For the three and nine months ended September 30, 1999 and 2000..................................3 b) Condensed Consolidated Balance Sheets as of December 31, 1999 and September 30, 2000...................................................................4 c) Condensed Consolidated Statements of Cash Flows For the three and nine months ended September 30, 1999 and 2000........................................5 d) Notes to Condensed Consolidated Financial Statements For the nine months ended September 30, 2000.....................................................7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ....................................................13 Item 3 Quantitative and Qualitative Disclosure About Market Risk...............................25 PART II. OTHER INFORMATION Item 2 Changes in Securities and Use of Proceeds...............................................26 Item 5 Other Information.......................................................................26 Item 6 Exhibits and Reports on Form 8-K........................................................27 SIGNATURE ........................................................................................28
- 2 - 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ASIAINFO HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In US dollars)
Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------- ----------------------------------- 1999 2000 1999 2000 ------------- ------------- ------------- ------------- (unaudited) (unaudited) Revenues: Network solutions ................... $ 21,852,312 $ 53,158,891 $ 43,672,744 $ 120,906,674 Software license .................... 1,669,310 4,909,455 4,642,523 11,144,769 ------------- ------------- ------------- ------------- Total revenues ....................... 23,521,622 58,068,346 48,315,267 132,051,443 ------------- ------------- ------------- ------------- Cost of revenues: Network solutions ................... 16,219,803 48,252,719 33,531,856 111,566,209 Software license .................... 1,380 25,750 2,814 28,584 ------------- ------------- ------------- ------------- Total cost of revenues .............. 16,221,183 48,278,469 33,534,670 111,594,793 ------------- ------------- ------------- ------------- Gross profit ......................... 7,300,439 9,789,877 14,780,597 20,456,650 ------------- ------------- ------------- ------------- Operating expenses: Sales and marketing ................. 2,346,708 5,702,270 4,867,834 13,290,821 General and administrative .......... 2,793,578 3,499,681 6,386,453 9,273,739 Research and development ............ 895,056 1,743,171 1,993,535 4,432,965 Amortization of deferred stock compensation ....................... 1,847,912 467,207 2,809,148 1,751,813 ------------- ------------- ------------- ------------- Total operating expenses ............ 7,883,254 11,412,329 16,056,970 28,749,338 ------------- ------------- ------------- ------------- Loss from operations ................ (582,815) (1,622,452) (1,276,373) (8,292,688) ------------- ------------- ------------- ------------- Other income (expense): Interest income ..................... 203,999 2,283,139 499,018 5,503,698 Interest expense .................... (182,668) (284,876) (451,780) (894,441) Other income, net ................... 149,302 14,310 323,632 (192,564) ------------- ------------- ------------- ------------- Total other income (expense), net ... 170,633 2,012,573 370,870 4,416,693 ------------- ------------- ------------- ------------- Income (loss) before income taxes and minority interests .................. (412,182) 390,121 (905,503) (3,875,995) Income tax expense (benefit) ........ 121,517 (6,479) 297,271 (67,808) ------------- ------------- ------------- ------------- (Loss) income before minority interests .......................... (533,699) 396,600 (1,202,774) (3,808,187) Minority interests in loss of consolidated subsidiaries .......... 21,033 18,808 84,131 18,808 Equity in loss of affiliate ......... (8,997) -- (8,997) -- ------------- ------------- ------------- ------------- Net (loss) income .................... $ (521,663) $ 415,408 $ (1,127,640) $ (3,789,379) ============= ============= ============= ============= Net (loss) income per share: Basic ............................... $ (0.04) $ 0.01 $ (0.08) $ (0.10) ============= ============= ============= ============= Diluted ............................. $ (0.04) $ 0.01 $ (0.08) $ (0.10) ============= ============= ============= ============= Shares used in computation: Basic ............................... 14,128,275 39,841,935 13,969,317 36,133,972 ============= ============= ============= ============= Diluted ............................. 14,128,275 45,456,176 13,969,317 36,133,972 ============= ============= ============= =============
See notes to condensed consolidated financial statements. - 3 - 4 ASIAINFO HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In US dollars)
December 31, September 30, ------------- ------------- 1999 2000 ------------- ------------- (unaudited) ASSETS Current Assets: Cash and cash equivalents ..................................... $ 25,403,884 $ 106,344,378 Restricted cash ............................................... 12,189,794 23,166,369 Short-term investment ......................................... -- 50,100,000 Accounts receivable, trade - net ............................. 21,928,036 62,099,751 Inventories ................................................... 2,908,426 1,167,401 Advance to suppliers .......................................... 228,323 782,619 Other receivables ............................................. 1,346,884 3,278,568 Deferred income taxes ......................................... 25,117 44,902 Deferred offering costs ....................................... 401,607 -- Prepaid expenses and other current assets ..................... 340,502 466,155 ------------- ------------- Total current assets ........................................ 64,772,573 247,450,143 Property, plant, and equipment--net ............................. 2,183,545 5,318,671 Goodwill, at cost less accumulated amortization ................. 4,302,633 3,509,641 Deferred income taxes ........................................... 168,228 247,211 ------------- ------------- Total Assets ................................................ $ 71,426,979 256,525,666 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Short-term bank loans ......................................... $ 9,698,882 $ 19,432,837 Accounts payable .............................................. 11,867,188 51,257,586 Deferred revenue .............................................. 495,470 3,455,413 Other payables ................................................ 360,968 645,539 Accrued employee benefit ...................................... 4,810,650 9,401,634 Accrued expenses .............................................. 1,930,145 4,686,582 Other taxes payable ........................................... 2,295,030 2,020,767 Income taxes payable .......................................... 180,475 -- ------------- ------------- Total current liabilities ................................... 31,638,808 90,900,358 ------------- ------------- Minority interest ............................................. -- 198,589 Commitments and contingencies (Note 8) Stockholders' Equity: Convertible preferred stock ................................... 47,913 -- Common stock, 50,000,000 shares authorized, $0.01 par value, shares issued and outstanding: December 31, 1999, 25,532,144; September 30, 2000, 39,970,680 .......... 255,321 399,707 Additional paid-in capital ...................................... 46,118,424 173,677,702 Deferred stock compensation ................................... (3,865,373) (2,113,560) Accumulated deficit ........................................... (2,764,854) (6,554,233) Accumulated other comprehensive (loss) income ................. (3,260) 17,103 ------------- ------------- Total stockholders' equity .................................. 39,788,171 165,426,719 ------------- ------------- Total Liabilities and Stockholders' Equity .................. $ 71,426,979 $ 256,525,666 ============= =============
See notes to condensed consolidated financial statements. - 4 - 5 ' ASIAINFO HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In US dollars)
