424B4 1 d424b4.htm 424B(4) 424B(4)
Table of Contents
PROSPECTUS  

Filed Pursuant to Rule 424(b) (4)

Registration No. 333-112800

11,250,000 American Depositary Shares

 

LOGO

TOM Online Inc.

Representing 900,000,000 Ordinary Shares

 


 

We are selling 900,000,000 ordinary shares in the form of American Depositary Shares, or ADSs, and ordinary shares. Each ADS represents the right to receive 80 ordinary shares. Investors may choose to receive ADSs or ordinary shares.

 

This is our initial public offering. The initial public offering price per ADS is US$15.552, equivalent to HK$1.515 per ordinary share, assuming an exchange rate of HK$7.7930 to US$1.00, the noon buying rate on March 4, 2004.

 

This offering of ADSs is part of a global offering of an aggregate of 1,000,000,000 ordinary shares, including a Hong Kong public offering of 100,000,000 ordinary shares.

 

The ADSs have been approved to be included for quotation on the Nasdaq National Market under the symbol “TOMO.” The Hong Kong Stock Exchange has granted approval in principle for the listing of, and permission to deal in, our ordinary shares on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited under the stock code of “8282.”

 


 

Investing in the ADSs involves risks. See “Risk Factors” beginning on page 15.

 


 

US$15.552 per ADS

 


 

           Price to Public    

         Underwriting    
Discounts and
Commissions


         Proceeds to Us    

Per ADS

       US$15.552        US$1.0886        US$14.4634

Total

     US$ 174,960,000      US$ 12,246,750      US$ 162,713,250

 

The information in the above table excludes ordinary shares initially offered in the Hong Kong public offering, with aggregate proceeds to us of HK$146,250,000. TOM Group Limited (formerly TOM.COM LIMITED), our parent company, has granted the underwriters an option to purchase up to 1,875,000 additional ADSs to cover over-allotments, if any. We will not receive any proceeds from the sale of ADSs by TOM Group Limited.

 

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 March 11, 2004. The ADSs are expected to commence trading on the Nasdaq National Market on March 10, 2004. You will not be able to sell or otherwise deal in these securities prior to the commencement of trading.

 

Citigroup

Morgan Stanley

 

(in alphabetical order)


 

Piper Jaffray

 

March 5, 2004

 


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

Summary

   2

Risk Factors

   15

General

   35

Forward-Looking Statements

   36

Our Corporate Structure

   37

Use of Proceeds

   41

Dividend Policy

   42

Dilution

   43

Capitalization

   45

Exchange Rate Information

   46

Selected Historical Consolidated Financial and Operating Data

   47

Selected Financial Data of Wu Ji Network

   49

Selected Unaudited Pro Forma Consolidated Financial Data

   50

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

   52

Industry Overview

   81

Our Business

   85

Our Acquisition

   104

Management

   110

Regulation

   117

Relationship with Our Parent Company

   125

Related Party Transactions

   127

Principal Shareholders and Selling Shareholder

   138

Description of Share Capital

   139

Description of American Depositary Shares

   148

Shares Eligible for Future Sale

   158

Taxation

   160

Underwriting

   167

Legal Matters

   177

Experts

   178

Expenses Related to the Global Offering

   179

Where You Can Find More Information

   180

Enforceability of Civil Liabilities

   181

Additional Information Disclosed in The Hong Kong Public Offering Regarding Statement of Business Objectives and Strategies and Our Reorganization

   182

Glossary of Technical Terms

   194

Index to Financial Statements

   F-1

Index to Unaudited Pro Forma Consolidated Financial Information and Supplemental Selected Unaudited Pro Forma Consolidated Quarterly Financial Information

   P-1

Appendix A—Property Valuation

   A-1

 


 

Until March 30, 2004 (25 days after the date of this prospectus), all dealers that buy, sell or trade our ordinary shares or ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscription.

 

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SUMMARY

 

This summary highlights selected information from this prospectus and does not contain all of the information that may be important to you. You should read the entire prospectus carefully when evaluating an investment in our ADSs or ordinary shares. Unless otherwise stated, references to and statements regarding China or the People’s Republic of China, or the PRC, in this prospectus do not apply to Hong Kong, Macau or Taiwan.