Nine Months Ended September 30, --------------------------------- 1999 2000 ------------ ------------ (unaudited) Cash flows from operating activities: Net loss ................................ $ (1,127,640) $ (3,789,379) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation ............................ 365,824 869,096 Amortization of goodwill ................ 520,719 792,992 Amortization of deferred stock compensation ........................... 2,809,148 1,751,813 Deferred income taxes ................... (277,099) (98,769) Minority interest in loss of consolidated subsidiaries ........................... (84,131) (18,808) Equity in loss of affiliate ............. (8,997) -- Gain on disposal of property, plant, and equipment .......................... -- 90,721 Gain on sale of investment in subsidiary ............................. (15,335) -- Provision for doubtful accounts ......... 640,103 (226,257) Changes in operating assets and liabilities: Restricted cash ........................ (3,690,136) (10,944,419) Accounts receivable .................... (660,883) (39,951,040) Inventories ............................ 484,339 1,741,025 Advance to suppliers ................... 591,241 (554,296) Amount due from a related party ........ 56,829 -- Other receivables ...................... 561,947 (2,118,434) Prepaid expenses and other current assets ................................ (758,934) (223,680) Accounts payable ....................... (3,765,335) 39,390,398 Deferred revenue ....................... (3,655,488) 2,959,943 Other payables ......................... (8,738) (451,776) Accrued employee benefit ............... 2,417,523 4,590,984 Accrued expenses ....................... (546,780) 2,756,437 Other taxes payable .................... 123,373 (274,263) Income taxes payable ................... 322,343 (180,475) ------------ ------------ Net cash used in operating activities .... (5,688,113) (3,888,187) ------------ ------------ Cash flows from investing activities: Increase in short-term investment ....... -- (50,100,000) Purchases of property, plant, and equipment .............................. $ (335,913) $ (4,097,065) Increase in investment in a subsidiary ............................. (239,000) -- Proceeds from disposal of a subsidiary, net ........................ 33,477 -- Purchase of subsidiary-AI Zhejiang ...... (1,297,184) -- ------------ ------------ Net cash used in investing activities .... (1,838,620) (54,197,065) ------------ ------------
See notes to condensed consolidated financial statements. - 5 - 6 ASIAINFO HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED) (In US dollars)
Nine Months Ended September 30, ----------------------------------- 1999 2000 ------------- ------------- (unaudited) Cash flows from financing activities: Increase in short-term bank loans ........ $ 11,585,624 $ 33,367,518 Repayment of short-term bank loans ....... (8,498,943) (23,631,629) Net proceeds from issuance of convertible preferred stock ............ 20,000,000 -- Net proceeds on issuance of common stock in initial public offering ...... -- 127,851,874 Proceeds on exercise of stock options .... 66,716 1,226,210 Warrants exercised ....................... 200 400 Capital contribution by minority interest -- 217,397 ------------- ------------- Net cash provided by financing activities . 23,153,597 139,031,770 ------------- ------------- Net (decrease) increase in cash and cash equivalents .............................. 15,626,864 80,946,518 Cash and cash equivalents at beginning of period ................................ 9,749,374 25,403,884 Effect of exchange rate changes on cash and cash equivalents ..................... (22,036) (6,024) ------------- ------------- Cash and cash equivalents at end of period ................................... $ 25,354,202 $ 106,344,378 ============= ============= Supplemental cash flow information: Cash paid during the period: Interest ................................. $ 441,492 $ 724,581 Income taxes ............................. 457,010 188,475 ============= ============= Noncash investing and financing activities: Deferred stock compensation .............. $ 6,589,717 $ -- ============= =============
See notes to condensed consolidated financial statements. - 6 - 7 ASIAINFO HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Nine Months Ended September 30, 2000 (In US dollars) 1. GENERAL AND BASIS OF PREPARATIONS AsiaInfo Holdings, Inc. (the "Company") was incorporated in the State of Texas, in the United States, on June 17, 1993 and was subsequently reincorporated in the State of Delaware in June 1998. The Company currently operates through the following subsidiaries: AsiaInfo Technologies (China), Inc. ("AI Technology") (100% owned), Zhejiang AsiaInfo Telecommunication Technology Co., Ltd. ("AI Zhejiang") (100% owned) and Guangdong Wang Ying Information Technology Co., Ltd. ("Wang Ying") (40% owned, but controlled by the Company), all incorporated in the People's Republic of China ("China" or the "PRC") and Marsec Holdings, Inc. ("Marsec") (75% owned) incorporated in August 2000 in the Cayman Islands. Two previous subsidiaries: AsiaInfo Services Inc., and AsiaInfo-CTC Network System Inc. were dissolved in May 1999 and August 2000, respectively. In addition, the Company previously held a 55% interest in Beijing AsiaInfo Data Communications Technology Co., Ltd., ("AI Data") which was consolidated until the Company's sale of a 16.5% interest in AI Data in August 1999. AI Data was subsequently accounted for using the equity method until December 1999, when the Company sold its remaining interest. Marsec and Wang Ying were formed in August 2000. The consolidated financial statements of the Company include the accounts of the Company and its subsidiaries. Investments in 50% or less owned affiliates over which the Company exercises significant influence, but not control, are accounted for using the equity method. Intercompany transactions and balances have been eliminated. In the Company's opinion, all adjustment necessary for a fair presentation of the unaudited results of operations for the three-month and nine-month periods ended September 30, 1999 and 2000 are included. All such adjustments are accruals of a normal and recurring nature. The results of operations for the periods are not necessarily indicative of the results of operations for the full year. The financial statements are unaudited. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at December 31, 1999 and September 30, 2000 and the reported amounts of revenues and expenses during the three-month and nine-month periods ended September 30, 1999 and 2000. Actual results could differ from those estimates. Revenue in excess of billings on service contracts is recorded as unbilled receivables and included in trade accounts receivable, and amounted to $11,945,082 at December 31, 1999 and $33,907,981 at September 30, 2000. Billings in excess of revenues recognized on service contracts are recorded as deferred income until the revenue recognition criteria are met. At December 31, 1999 and September 30, 2000 the balance of trade account receivables of $9,982,954 and $28,543,352, respectively, represented amounts billed but not yet collected. All billed and unbilled amounts are expected to be collected within 1 year. The financial records of the Company's PRC subsidiaries are maintained in Renminbi. The Renminbi is not fully convertible into United States dollars or other foreign currencies. The rate of exchange quoted by the People's Bank of China on September 30, 2000 was US$1.00=RMB8.2798. No representation is made that the Renminbi amounts could have been, or could be, converted into United States dollars at that rate or at any other rate. - 7 - 8 ASIAINFO HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Nine Months Ended September 30, 2000 (In US dollars) In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which was amended by SFAS137 and SFAS138. This statement requires companies to record all derivatives on the balance sheet as assets or liabilities measured at fair value. Gains and losses resulting from changes in fair market values of those derivative instruments would be accounted for depending on the use of the instrument and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's year ending December 31, 2001. In December 1999, the Securities and Exchange Committee issued Staff Accounting Bulletin ("SAB")101, "Revenue Recognition in Financial Statements". SAB 101 establishes accounting and reporting standards for the recognition of revenue. It states that revenue generally is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller's price to the buyer is fixed or determinable; (4) collectibility is reasonably assured. SAB 101 is effective no later than the fourth quarter of fiscal years beginning after December 15, 1999. The Company does not believe there will be significant effect, if any, on the Company's financial position, results of operations or cash flows from the implementation of SFAS No. 133 or SAB 101. Information concerning the organization and business of the Company, accounting policies followed by the Company and other information is contained in the notes to the Company's financial statements for the year ended December 31, 1999 prepared as part of the Company's final prospectus filed with the Securities and Exchange Commission on March 2, 2000. This report should be read in conjunction with such financial statements. 2. CASH AND CASH EQUIVALENTS The Company considers all highly liquid, low-risk debt instruments with an original maturity at the date of purchase of three months or less to be cash equivalents. Through March 31, 2000, the Company maintained cash and cash equivalents in deposit accounts with major banks. Upon the completion of the initial public offering in March 2000 (see Note 6), the Company received additional cash which is available for investment. At September 30, 2000, cash equivalents consist primarily of money market funds with a major financial institution.
September 30, 2000 December 31, 1999 (unaudited) ------------ ------------ Cash and cash equivalents: Cash .................................... $ 25,403,884 $ 81,344,378 Money market funds ...................... -- 25,000,000 ------------ ------------ Total ................................... $ 25,403,884 $106,344,378 ============ ============ Short-term investment: Time deposits with original maturities of less than twelve months ............... $ -- $ 50,100,000 ============ ============
- 8 - 9 ASIAINFO HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Nine Months Ended September 30, 2000 (In US dollars) 3. COMPREHENSIVE INCOME (LOSS) The components of comprehensive loss for the periods presented are as follows:
Nine Months Ended September 30, ------------------------------- 1999 2000 ----------- ----------- (unaudited) Net Loss .................................. $(1,127,640) $(3,789,379) Change in cumulative translation adjustment (40,102) 20,363 ----------- ----------- Comprehensive loss ........................ $(1,167,742) $(3,769,016) =========== ===========
4. SHORT-TERM BANK LOANS As of September 30, 2000, the Company had total short-term credit facilities totaling $24.8 million expiring in November, 2000 and March, 2001 for working capital purposes. At September 30, 2000, funds available under unused short-term credit facilities were $10 million. The loans carry interest ranging from approximately 5.58% to 6.435% per annum and are repayable within one year. The secured bank loans and short-term credit facilities were secured by bank deposits of $12.2 million as of December 31, 1999 and $23.2 million as of September 30, 2000, which are presented as restricted cash in the condensed consolidated balance sheets. 5. INCOME TAXES The Company is subject to US federal and state income taxes. The Company's subsidiaries incorporated in the PRC are subject to PRC income taxes. The tax provisions (benefit) of $297,271 and $(67,808) for the nine months ended September 30, 1999 and 2000, respectively, represent deferred income taxes. 6. CAPITAL STOCK Initial public offering On March 2, 2000, the Company completed an initial public offering of its common stock. All 5.75 million shares of common stock covered by the Company's Registration statement on Form S-1, including shares covered by an over allotment option that was exercised, were sold by the Company at a price of $24.00 per share, less an underwriting discount of $1.68 per share. Net proceeds to the Company from all shares sold were approximately $127 million. Upon the consummation of the Company's initial public offering on March 3, 2000, all of the outstanding preferred stock automatically converted into Common Stock. Warrants to purchase common stock During the nine months ended September 30, 2000 warrants to purchase 40,000 share of common stock at $0.01 per share were exercised. At September 30, 2000, no warrants to purchase shares of common stock were outstanding. - 9 - 10 ASIAINFO HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Nine Months Ended September 30, 2000 (In US dollars) Stock options Option activity of the Company's stock option plans is summarized as follows:
Outstanding options ------------------------- Weighted average exercise price Number of shares per share ---------- ------ Outstanding, January 1, 2000: 8,891,811 $ 2.99 Granted ....................... 2,575,150 24.03 Cancelled ..................... (484,676) (4.53) Exercised ..................... (1,730,450) (1.76) ---------- ------ Outstanding, September 30, 2000 9,251,835 $ 9.00 ========== ======
7. NET INCOME (LOSS) PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted net loss per share computations:
Three Months Ended September 30 Nine Months Ended September 30 ------------------------------- ------------------------------- 1999 2000 1999 2000 ------------ ------------ ------------ ------------ (unaudited) (unaudited) Net income (loss) (numerator): Net income (loss) Basic and diluted ................. $ (521,663) $ 415,408 $ (1,127,640) $ (3,789,379) ============ ============ ============ ============ Shares (denominator): Weighted average Common Stock Outstanding .......... 15,635,387 39,841,935 15,231,231 36,133,972 Outstanding subject to repurchase . 1,507,112 -- 1,261,914 -- ------------ ------------ ------------ ------------ Basic ............................. 14,128,275 39,841,935 13,969,317 36,133,972 ============ ============ ============ ============ Diluted ............................. 14,128,275 45,456,176 13,969,317 36,133,972 ============ ============ ============ ============ Net income (loss) per share: Basic ............................. $ (0.04) $ 0.01 $ (0.08) $ (0.10) Diluted ........................... $ (0.04) $ 0.01 $ (0.08) $ (0.10)
- 10 - 11 ASIAINFO HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Nine Months Ended September 30, 2000 (In US dollars) For the three months ended September 30, 1999 and nine months ended September 30, 1999 and 2000, the Company had securities outstanding which could potentially dilute basic EPS in the future, but were excluded in the computation of diluted EPS in such periods, as their effect would have been antidilutive due to the net loss reported in these periods. The effect of dilutive securities on net income per share for the three months ended September 30, 2000 was insignificant. Such outstanding securities consist of the following:
Nine Months Ended September 30 ---------------------------- 1999 2000 ---------- ---------- (unaudited) Convertible preferred stock ................ 2,160,864 -- Shares of common stock subject to repurchase 1,498,060 -- Outstanding options ........................ 7,775,400 9,251,835 Warrants ................................... 9,489,226 -- ---------- ---------- 20,923,550 9,251,835 ========== ==========
8. COMMITMENTS Performance options--In connection with the acquisition of AI Zhejiang, the Company has granted management and employees of AI Zhejiang performance options if in the year 2000, AI Zhejiang's earnings before interest and taxes ("EBIT") exceeds AI Zhejiang's EBIT for 1999 and AI Zhejiang's combined EBIT for 1999 and 2000 exceeds $3,000,000. The total number of performance options granted will equal the amount by which AI Zheijiang's EBIT for 1999 and 2000 exceeds $3,000,000, expressed as a percentage and multiplied by 187,500. Each performance option will represent the right to purchase one share of the Company's common stock at the weighted average exercise price for stock options granted at such time. The performance options will be granted within 30 days of the determination of AI Zhejiang's EBIT for 2000. Marsec Holdings, Inc.--In connection with the establishment of a majority-owned subsidiary in the network security services business, the Company entered into a shareholders agreement as of September 15, 2000 pursuant to which the Company is obligated to contribute $2 million to the equity capital of the subsidiary. The subsidiary, Marsec Holdings, Inc., is 76% owned by AsiaInfo Holdings, Inc. - 11 - 12 ASIAINFO HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Nine Months Ended September 30, 2000 (In US dollars) 9. SEGMENT AND GEOGRAPHIC OPERATING INFORMATION Information on the Company's operating segments is as follows:
Three Months Ended September 30, --------------------------------------------------------- 1999 2000 ------------ ------------------------------------------ Company Excluding AI Zhejiang AI Zhejiang Total Revenues net of hardware cost: Network solutions net of hardware cost ....... $ 6,342,711 $ 8,315,275 $ 74,188 $ 8,389,463 Software license ..... 1,669,310 4,531,799 377,656 4,909,455 ------------ ------------ ------------ ------------ Consolidated revenues net of hardware cost 8,012,021 12,847,074 451,844 13,298,918 Consolidated cost of sales net of hardware cost ................ 711,582 3,132,603 376,438 3,509,041 ------------ ------------ ------------ ------------ Consolidated gross profit .............. $ 7,300,439 $ 9,714,471 $ 75,406 $ 9,789,877 ============ ============ ============ ============ Gross profit: Network Solutions .... $ 5,632,509 $ 5,198,583 $ (292,411) $ 4,906,172 Software license ..... 1,667,930 4,515,888 367,817 4,883,705 ------------ ------------ ------------ ------------ Consolidated gross profit .............. $ 7,300,439 $ 9,714,471 $ 75,406 $ 9,789,877 ============ ============ ============ ============ Income (loss) from operations: Network Solutions .... $ 100,307 $ (833,822) $ (349,731) $ (1,183,553) Software license ..... $ (683,122) $ (248,574) $ (190,325) $ (438,899) ------------ ------------ ------------ ------------ Consolidated loss from operations .......... $ (582,815) $ (1,082,396) $ (540,056) $ (1,622,452) ============ ============ ============ ============
Nine Months Ended September 30, ---------------------------------------------------------- 1999 2000 ------------ ------------------------------------------- Company Excluding AI Zhejiang AI Zhejiang Total Revenues net of hardware cost: Network solutions net of hardware cost ....... $ 14,105,837 $ 19,028,808 $ 332,373 $ 19,361,181 Software license ..... 4,642,523 10,037,320 1,107,449 11,144,769 ------------ ------------ ------------ ------------ Consolidated revenues net of hardware cost 18,748,360 29,066,128 1,439,822 30,505,950 Consolidated cost of sales net of hardware cost ................ 3,967,763 8,891,212 1,158,088 10,049,300 ------------ ------------ ------------ ------------ Consolidated gross profit .............. $ 14,780,597 $ 20,174,916 $ 281,734 $ 20,456,650 ============ ============ ============ ============ Gross profit: Network Solutions .... $ 10,140,888 $ 10,154,562 $ (814,097) $ 9,340,465 Software license ..... 4,639,709 10,020,354 1,095,831 11,116,185 ------------ ------------ ------------ ------------ Consolidated gross profit .............. $ 14,780,597 $ 20,174,916 $ 281,734 $ 20,456,650 ============ ============ ============ ============ Income (loss) from operations: Network Solutions .... $ (440,119) $ (4,967,524) $ (1,095,191) $ (6,062,715) Software license ..... $ (836,254) $ (1,570,548) $ (659,425) $ (2,229,973) ------------ ------------ ------------ ------------ Consolidated loss from operations .......... $ (1,276,373) $ (6,538,072) $ (1,754,616) $ (8,292,688) ============ ============ ============ ============