 

Overview

 

We are one of the leading Internet companies in China providing value-added multimedia products and services. We deliver our products and services from our Internet portal to our users both through their mobile phones and through our websites. Our primary business activities include wireless value-added services, online advertising and commercial enterprise solutions. We are one of the leading wireless value-added service providers in China. We are also one of the leading Internet portal websites based on average daily website page views. As of December 31, 2003, we had approximately 27 million cumulative registered users of our wireless data services, and during the fourth quarter of 2003, we sent an average of approximately 7 million daily wireless data messages. We recorded an average of approximately 148 million daily website page views during the fourth quarter of 2003.

 

Our revenues increased to US$77.1 million in 2003 from US$30.0 million in 2002. In 2003, our revenues from our wireless value-added services, advertising and commercial enterprise solutions accounted for 72.5%, 7.6% and 17.9%, respectively, of our total revenues. We have historically operated as a wholly-owned subsidiary of our parent company, TOM Group Limited (formerly TOM.COM LIMITED), and our historical consolidated financial statements for periods prior to our reorganization may not reflect our operations, financial condition and cash flow had we operated as a stand-alone entity in the past.

 

Industry Overview

 

China has experienced rapid growth in Internet use in recent years. According to China Internet Network Information Center, the number of Internet users in China increased from approximately 9 million as of December 31, 1999 to approximately 80 million as of December 31, 2003, making China the second largest Internet market in the world. China has also experienced rapid growth in mobile telecommunications use in recent years. According to China’s Ministry of Information Industry, China is now the largest mobile telecommunications market in the world with approximately 269 million mobile phone users as of December 31, 2003. In addition, China has experienced a significant increase in the use of wireless value-added services, the most popular form of which is short messaging services, or SMS. The most common application for SMS is point-to-point SMS, which allows users to send short messages between mobile phones. In 2000, China Mobile Communications Corporation, or China Mobile, launched its Monternet wireless value-added services platform, and in 2001, China United Telecommunications Corporation, or China Unicom, launched its UNI-Info wireless value-added services platform. These platforms enabled the development of an additional type of SMS, which allows users to access products and services provided by third parties, such as ourselves. China Mobile and China Unicom also began to allow these third party providers to use their billing and collection systems to charge fees for products and services that are delivered through the Monternet and UNI-Info platforms. This created an opportunity for Internet companies to deliver their Internet portal products and services to users in China through their mobile phones and to utilize these billing and collection systems to collect fees for these products and services.

 

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According to Norson Telecom Consulting, the total number of short messages transmitted in China in 2003 was approximately 180 billion, compared to approximately 90 billion in 2002, and point-to-point SMS accounted for approximately 78.6% of the total number of SMS messages sent through China Mobile’s telecommunications network, while the remaining approximately 21.4% was accounted for by other SMS-based wireless data services. In addition, we believe that with the continuous upgrading of mobile telecommunications networks in China, the wireless value-added services market will further expand by allowing users to transmit larger amounts of data at higher speeds and to access additional products and services through their mobile phones.

 

Due to the rapid growth in Internet use, companies in China are spending an increasing amount on advertising through Internet websites to promote their products and services. According to International Data Corporation, China’s online advertising market is expected to increase to approximately US$344 million in 2007 from approximately US$63 million in 2002. The expected increase in Internet use in China may also lead to an expansion in the market for other Internet services, such as online games and directory listings, which we believe will create additional opportunities for growth in the Internet services market.

 

Our Business

 

Our Internet portal contains our content and is the foundation for our primary business activities. We provide content, products and services through the Internet and wireless communications networks. We launched our Internet portal in July 2000 and have since focused on the development and the provision of content products and services to users. Our content, which is both developed in-house and obtained from third party content providers, is edited, redesigned and repackaged through our content management system for our different products and services.

 

Over time, as our user base increased and with the introduction of China Mobile’s Monternet and China Unicom’s UNI-Info platforms in 2001, we capitalized on the opportunity to offer wireless value-added services from our portal by using China Mobile and China Unicom’s platforms. Our newly acquired wireless interactive voice response, or wireless IVR, services provide an additional distribution channel for our content and services. Our users can access our wireless value-added products and services through both their mobile phones and our websites. Our commercial enterprise solutions services also leverage our expertise in Internet and wireless value-added services by offering business system solutions to corporate and government entities. Online advertising services have been part of our business since the launch of, and rely on the success of, our Internet portal.