For the three months and nine months ended September 30, 1999 and 2000, all of the Company's revenues have been derived from sales to customers in the People's Republic of China. Revenues are attributed to the country based on the country of installation of hardware and performance of system integration work. Also, as of December 31, 1999 and September 30, 2000, 99% of the Company's long-lived assets are located in the People's Republic of China. - 12 - 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for historical information, the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Private Securities Litigation Reform Act of 1995 (the "Reform Act") contains certain safe harbors regarding forward-looking statements. Certain of the forward-looking statements include management's expectations, intentions and beliefs with respect to our growth, our operating results, the nature of the industry in which we are engaged, our business strategies and plans for future operations, our needs for capital expenditures, capital resources and liquidity; and similar expressions concerning matters that are not historical facts. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the statements. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. These cautionary statements are being made pursuant to the provisions of the Reform Act with the intention of obtaining the benefits of the safe harbor provisions of the Reform Act. Among the factors that could cause actual results to differ materially are the factors discussed below under the heading "Factors Affecting our Business Condition." OVERVIEW We are a leading provider of Internet-related, IT professional services and software products in China. We offer total network solutions and proprietary software to meet our customers' Internet and telecommunications infrastructure and operating needs. We offer these services in the context of total solutions, which include systems integration and customization of our proprietary and third party software. We have historically sold our software products as a part of our network solutions projects, but we are increasingly selling these products on a stand-alone basis. We commenced our operations in 1993 as an Internet content provider. We moved our operations from Texas to China in 1995 and began generating significant network solutions revenues in 1996 and significant software product revenues in 1998. While we source hardware for our customers through our U.S. parent company, AsiaInfo Holdings, Inc., we conduct the bulk of our business through our two wholly-owned operating subsidiaries, each of which is a Chinese company. On April 5, 1999, we acquired AI Zhejiang, a leading Chinese producer of wireless customer management and billing software. The acquisition reflects our strategy of expanding the scope and size of our software operations. AI Zhejiang was one of the earliest entrants in the market for wireless customer management and billing software. We acquired AI Zhejiang for $2 million in cash and the issuance of 437,500 shares of common stock to AI Zhejiang's senior management for their past services. A wholly-owned subsidiary of AsiaInfo, AI Zhejiang's financial results have been consolidated in our financial statements since the date of acquisition. We expect our business to continue to evolve as the Internet and telecommunications markets in China change and expand. In particular, we are investing substantial personnel and financial resources to expand our software business, which we expect will account for a significantly greater portion of our revenues and operating expenses in the future. Moreover, we intend to establish arrangements with foreign companies to distribute our software products outside of China. We also believe that there are opportunities for us to expand into new business areas. In particular, we plan to become an application infrastructure provider (AIP), and have invested $0.5 million in research and development and sales and marketing in connection with the AIP model in the third quarter of this year. We anticipate that we will begin recognizing significant sales activity, operating costs and revenues from the AIP business in 2001. We have also committed to invest $2 million as a capital injection into our majority-owned network security business called Marsec, which will focus on high-end security services for our customers. We anticipate that Marsec will generate sales orders of approximately $0.5 million in the fourth quarter of this year and more than $3 million in 2001. Other areas of focus for our business development team include Internet Data Center technologies and Wireless Data technologies and products. In view of these recent and potential future changes - 13 - 14 to our business, our historical financial data may not be a meaningful basis upon which to evaluate us and our prospects. Most of our revenues are derived from customer's orders under contracts for software licenses, systems integration services and hardware pass through costs. These contracts constitute our backlog at any given time. Revenue for hardware, system integration services and software products is recognized during the course of the project. We have generated a significant portion of our historical revenues from a limited number of customers, particularly various provincial entities of the China Telecom system and China Unicom. At September 30, 2000, approximately 44% of our backlog was attributable to orders placed by various entities of the China Telecom system and China Unicom, 52% were from China Netcom and China Mobile, and the remainder were from non-telcom customers. Of our growing software license revenues, 44% were from non-telcom customers in the third quarter of 2000. We believe that these figures demonstrate that the customer base for our products and services is broadening. We generate revenues from our two principal business lines: network solutions and proprietary software products. Software revenues have accounted for an increasing portion of total revenues, increasing from 2.1% of total revenues in 1997 to 8.5% of total revenues for the nine months ended September 30, 2000. We expect that software revenues will account for a growing portion of our revenues in the future. Network solutions revenues consist of hardware sales for equipment procured by us on behalf of our customers from hardware vendors and services for planning, design, systems integration, training and customization of our proprietary and third party software. Network solutions revenues also include fees that we earn under service contracts to maintain and upgrade installed software. Software license revenues consist of fees received from customers for licenses to use our products in perpetuity up to a specified maximum number of users. Substantially all of our software revenues are derived from our IP billing, wireless customer management and billing, and messaging software products. Total revenue includes the costs of hardware equipment for internet backbone construction projects, a cost that is passed on to the customer. Our revenues from network solutions is subject to significant fluctuation from quarter to quarter, depending on the timing of hardware deliveries in large internet backbone projects. Although we account for our network solutions revenues on a gross basis that includes hardware sales, we manage our business internally based on total revenues net of hardware costs, which is consistent with our strategy of focusing on providing our customers with high value IT professional services, while gradually outsourcing lower end services such as hardware installation. This strategy may result in lower growth rates for total revenues as against prior periods, but should not adversely impact revenues net of hardware costs. The following table shows our revenue breakdown by business line on this basis:
Nine Months Year Ended December 31, Ended September 30, --------------------------------------------------- ------------------- 1995 1996 1997 1998 1999 2000 --- --- --- --- --- --- Business Line Network solutions net of hardware costs 100% 89% 93% 88% 74% 63% Software license ...................... -- 11% 7% 12% 26% 37% --- --- --- --- --- --- Total revenues net of hardware costs 100% 100% 100% 100% 100% 100% === === === === === ===
RESULTS OF OPERATIONS REVENUES Our total revenues were $58.1 million and $132.1 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of - 14 - 15 $34.5 million (or 147%) and $83.7 million (or 173%), respectively, over the comparable periods in fiscal 1999. Network solutions revenues totaled $53.2 million and $120.9 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of $31.3 million (or 143%) and $77.2 million (or 177%), respectively, over the comparable periods in fiscal 1999. The increases in total revenue and network revenue during these periods are partially attributable to high hardware pass-through costs related to our backbone construction project for China Unicom, and to other regional backbone construction projects. In addition, these increases represent an overall expansion in our sales of network solutions. Software revenues were $4.9 million and $11.1 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of $3.2 million (or 194%) and $6.5 million (or 140%), respectively, over the comparable periods in 1999. The growth in software revenues during these periods reflected greater demand for our products and faster development and installation of those products. We sold, in total, $17 million in licenses for our customer care and billing software and $3.6 million in messaging software licenses during the quarter ended September 30, 2000. In addition, AI Zhejiang, which we acquired in April 1999, contributed revenues of $1,851,479 for the nine months ended September 30, 2000, 60% of which was software revenues. Recently, a successful benchmark testing was completed on our customer care and billing software in Tokyo on Sun Mircrosystem's platform. We believe that the high quality of our software products has fueled software license sales and revenues. We anticipate that our total revenues will continue to grow and that net revenues for the fourth quarter of 2000 will increase approximately 100-110 percent over the comparable period in 1999. We expect software revenues for the fourth quarter to grow at a rate of 160-170 percent over the comparable period in 1999. COST OF REVENUES Cost of revenues consist primarily of the hardware costs we pass through to our customers. Our cost of revenues was $48.3 million and $111.6 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of $32.1 million (or 198%) and $78.1 million (or 233%) over the comparable periods in fiscal 1999. The increases were primarily due to our overall business expansion. As a result of the completion of our Internet backbone project for China Unicom, we anticipate that hardware pass-through costs will be significantly lower in the fourth quarter of 2000. GROSS PROFIT Gross profit was $9.8 million and $20.5 million, respectively, for the three- and nine-month periods ended September 30, 2000, representing increases of $2.5 million (or 34%) and $5.7 million (or 38%), respectively, over the comparable periods in 1999. The increase in our gross profit is attributable to the expansion of our higher-margin software business and our strategy of outsourcing low-end system integration delivery services. OPERATING EXPENSES Operating expenses were $11.4 million and $28.7 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of $3.5 million (or 45%) and $12.7 million (or 79%) over the comparable periods in 1999. The increases were primarily due to the overall