 

Wireless Value-Added Services

 

Wireless Data Services: We began providing wireless data services in the second half of 2001. Our wireless data services include SMS, multimedia messaging services, or MMS, and wireless application protocol, or WAP, services. Through these services we provide download, information and community-oriented products, such as news headlines, sports, games, ring tones, ring back tones, dating and wallpapers. As of December 31, 2003, we had approximately 27 million cumulative registered users of our wireless data services, compared to approximately 10 million as of December 31, 2002. Users pay for our wireless data services on either a monthly subscription or a per message basis. As we believe that our subscription-based services provide us with a more stable flow of revenue, we have increased our focus on promoting our subscription-based services since late 2002. In 2003, our subscription-based services revenue accounted for a majority of our wireless data services revenue. Revenues from our wireless data services increased to US$53.5 million in 2003 from US$10.0 million in 2002, and according to China Mobile, we had achieved a top three ranking on China Mobile’s platform in terms of revenue for each of SMS and MMS for the month of December 2003, and WAP for the month of January 2004, the latest periods for which such data was made available to us.

 

We provide our wireless data services to users in China through China Mobile’s Monternet platform and China Unicom’s UNI-Info platform, and we share revenues from these services with China Mobile and China

 

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Unicom. We were one of the first wireless data service providers to jointly develop and launch MMS and WAP with China Mobile. In addition, we cooperate with several of China’s leading mobile phone producers. These companies manufacture select handset models with a wireless value-added services icon in the handset’s menu that directs users to our Internet portal, which we believe helps us promote our services and acquire new users.

 

Wireless IVR Services: On November 19, 2003, we acquired the entire issued share capital of Puccini International Ltd., or Puccini, which provides wireless IVR services through Beijing Lei Ting Wu Ji Network Technology Limited, or Wu Ji Network. Wireless IVR services are a new category of wireless value-added services that allow users to access prerecorded information from their mobile phones and to interact with other users through chat and dating services. We believe this acquisition will create synergies between our wireless data services and Wu Ji Network’s wireless IVR services. For a description of the terms of our acquisition and a discussion of Wu Ji Network’s business, see “Our Acquisition.” Wu Ji Network’s revenue was US$9.1 million for the full year ended December 31, 2003.

 

Online Advertising

 

At the beginning of 2003, we began increasing our focus on developing our online advertising business. We believe that developing attractive content and services for our websites helps us to increase our user traffic and develop our online advertising business. As our wireless value-added services target young and trendy users, we believe that we are able to attract companies in industries that cater to the younger and more affluent market to advertise on our websites. In addition, we have established relationships with several leading advertising agencies to promote and market our online advertising services to their clients. We will continue to engage in offline advertising activities only to the extent that they are bundled with online advertising. Revenues from our advertising, including online and offline advertising, increased to US$5.8 million in 2003 from US$4.2 million in 2002.

 

Commercial Enterprise Solutions

 

Our commercial enterprise solutions provide technical services for Internet-related computer hardware and software needs of our clients. In the first half of 2003, computer hardware sales accounted for the majority of our commercial enterprise solutions revenues. However, we intend to increase our focus on providing higher margin integrated solutions that leverage our expertise in wireless value-added services. We help our clients employ Internet and wireless data-related services, such as SMS, to improve their internal and external communication systems. Our clients can also use our solutions to implement customer service systems, which enable them to promote their products and provide timely information and updates to their customers through wireless data services. Revenues from our commercial enterprise solutions increased to US$13.8 million in 2003 from US$11.2 million in 2002.

 

Our Strengths

 

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

 

    A leading Internet company with strong market position and brand name;

 

    Ability to identify industry developments and rapidly introduce innovative products and services;

 

    Established relationships with key industry partners in the industry value chain;

 

    Proven and innovative management team;

 

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    Success in expanding our subscription-based business; and

 

    Shareholder backing from our parent company, TOM Group Limited, and its shareholders.

 

Our Strategies

 

Our objective is to be the leading Internet company in China providing value-added multimedia products and services through multiple distribution channels. In pursuing our objective, we expect to face competition from other leading Internet portals, which may already have access to capital markets, more human and financial resources than we do and a longer operating history than us. To achieve our objective, we intend to pursue the following business strategies:

 

    Further promote and build our brand name;

 

    Continue to develop our Internet portal content and expand our user base;

 

    Continue to develop cooperation arrangements with key industry players and expand our distribution channels to reach a broader user base;

 

    Expand our subscription-based product portfolio and revenues;

 

    Continue to develop our online advertising business; and

 

    Selectively acquire businesses and form strategic alliances that enhance our product portfolio, proprietary content, distribution channels and technology.

 

Our Corporate Structure

 

In August 2001, we were incorporated under the laws of the Cayman Islands and we became a wholly-owned subsidiary of our parent company, TOM Group Limited. As part of our pre-initial public offering reorganization, our parent company transferred its wireless value-added services, online advertising and commercial enterprise solutions businesses in China to us. For a description of our reorganization, see “Our Corporate Structure.” Prior to our reorganization, we had not operated as a stand-alone entity as we have historically operated as a wholly-owned subsidiary of our parent company, TOM Group Limited. Our audited historical consolidated financial statements pertain to our results of operations prior to our reorganization. As a result, our historical consolidated financial statements were constructed based on combined activities of us and our parent company and they depend on certain assumptions and allocations that might not reflect our operations, financial condition and cash flow had we operated as a separate entity in the past.

 

As a result of PRC legal considerations, we conduct substantially all of our operations through Beijing Lei Ting Wan Jun Network Technology Limited, or Beijing Lei Ting, Shenzhen Freenet Information Technology Company Limited, or Shenzhen Freenet, and Wu Ji Network, each of which is wholly owned by PRC citizens. We exercise managerial control over those companies as individuals nominated by our wholly-owned subsidiaries were appointed to the management of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network pursuant to the business operation agreements between those companies and our wholly-owned subsidiaries. In addition, some of those individuals also have the full power and authority to exercise all of the shareholder’s rights of the shareholders of these companies pursuant to the power of attorneys granted by these shareholders. As a result, our wholly-owned subsidiaries are able to conduct substantially all of their business activities through those companies. Other than acting as the performance guarantor for those companies in connection with

 

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certain operations-related agreements they entered into with third parties, neither us nor our wholly-owned subsidiaries have any contractual responsibilities for any liabilities of those companies incurred in the course of their business activities. In addition, we are entitled to receive service fees which amount to substantially all of the net income of these companies pursuant to technical and consulting services agreements entered into between those companies and our wholly-owned subsidiaries. For a description of these contractual arrangements, see “Our Corporate Structure” and “Related Party Transactions.”

 

General Information

 

Our principal executive office is located at 8th Floor, Tower W3, Oriental Plaza, No. 1 Dong Chang An Avenue, Dong Cheng District, Beijing, China 100738. Our telephone number at this location is (8610) 6528-3399. In addition, we also have offices located at Beijing Economic Technology Development Zone, 3 Yong Chang Bei Lu, Yong Chang Shang, Wu Zong Xin, Beijing, China 100176. Our registered office in the Cayman Islands is located at M&C Corporate Services Limited, P.O. Box 309, Ugland House, South Church Street, George Town, Grand Cayman, Cayman Islands, British West Indies. Our primary website address is www.tom.com. Information contained on our website does not constitute a part of this prospectus. Our agent for service of process is CT Corporation System located at 111 Eighth Avenue, New York, New York 10011.

 

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The Global Offering

 

Unless otherwise indicated, the information in this prospectus assumes that the underwriters will not exercise their over-allotment option to purchase additional ADSs or ordinary shares. See “Underwriting.”

 

Global Offering

   1,000,000,000 ordinary shares, including ordinary shares represented by ADSs, consisting of the U.S. offering, the international offering and the Hong Kong public offering.

U.S. offering

   450,000,000 ordinary shares in the form of ordinary shares or ADSs to be offered in the United States and Canada.

International offering

   450,000,000 ordinary shares in the form of ordinary shares or ADSs to be offered outside the United States and Canada, including the preferential offering and a placing to professional and institutional investors in Hong Kong.

Hong Kong public offering

   100,000,000 ordinary shares offered to the public in Hong Kong by the listing of our ordinary shares on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited, or GEM.

ADSs

   Each American depositary share, or ADS, represents 80 ordinary shares, par value HK$0.01 per share. The ADSs will be evidenced by American depositary receipts, or ADRs, issued by the depositary bank. The ordinary shares will initially be represented by one or more certificates of payment that represent the irrevocable right to receive the ordinary shares.

Ordinary shares in lieu of ADSs

   Investors in the U.S. offering and the international offering can choose to receive ordinary shares in lieu of ADSs as described in “Underwriting.”