expansion of our business, and increased investments in sales and marketing and personnel development activities. Relative to the comparable periods in 1999, operating expenses as a percentage of revenues decreased from 34% to 20% and from 33% to 22%, respectively, in the three- and nine-month periods ended September 30, 2000. This decrease in operating expenses as a percentage of revenues is attributable to the decreasing rate of growth in our spending on sales and marketing and research and development. We have invested aggressively in sales and marketing and research and development during the past two years in order to grow our business, but we anticipate that our spending in these areas will decrease as a percentage of revenues in the future. Sales and marketing expenses were $5.7 million and $13.3 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of $3.4 million (or 143%) and $8.4 million (or 173%), respectively, over the - 15 - 16 comparable periods in 1999. These increases were primarily attributable to the implementation of new marketing activities, the hiring of additional personnel and higher compensation levels. Research and development expenses were $1.7 million and $4.4 million, respectively, in the three- and nine-month periods ended September 30, 2000, representing increases of $0.8 million (or 95%) and $2.4 million (or 122%), respectively, over the comparable periods in 1999. These increases were primarily due to increased spending associated with the expansion of our software business, the hiring of additional personnel and higher compensation levels. General and administrative expenses increased 25% to $3.5 million and 45% to $9.3 million for the three- and nine-month periods ended September 30, 2000, from $2.8 million for the quarter ended September 30, 1999 and $6.4 million from the nine-month period ended September 30, 1999. The increase in general and administrative expenses was lower than the increases in other operating expenses as a result of our cost control efforts in this area. General and administrative expenses as a percentage of net revenues was 29% for the nine-months ended September 30, 2000, but we expect these expenses to decrease as a percentage of net revenues in the future as we achieve increasing administrative efficiency. OTHER INCOME AND EXPENSES Other income and expenses (net), consisting primarily of net interest income and expense, totaled $2 million and $4.4 million for the three- and nine-month periods ended September 30, 2000, as compared to net income of $170,633 and net income of $370,870, respectively, for the corresponding periods in 1999. This increase is primarily due to the investment of the funds we received upon completion of our initial public offering in March. Interest income rose to $2.3 million and to $5.5 million for the three- and nine-month periods ended September 30, 2000, compared to $203,999 and $499,018 for the comparable periods in 1999. Net interest income was $2 million and $4.6 million, respectively, for the three-and nine-month periods ended September 30, 2000. NET INCOME (LOSS) We recorded net income of $415,408, or $0.01 per share, for the quarter ended September 30, 2000 and a net loss of $3.8 million, or $0.10 per share for the nine-month period ended September 30, 2000. This is in comparison to a net loss of $0.5 million or $0.04 per share in the quarter ended September 30, 1999 and a net loss of $1.1 million or $0.08 per share for the nine-month period ended September 30, 1999. Our net income for the three months ended September 30, 2000 was primarily driven by the growth of our software business and the interest income from our cash position. We are anticipating similar results for the fourth quarter of 2000. LIQUIDITY AND CAPITAL RESOURCES In March 2000, we completed an initial public offering of our common stock, from which we derived net proceeds of approximately $127 million. Total contributed shareholder capital at September 30, 2000 was $165.4 million. Our capital requirements are primarily working capital requirements related to hardware sales and costs associated with the expansion of our business, such as research and development and sales and marketing expenses. We have historically financed our working capital and other financing requirements through careful management of our network solutions billing cycle, private placements of equity securities, our initial public offering in March of 2000 and, to a limited extent, bank loans. Our accounts receivable at September 30, 2000 were $62.1 million, consisting of $28.2 million in billed receivables and $33.9 million in unbilled receivables. Our unbilled receivables are based on revenue we have booked through the percentage completion method, but for which we have not yet billed the customer. Our billed receivables are based on revenue we have booked and billed. The process of billing receivables in China is somewhat different than in the United States, as customers typically do not make full payment until complete satisfaction of the project. Despite these longer receivable cycles, since our inception we have provided less than 1% of our accounts receivable as bad debt. - 16 - 17 Of the $28.2 million in billed receivables at September 30, 2000, 76% were under 30 days old. Our cash position increased significantly in the three month period ended September 30, 2000 due to our well-managed collection process for a large Internet backbone project. We have a $10.0 million working capital line of credit with the Bank of China's New York branch and lines of credit totalling $14.8 million with local Chinese banks in the PRC, secured by bank deposits of $17.7 million. We have borrowed $14.8 million under these lines of credit. As of September 30, 2000, we had available a total of $10 million under these lines. In addition, as of September 30, 2000 we had borrowings of $4.1 million, secured by bank deposits of $5.5 million from local banks. AI Zhejiang has also drawn $500,000 on a credit line guaranteed by AI Technology. The lines of credit and loans carry interest ranging from 5.58% to 6.435% per annum and are repayable within one year. We anticipate that the net proceeds of our initial public offering, together with available funds and cash flows generated from operations and the proceeds of our private placements, will be sufficient to meet our anticipated needs for working capital, capital expenditures and business expansion through 2001. We may need to raise additional funds in the future, however, in order to fund acquisitions, to develop new or enhanced services or products, to respond to competitive pressures to compete successfully for larger projects involving higher levels of hardware purchases, or if our business otherwise grows more rapidly than we currently predict. We plan to raise additional funds, if necessary, through new issuances of shares of our equity securities through one or more public offerings, or private placements, or through credit facilities extended by lending institutions. In the event that we decide to pay dividends to our shareholders, our ability to pay dividends will depend in part on our ability to receive dividends from our operating subsidiaries in China. Foreign exchange and other regulations in China may restrict our ability to distribute retained earnings from our operating subsidiaries in China or convert those payments from Renminbi into foreign currencies. FACTORS AFFECTING OUR BUSINESS CONDITION In addition to the other information in this report, the following factors should be considered in evaluating our business and our future prospects: THE GROWTH OF OUR BUSINESS IS DEPENDENT ON GOVERNMENT BUDGETARY POLICY, PARTICULARLY THE ALLOCATION OF FUNDS TO SUSTAIN THE GROWTH OF THE TELECOMMUNICATIONS INDUSTRY AND THE INTERNET IN CHINA. Virtually all of our large customers are directly or indirectly owned or controlled by the government of the People's Republic of China (the PRC). Accordingly, their business strategies, capital expenditure budgets and spending plans are largely decided in accordance with government policies, which, in turn, are determined on a centralized basis at the highest level by the State Planning Commission of the PRC. As a result, the growth of our business is heavily dependent on government policies for telecommunications and Internet infrastructure. Despite the high priority currently accorded by the government to the development of telecommunications industry and Internet infrastructure and a high level of funding allocated by the government to these sectors in 1999, we believe that our customers' capital spending for Internet infrastructure was lower in 1999 than - 17 - 18 1998 due to a variety of factors, particularly the current restructuring of the telecommunications industry. Insufficient government allocation of funds to sustain the growth of the telecommunications industry and the Internet in China could reduce the demand for our products and services and thus have a material adverse effect on our ability to maintain the current level of revenue and grow our business. LAWS AND REGULATIONS APPLICABLE TO THE INTERNET IN CHINA REMAIN UNSETTLED AND COULD HAVE A MATERIAL ADVERSE EFFECT ON THE INTERNET'S GROWTH AND THEREBY HAVE MATERIAL ADVERSE EFFECT ON OUR BUSINESS. Growth of the Internet in China could be materially adversely affected by governmental regulation of the industry. Due to the increasing popularity and use of the Internet and other online services, new regulations have been, and may continue to be adopted with respect to the Internet or other online services. The Ministry of Information Industries (MII) has recently promulgated the "Internet Information Services Administrative Measures" and related implementing regulations. Among other things, the "Internet Information Services Administrative Measures": - require ICPs to obtain approval from MII before they can list securities overseas or obtain foreign investment; - require ICPs to obtain licenses from various ministries, depending on the nature of the content they provide; and - require ICPs to police their content in order to prevent restricted material from appearing on their websites. Because we are engaged in Internet infrastructure development and Internet-related software development and licensing, we do not expect these new regulations to have a direct impact on us. However, we cannot guarantee that the adoption of these regulations or other regulations will not slow the growth of the Internet or other online services in China. In particular, the prohibitions against a broad but vague range of information on the Internet (such as information that is damaging to national security, national interest, and social order), the relevant monitoring, record-keeping, reporting and other administrative burdens imposed on Internet access and content providers, and the severe penalties for violations of these regulations could have a chilling effect on ICPs and Internet users and could lead to increased compliance