Over-allotment option

   Up to 1,875,000 ADSs, representing 150,000,000 ordinary shares, offered by TOM Group Limited, our parent company, and exercisable, in whole or in part, by the underwriters within 30 days from the date of commencement of trading of our ordinary shares on GEM to cover over-allotments.

Preferential offering

   38,782,700 ordinary shares offered to certain qualifying shareholders of TOM Group Limited, our parent company, pursuant to the requirements of The Stock Exchange of Hong Kong Limited, or the Hong Kong Stock Exchange. See “Underwriting.”

 

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Price per ADS in the U.S. offering and international offering

  

The initial public offering price per ADS is US$15.552. The initial public offering price per ADS includes any brokerage fees, transaction levies, investor compensation levies and Hong Kong Stock Exchange trading fees payable in connection with the initial sale and purchase of the ADSs. These fees and levies will be paid over to the relevant authorities or brokers by us.

Price per ordinary share in the Hong Kong public offering and preferential offering

  

The initial public offering price per ordinary share in the Hong Kong public offering and preferential offering is HK$1.500. The initial public offering price per ordinary share excludes a 1% brokerage fee, a 0.005% transaction levy, a 0.002% investor compensation levy and a 0.005% Hong Kong Stock Exchange trading fee payable by purchasers.

Timing of global offering

   The following is an indicative timetable of key events in the global offering given in business days:

Hong Kong public offering commences

   March 2, 2004, Hong Kong time

Hong Kong public offering closes

   March 5, 2004, Hong Kong time

Pricing of global offering

   March 5, 2004, Hong Kong time

Final allocation of shares announced

   March 10, 2004, Hong Kong time

Trading of ADSs commences on the Nasdaq National Market

   March 10, 2004, New York time

Trading of ordinary shares commences on GEM

   March 11, 2004, Hong Kong time
Three-day gap between pricing and trading of ordinary shares   

Trading of the ordinary shares offered in the global offering will not commence on GEM until all of the conditions contained in the underwriting agreement for the Hong Kong public offering have been satisfied or waived, which is expected to be three Hong Kong business days after the date of pricing of the ordinary shares. The ADSs offered in the global offering are expected to commence trading on the Nasdaq National Market on the business day in New York immediately preceding the day when trading of the ordinary shares commences trading on GEM. You will not be able to sell or otherwise deal in the ADSs prior to the commencement of their trading on the Nasdaq National Market and you will not be able to

 

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     sell or otherwise deal in the ordinary shares prior to the commencement of their trading on GEM.
Reallocation between offerings    The joint global coordinators may, at their discretion, reallocate all or any of the ADSs or ordinary shares among the U.S. offering, the international offering and the Hong Kong public offering listed above.
Payment and delivery    The underwriters expect to deliver the ADSs to purchasers on or about March 11, 2004.

Use of proceeds

   The aggregate net proceeds to us from the global offering will be approximately US$170 million. We currently intend to use the proceeds for enhancing and expanding our content and applications for wireless value-added services; research and development of new technologies and future upgrading of our existing technologies and infrastructure; sales and marketing activities; any contingent payments owed in connection with the acquisition of Puccini (however, if at the time of such payments, we have sufficient internal or other resources, all or a portion of such payments may be satisfied by such resources); funding future potential acquisitions and strategic alliances in the wireless value-added services, content and Internet industries in China; and general corporate purposes. See “Use of Proceeds.”

Shares outstanding after the global offering

   3,896,200,000 ordinary shares, including ordinary shares represented by ADSs, will constitute our entire issued and outstanding share capital after the global offering. Cranwood Company Limited will directly own 96,200,000 ordinary shares, which will represent 2.5% of our issued and outstanding share capital. Assuming that the over-allotment option is not exercised by the underwriters, TOM Group Limited, our parent company, will own 2,800,000,000 ordinary shares, which will represent 71.9% of our issued and outstanding share capital.

Listing

   We have received approval to have our ADSs included for quotation on the Nasdaq National Market. The Hong Kong Stock Exchange has granted approval in principle for the listing of, and permission to deal in, our ordinary shares on GEM.