costs for ICPs. Any slow-down in the growth of the Internet in China could in turn lead to reduced Internet traffic, a decrease in the demand for our network solutions and Internet-related software products and increases in our cost of doing business. OUR CUSTOMER BASE IS HIGHLY CONCENTRATED AND THE LOSS OF ONE OR MORE OF OUR CUSTOMERS COULD CAUSE OUR BUSINESS TO SUFFER SIGNIFICANTLY. We have derived and believe that we will continue to derive a significant portion of our revenues from a limited number of large customers, such as the China Telecom system and China Unicom. Although various provincial and local entities of the China Telecom system are separate legal entities and generally make purchasing decisions independent of the Directorate General of Telecommunications, or DGT, their business decisions may nonetheless be affected by the DGT. Entities of the China Telecom system accounted for almost all of our revenues in 1997, 1998 and 1999. At September 30, 2000, entities of the China Telecom system and China Unicom accounted for approximately 44% of our backlog. In the future, we expect to derive an increasing portion of our revenues from China Unicom, China Mobile and China Netcom. The loss of the China Telecom system, whose provincial and local entities have historically accounted for a major portion of our business, or cancellation or deferral of any large contract by any of our large customers would have a material adverse effect on our revenues, and consequently our profits. - 18 - 19 THE LONG AND VARIABLE SALES CYCLES FOR OUR PRODUCTS AND SERVICES CAN CAUSE OUR REVENUES AND OPERATING RESULTS TO VARY SIGNIFICANTLY FROM PERIOD TO PERIOD AND MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK. Our revenues and operating results will vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control and any of which may cause our stock price to fluctuate. A customer's decision to purchase our services and products involves a significant commitment of its resources and an extended evaluation. As a result, our sales cycle tends to be lengthy. We spend considerable time and expense educating and providing information to prospective customers about features and applications of our services and products. Because our major customers operate large and complex networks, they usually expand their networks in large increments on a sporadic basis. The combination of these factors can cause our revenues and results of operations to vary significantly and unexpectedly. Other factors that may affect us include the following: - fluctuation in demand for our products and services as a result of budgetary cycles of our large customers, particularly state-owned enterprises; - the reduction, delay, interruption or termination of one or more infrastructure projects; and - our ability to introduce, develop and deliver new software products that meet customer requirements in a timely manner. A large part of the contract amount of a network solutions project usually relates to hardware procurement. Since we recognize most of the revenues relating to hardware plus a portion of contract services revenues at the time of hardware delivery, the timing of hardware delivery can cause our quarterly revenues to fluctuate significantly. Due to the foregoing factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance and should not be relied upon. It is likely that our operating results in some periods may be below the expectations of public market analysts and investors. In this event, the price of our common stock will probably decline, perhaps significantly more in percentage terms than the decline in operating results. OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE SIGNIFICANTLY. We typically purchase hardware for our customers as part of our turnkey total solutions services. We generally require our customers to pay 90% of the invoice value of the hardware upon delivery. We place orders for hardware only against a back-to-back order from customers and seek favorable payment terms from hardware vendors. This policy has historically minimized our working capital requirements. However, for certain large and strategically important projects, we have agreed to payment of less than 90% of the invoice value of the hardware upon delivery in order to maintain competitiveness. Wider adoption of less favorable payment terms or delays in hardware deliveries would require us to increase our working capital needs. Our working capital requirements may also increase significantly in order to fund more rapid expansion and acquisitions, to develop new or enhanced services or products, to respond to competitive pressure to compete successfully for larger projects involving higher levels of hardware purchases or otherwise if our business grows more rapidly than we currently predict. An increase in our working capital needs may require that we raise additional funding sooner than we presently expect. - 19 - 20 WE HAVE SUSTAINED LOSSES IN PRIOR YEARS AND MAY INCUR SLOWER EARNINGS GROWTH, EARNINGS DECLINES OR NET LOSSES IN THE FUTURE. Although we made a net profit in 1996 and 1998, we have sustained losses in 1997, 1999 and prior years, and for the nine months ended September 30, 2000. There are no assurances that we can regain or sustain profitability or avoid net losses in the future. We continue to expect to increase our operating expenses as our business grows. The level of these expenses will be largely based on anticipated organizational growth and revenue trends and a high percentage will be fixed. As a result, any delays in expanding sales volume and generating revenue could result in substantial operating losses. Any such developments could cause the market price of shares of our common stock to decline. MANAGEMENT'S ABILITY TO IMPLEMENT ADEQUATE CONTROL SYSTEMS WILL BE CRITICAL TO MANAGE SUCCESSFULLY OUR FUTURE GROWTH. In recent years, we have been expanding our operations rapidly, both in size and scope. Our growth places a significant strain on our management systems and resources. Our ability to market our products successfully and implement our business plan in a rapidly evolving market requires an effective planning and management process. We will need to continue to improve our financial, managerial and operational controls and reporting systems, and to expand, train and manage our work force. We may not be able to implement adequate control systems in an efficient and timely manner. WE FACE A COMPETITIVE LABOR MARKET IN CHINA FOR SKILLED PERSONNEL AND THEREFORE ARE HIGHLY DEPENDENT ON THE SKILLS AND SERVICES OF OUR EXISTING KEY SKILLED PERSONNEL AND OUR ABILITY TO HIRE ADDITIONAL SKILLED EMPLOYEES. Competition for highly skilled software design, engineering and sales and marketing personnel is intense in China. Failure to attract, assimilate or retain qualified personnel to fulfill our current or future needs could impair our growth. Competition for skilled personnel comes primarily from a wide range of foreign companies active in China, many of which have substantially greater resources than us. Limitations on our ability to hire and train sufficient number of personnel at all levels would limit our ability to undertake projects in the future and could cause us to lose market share. We may need to increase the levels of our employee compensation more rapidly than in the past in order to remain competitive. These additional costs could reduce our profitability and cause losses. SINCE OUR BUSINESS HAS BEEN EVOLVING, OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE AN APPROPRIATE BASIS ON WHICH TO EVALUATE US OR OUR PROSPECTS. We moved our operations from Texas to China in 1995 and began generating significant network solutions revenue in 1996 and significant software product revenues in 1998. We expect our business to continue to evolve as the Internet and telecommunications markets in China change and expand. In particular, we are currently investing substantial personnel and financial resources in expanding our software business, which we expect to account for a significantly greater portion of our operating expenses and revenues than in the past. As a result, our historical financial data may not provide a meaningful basis upon which investors may evaluate us and our prospects. You should consider the risks and difficulties encountered by companies like ours in a new and rapidly evolving market. Our ability to sell products and the level of success, if any, we achieve depends, among other things, on the level of demand for Internet-related, professional IT services and software products in China. WE EXTEND WARRANTIES TO OUR NETWORK SOLUTIONS CUSTOMERS THAT EXPOSE US TO POTENTIAL LIABILITIES. We customarily provide our customers with one to three year warranties, under which we agree to maintain the installed systems at no additional cost to our customers. The maintenance services cover both hardware and our proprietary and third party software products. Although we seek to arrange back-to-back - 20 - 21 warranties with hardware and software vendors, we have the primary responsibility to maintain the installed hardware and software. Our contracts do not have disclaimers or limitations on liability for special, consequential and incidental damages nor do we cap the amounts recoverable for damages. In addition, we do not currently maintain any insurance policy with respect to our exposure to warranty claims. Although to date we have not incurred any liability for special, consequential or incidental damages, failure of our installed projects to operate properly could give rise to substantial claims against us that in turn could materially and adversely affect us, particularly because our customers are primarily large telecommunication service providers. WE SELL OUR LARGE SYSTEMS INTEGRATION PROJECTS ON A FIXED PRICE, FIXED-TIME BASIS WHICH EXPOSES US TO RISKS ASSOCIATED WITH COST OVERRUNS AND DELAYS. We sell substantially all our systems integration projects on a fixed-price, fixed-time basis. Failure to complete a fixed-price, fixed-time project within budget and the required time frame would expose us to cost overruns and penalties that could have a material adverse effect on our business, operating results and financial condition. In contracts with our customers, we typically agree to pay late completion fines up to 5% of the total contract value. In large scale Internet infrastructure projects, there are many factors beyond our control which could cause delays or cost overruns. In this event, we would be exposed to cost overruns and liable for late completion fines. A part of our network solutions business is installing Internet network hardware. If we are unable to obtain access to such equipment in a timely manner or on acceptable commercial terms, our business, particularly our relationships with our customers, may be materially and adversely affected. WE MAY BECOME LESS COMPETITIVE IF WE ARE UNABLE TO DEVELOP OR ACQUIRE NEW PRODUCTS OR ENHANCEMENTS TO OUR SOFTWARE PRODUCTS THAT ARE MARKETABLE ON A TIMELY AND COST-EFFECTIVE BASIS. We continually develop new services and proprietary software products. Unexpected technical, operational, distribution or other problems could delay or prevent the introduction of one or more of these products or services or any products or services that we may plan to introduce in the future. Moreover, we cannot be sure that any of these products and services will achieve widespread market acceptance or generate incremental revenue. OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED AND THERE IS A RISK OF POOR LAW ENFORCEMENT. Our success and ability to compete depend substantially upon our intellectual property rights, which we protect through a combination of copyright, trade secret law and trademark law. We have filed trademark applications with the United States Trademark Office and the Trademark Bureau of the State Administration of Industry and Commerce in China. We have also been granted copyrights by the State Copyright Bureau in China with respect to Internet-related software products although we have not applied for copyright protection elsewhere (including the United States). Despite these precautions, the legal regime protecting intellectual property rights in China is weak. Because the Chinese legal system in general and the intellectual property regime in particular are relatively weak, it is often difficult to enforce intellectual property rights in China. In addition, there are other countries where effective copyright, trademark and trade secret protection may be unavailable or limited, and the global nature of the Internet makes it virtually impossible to control the ultimate destination of our products. We do not own any patents and have not filed any patent applications, as we do not believe that the benefits of patent protection outweigh the costs of filing and updating patents for our software products. We enter into confidentiality agreements with our employees and consultants, and control access to and distribution of our documentation and other licensed information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our licensed services or technology without authorization, or to develop - 21 - 22 similar technology independently. Policing unauthorized use of our licensed technology is difficult and there can be no assurance that the steps taken by us will prevent misappropriation or infringement of our proprietary technology. In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, which could result in substantial costs and diversion of our resources. WE ARE EXPOSED TO CERTAIN BUSINESS AND LITIGATION RISKS WITH RESPECT TO TECHNOLOGY RIGHTS HELD BY THIRD PARTIES. We currently license technology from third parties and intend to do so increasingly in the future. As we introduce services that require new technology, we will probably need to license additional third party technology. We cannot assure you that these technology licenses will be available to us on commercially reasonable terms, if at all. Our inability to obtain any of these licenses could delay or compromise our ability to introduce new services. In addition, we may or may allegedly breach the technology rights of others and incur legal expenses and damages, which, in the aggregate, could be substantial. INVESTORS MAY NOT BE ABLE TO ENFORCE JUDGMENTS BY UNITED STATES COURTS AGAINST US. We are incorporated in the State of Delaware. However, a majority of our directors, executive officers and shareholders live outside the United States, principally in Beijing, China and Hong Kong. Also, all or most of our assets are located outside the United States. As a result, you may not be able to: - effect service of process upon us or these persons within the United States, or - enforce against us or these persons judgments obtained in United States courts, including judgments relating to the federal securities laws of the United States. WE DO NOT INTEND TO PAY AND MAY BE RESTRICTED FROM PAYING DIVIDENDS ON OUR COMMON STOCK. We have never declared or paid any dividends on our capital stock and we do not intend to declare any dividends. We currently intend to retain future earnings to fund growth. Furthermore, if we decide to pay dividends, foreign exchange and other regulations in China may restrict our ability to distribute retained earnings from China or convert these payments from Renminbi into foreign currencies. In addition, loan agreements and contractual arrangements we enter into in the future may also restrict our ability to pay dividends. THE FACT THAT OUR BUSINESS IS CONDUCTED IN BOTH U.S. DOLLARS AND RENMINBI MAY SUBJECT US TO CURRENCY EXCHANGE RATE RISK DUE TO FLUCTUATIONS IN THE EXCHANGE RATE BETWEEN THESE TWO CURRENCIES. Substantially all of our revenues, expenses and liabilities are denominated in either U.S. dollars or Renminbi. As a result, we are subject to the effects of exchange rate fluctuations between these currencies. The contracts we enter into with our customers provide for price adjustments reflecting foreign exchange fluctuations; however, we cannot guarantee that future contracts will contain such provisions. As a result of the unitary exchange rate system introduced in China on January 1, 1994, the official bank exchange rate for conversion of Renminbi to U.S. dollars experienced a devaluation of approximately 50%. We report our financial results in U.S. dollars, therefore, any future devaluation of the Renminbi against the U.S. dollar may have an adverse effect upon our reported net income. - 22 - 23 THE MARKETS IN WHICH WE SELL OUR SERVICES AND PRODUCTS ARE HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. The information technology services market for Internet infrastructure in China is new and rapidly changing. Our competitors in the market mainly include domestic systems integrators such as Suntek and Aotian. Although we are a leading player in this market, there are many large multinational companies with substantial, existing information technology operations in other markets in China, such as IBM and Hewlett-Packard, that have significantly greater financial, technological, marketing and human resources. Should they decide to enter the information technology services market for Internet infrastructure, this could hurt our profitability and erode our market share. In the customer management and billing market, we compete with both international and local software providers. In the online billing segment, we compete primarily with Portal Software Inc. and Suntek, and in the wireless billing segment, we compete with more than ten local competitors. The messaging software sector is highly competitive. Our principal competitors in this sector are Software.com and Netease. Currently, due in part to a stringent approval system for providers of wireless billing software in China and competitive pricing offered by domestic companies, some multinational information technology companies have been deterred from entering this market. In view of the gradual deregulation of the Chinese telecommunications industry and China's pending entry into the WTO, we anticipate the entrance of new competitors into the customer management and billing software market. Our competitors, some of whom have greater financial, technical and human resources than us, may be able to respond more quickly to new and emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of new products or services. It is possible that competition in the form of new competitors or alliances, joint ventures or consolidation among existing competitors may decrease our market share. Increased competition could result in lower personnel utilization rates, billing rate reductions, fewer customer engagements, reduced gross margins and loss of market share, any one of which could materially and adversely affect our profits and overall financial condition. POLITICAL AND ECONOMIC POLICIES OF THE CHINESE GOVERNMENT COULD AFFECT OUR INDUSTRY IN GENERAL AND OUR COMPETITIVE POSITION IN PARTICULAR. Since the establishment of the PRC in 1949, the Communist Party has been the governing political party in China. The highest bodies of leadership are the Politburo, the Central Committee and the National Party Congress. The State Council, which is the highest institution of government administration, reports to the National People's Congress and has under its supervision various commissions, agencies and ministries, including The Ministry of Information Industries, the telecommunications regulatory body of the Chinese government. Since the late 1970s, the Chinese government has been reforming the Chinese economic system. Although we believe that economic reform and the macroeconomic measures adopted by the Chinese government have had and will continue to have a positive effect on the economic development in China, there can be no assurance that the economic reform strategy will not from time to time be modified or revised. Such modifications or revisions, if any, could have a material adverse effect on the overall economic growth of China and investment in the Internet and the telecommunications industry in China. Such developments could reduce, perhaps significantly, the demand for our products and services. There is no guarantee that the Chinese government will not impose other economic or regulatory controls that would have a material adverse effect on our business. Furthermore, changes in political, economic and social conditions in China, adjustments in policies of the Chinese government or changes in laws and regulations could adversely affect our industry in general and our competitive position in particular. - 23 - 24 THE FAILURE OF CHINA TO GAIN ENTRY INTO THE WTO COULD NEGATIVELY IMPACT THE CHINESE ECONOMY AND OUR GROWTH. Failure by China to join the World Trade Organization, as expected, could slow down China's economic growth and could result in lower than forecasted spending in the telecommunications sector in China, which in turn could adversely affect the demand for our products and services from our large customers. UNCERTAINTIES WITH RESPECT TO THE CHINESE LEGAL SYSTEM COULD ADVERSELY AFFECT US. Our subsidiaries are wholly foreign owned enterprises, which are enterprises incorporated in China and wholly-owned by foreign investors. They are subject to laws and regulations applicable to foreign investment in China in general and laws applicable to wholly foreign owned enterprises in particular. The legislation and regulations over the past 20 years have significantly enhanced the protections afforded to various forms of foreign investment in China. However, since the Chinese legal system is still evolving, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit remedies available to us. FLUCTUATIONS IN EXCHANGE RATES COULD ADVERSELY AFFECT THE VALUE OF OUR SHARES. Substantially all our revenues and expenses relating to hardware sales are denominated in U.S. dollars, and substantially all our revenues and expenses relating to the service component of our network solutions business and software business are denominated in Renminbi. Although, in general, our exposure to foreign exchange risks should be limited, the value in our shares may be affected by the foreign exchange rate between the U.S. dollar and the Renminbi because the value of our business is effectively denominated in Renminbi, while our shares are traded in U.S. dollars. Furthermore, a decline in the value of the Renminbi could reduce the U.S. dollar value of earnings from and our investment in our subsidiaries in China. HIGH TECHNOLOGY AND EMERGING MARKET SHARES HAVE HISTORICALLY EXPERIENCED EXTREME VOLATILITY AND MAY SUBJECT YOU TO LOSSES. The trading price of our shares may be subject to significant market volatility due to: - investor perceptions of us and investments relating to China and Asia; - developments in the Internet and telecommunications industries; - variations in our operating results from period to period due to project timing; and - announcements of new products or services by us or by our competitors. In addition, the high technology sector of the stock market frequently experiences extreme price and volume fluctuations, which have particularly affected the market prices of many Internet and computer software companies and which have often been unrelated to the operating performance of these companies. FUTURE SALES OF SHARES BY OUR COMPANY OR EXISTING SHAREHOLDERS COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO FALL. If our stockholders sell substantial amounts of our common stock in the public market, including shares issued upon the exercise of outstanding options and warrants, the market price of our common stock could fall. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. - 24 - 25 A SMALL NUMBER OF SHAREHOLDERS CONTROLS US. Our seven largest shareholders, Warburg-Pincus Ventures, ChinaVest Group, Fidelity International and Intel Pacific, Inc., and their affiliates, as well as Edward Tian, one of our directors, James Ding, our Chief Executive Officer, and Louis Lau, our Chairman, in the aggregate, control approximately 70% of our voting stock. As a result, these shareholders are able to control all matters requiring shareholder approval, including election of directors and approval of significant corporate transactions, such as a sale of our assets and the terms of future equity financings. The combined voting power of our large shareholders could have the effect of delaying or preventing a change in control. WE ARE SUBJECT TO ANTI-TAKEOVER PROVISIONS THAT COULD PREVENT A CHANGE OF CONTROL OF ASIAINFO AND PREVENT YOU FROM REALIZING A PREMIUM ON YOUR INVESTMENT. The board of directors has the authority to issue up to 10,000,000 shares of preferred stock. Without any further vote or action on the part of the stockholders, the board of directors has the authority to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if it is ever issued, may have preference over and harm the rights of the holders of common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, this issuance may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have authorized the size of our board of directors to be not less than three nor more than nine directors. The terms of the office of the seven-member board of directors have been divided into three classes: Class I, whose term will expire at the annual meeting of the stockholders to be held in 2003; Class II, whose term will expire at the annual meeting of stockholders to be held in 2001; and Class III, whose term will expire at the annual meeting of stockholders to be held in 2002. This classification of the board of directors may have the effect of delaying or preventing changes in control or management of AsiaInfo. We are subject to the provisions of Section 203 of the Delaware General Corporation Law. In general, the statute prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date when the person became an interested stockholder unless, subject to exceptions, the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Generally, a "business combination" includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the stockholder. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We are exposed to interest-rate risk primarily associated with our underlying liabilities. To date, we have not entered into any types of derivatives to hedge against interest-rate changes, nor do we speculate in foreign currency. However, we do maintain a significant portion of our cash deposits in U.S. dollars to avoid currency risk related to Renminbi. A portion of these U.S. dollar deposits are used to collateralize Renminbi-denominated loans from Chinese banks. Because substantially all of our revenues and expenses relating to hardware sales are denominated in U.S. dollars, and substantially all of our revenues and expenses relating to the service component of our network solutions business and software business are denominated in Renminbi, we do not have significant exposure to either U.S. dollar or Renminbi. Thus, we do not believe that it is necessary to enter into derivatives contracts to hedge our exposures to either currency. We have historically been exposed to market risk related to changing interest rates. Our primary exposure to interest-rate risk relates to the lines of credit and short term loans described above under "Liquidity and Capital Resources." - 25 - 26 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On March 2, 2000, our Registration Statement on Form S-1 covering the offering of 5,000,000 shares of our common stock (No. 333-93199) was declared effective. The underwriters in the offering exercised an over-allotment option to purchase an additional 750,000 shares of our common stock. The total price to the public for the shares offered and sold was $138,000,000. The net proceeds of the offering (after deducting expenses) was approximately $126,608,884. From the effective dates of the Registration Statement, the net proceeds have been used for the following purposes: Construction of plant, building and facilitates -- Purchase and installation of machinery and equipment 3,744,711 Purchase of real estate -- Acquisition of other business (including transaction costs) -- Repayment of indebtedness -- Working capital -- Temporary investments, including cash and cash equivalents 122,719,224 Other purposes (investment in joint venture) 144,949 --------------- 126,608,884 ===============
All of the foregoing payments were direct or indirect payments to persons other than (i) directors, officers or their associates; (ii) persons owning ten percent (10%) or more of the Company's common stock; or (iii) affiliates of the Company. ITEM 5. OTHER INFORMATION We held our Annual Meeting of Shareholders on October 18, 2000. For more information on the following proposals, please refer to our definitive proxy statement dated September 15, 2000, the relevant portions of which are incorporated herein by reference. (1) Our shareholders elected each of the two nominees to our Board of Directors for a three-year term:
DIRECTOR FOR WITHHELD -------- --- -------- James Ding 33,645,301 36,140 Alan Bickell 33,646,136 35,305
(2) Our shareholders ratified the appointment of Deloitte Touche Tohmatsu as independent auditors: For 33,642,920 Against 11,208 Abstain 27,313 ---------------- Total 33,681,441
(3) Our shareholders approved the adoption of our 2000 Stock Option Plan: For 28,653,229 Against 1,934,608 Abstain 93,343 Broker No Vote 3,000,261 ---------------- Total 33,681,441
- 26 - 27 (4) Our shareholders approved the Amendment to our Certificate of Incorporation increasing our total number of authorized shares of common stock to 100,000,000: For 33,226,865 Against 399,469 Abstain 55,107 ---------------- Total 33,681,441
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed as a part of this Report.
Exhibit Number Description of Exhibits -------------- ----------------------- 3.1 Certificate of Incorporation of AsiaInfo, dated June 8, 1998/*/ 3.2 Bye-Laws of AsiaInfo, dated June 8, 1998/*/ 3.3 Certificate of Amendment to Certificate of Incorporation of AsiaInfo, dated August 27, 1999/*/ 4.1 Specimen Share Certificate representing AsiaInfo shares of common stock/*/ 10.1 2000 Stock Option Plan, approved and adopted as of October 18, 2000 10.2 Certificate of Merger of HTC Investments, Inc., a Delaware corporation, with and into AsiaInfo, a Delaware corporation, dated October 13, 1999/*/ 10.3 Shareholders' Agreement of Marsec Holdings Inc., dated as of September 15, 2000, by and among AsiaInfo Holdings, Inc. and the Founders (as defined therein) of Marsec Holdings, Inc. 10.4 Warrant to purchase Series A Preferred Shares of Marsec Holdings, Inc., issued to AsiaInfo Holdings, Inc. as of September 15, 2000 10.5 Lease of AsiaInfo's headquarters at 18 Baishiqiao Road, Beijing, dated August 31, 1999/*/ 11.1 Statement regarding computation of per share earnings (included in Note 7 to AsiaInfo's Condensed Consolidated Financial Statements) 27.1 Financial Data Schedules /*/ Incorporated by reference to the same numbered exhibit previously filed with our Registration Statement on Form S-1 (No. 333-93199).
(b) Reports on form 8-K None. - 27 - 28 Signature Pursuant to the requirements of the Securities Exchange Act of 1934, AsiaInfo Holdings, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AsiaInfo Holdings, Inc. Date: November 17, 2000 By: /s/ Ying Han -------------------------- Ying Han Chief Financial Officer (duly authorized officer and principal financial officer) - 28 - 29 INDEX TO EXHIBITS The following exhibits are filed as a part of this Report.
Exhibit Number Description of Exhibits ------- ----------------------- 3.1 Certificate of Incorporation of AsiaInfo, dated June 8, 1998/(*)/ 3.2 Bye-Laws of AsiaInfo, dated June 8, 1998/*/ 3.3 Certificate of Amendment to Certificate of Incorporation of AsiaInfo, dated August 27, 1999/*/ 4.1 Specimen Share Certificate representing AsiaInfo shares of common stock/*/ 10.1 2000 Stock Option Plan, approved and adopted as of October 18, 2000 10.2 Certificate of Merger of HTC Investments, Inc., a Delaware corporation, with and into AsiaInfo, a Delaware corporation, dated October 13, 1999/*/ 10.3 Shareholders' Agreement of Marsec Holdings Inc., dated as of September 15, 2000, by and among AsiaInfo Holdings, Inc. and the Founders (as defined therein) of Marsec Holdings, Inc. 10.4 Warrant to purchase Series A Preferred Shares of Marsec Holdings, Inc., issued to AsiaInfo Holdings, Inc. as of September 15, 2000 10.5 Lease of AsiaInfo's headquarters at 18 Baishiqiao Road, Beijing, as supplemented, dated August 31, 1999/*/ 11.1 Statement regarding computation of per share earnings (included in Note 7 to AsiaInfo's Condensed Consolidated Financial Statements) 27.1 Financial Data Schedules /*/ Incorporated by reference to the same numbered exhibit previously filed with the Company's Registration Statement on Form S-1 (No. 333-93199).
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