Proposed Nasdaq symbol for our ADSs

   “TOMO”

Proposed GEM code for our ordinary shares

   “8282”

 

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SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following summary historical consolidated financial data should be read in conjunction with our audited historical consolidated financial statements, the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The summary historical consolidated statement of operations data for the years ended December 31, 2001, 2002 and 2003, and the summary historical consolidated balance sheet data as of December 31, 2001, 2002 and 2003 set forth below are derived from our audited historical consolidated financial statements included elsewhere in this prospectus. The summary historical consolidated statement of operations data for the year ended December 31, 2000 and the summary historical consolidated balance sheet as of December 31, 2000 set forth below are derived from our audited historical consolidated financial statements that are not included in this prospectus. Our historical consolidated financial data reflects the effects of our reorganization from September 26, 2003, and the effects of our acquisition from November 19, 2003. Our audited historical consolidated financial statements have been prepared and presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, and audited by PricewaterhouseCoopers. For a description of the basis of presentation of these financial statements, see note 2 to our audited historical consolidated financial statements. For a description of our reorganization, see “Our Corporate Structure.”

 

     As of or for the year ended December 31,

 
     2000

    2001

    2002

        2003    

 

Historical Consolidated Statement of Operations Data

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

Revenues

   2,610     6,433     29,975     77,073  

Cost of revenues

   (5,483 )   (10,908 )   (24,874 )   (44,085 )
    

 

 

 

Gross (loss)/profit

   (2,873 )   (4,475 )   5,101     32,988  

Operating expenses

   (71,866 )   (18,616 )   (13,420 )   (13,223 )
    

 

 

 

(Loss)/income from operations

   (74,739 )   (23,091 )   (8,319 )   19,765  

Other expenses

   (17 )   (347 )   (408 )   (320 )
    

 

 

 

(Loss)/income before tax

   (74,756 )   (23,438 )   (8,727 )   19,445  

Income tax (expense)/credit

           (16 )   254  
    

 

 

 

(Loss)/income after tax

   (74,756 )   (23,438 )   (8,743 )   19,699  

Minority interests

   72     294     389     (127 )
    

 

 

 

Net (loss)/income attributable to shareholders

   (74,684 )   (23,144 )   (8,354 )   19,572  
    

 

 

 

Historical Consolidated Balance Sheet Data

                        

Cash and cash equivalents

   8,278     5,320     6,752     22,636  

Restricted cash

       4,030          

Other current assets

   3,411     9,925     12,310     32,182  

Property and equipment, net

   5,413     2,960     5,518     7,094  

Other assets

       3,391     994     5,464  
    

 

 

 

Total assets

   17,102     25,626     25,574     67,376  
    

 

 

 

Current liabilities

   3,941     14,445     8,498     32,831  

Long-term liabilities

   6,100     11,801     26,316     19,983  
    

 

 

 

Total liabilities

   10,041     26,246     34,814     52,814  

Minority interests

       613     224     152  

Total shareholders’ equity/(deficit)

   7,061     (1,233 )   (9,464 )   14,410  
    

 

 

 

Total liabilities and shareholders’ equity/(deficit)

   17,102     25,626     25,574     67,376  
    

 

 

 

Other Historical Consolidated Financial Data

                        

Gross (loss)/profit margin

   (110 %)   (70 %)   17 %   43 %

Operating (loss)/profit margin

   (2,864 %)   (359 %)   (28 %)   26 %

Net (loss)/profit margin

   (2,861 %)   (360 %)   (28 %)   25 %

Depreciation

   533     2,360     1,865     3,016  

Amortization

   3,270     8     88     629  

Capital expenditure

   2,581     2,749     4,451     4,790  

Unaudited Operating Data

                        

Registered users (in millions)(1)

       0.4     10.1     27.4  

(1)   Approximate cumulative number of users of our wireless data services that have registered with us since our launch of these services in July 2001, irrespective of activity level.

 

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SUMMARY UNAUDITED HISTORICAL CONSOLIDATED QUARTERLY FINANCIAL AND OPERATING DATA

 

The following summary unaudited historical consolidated quarterly financial data should be read in conjunction with our audited historical consolidated financial statements, the notes thereto, and “Management‘s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The summary unaudited historical consolidated quarterly financial data for the three months ended March 31, 2003, June 30, 2003, September 30, 2003 and December 31, 2003 were derived from our management financial information, which was prepared on substantially the same basis as our audited historical consolidated financial statements and include all adjustments necessary for a fair statement of the financial results for the periods presented. Our unaudited historical consolidated quarterly financial information reflects the effects of our reorganization from September 26, 2003, and the effects of our acquisition from November 19, 2003. For a description of the basis of presentation of our audited historical consolidated financial statements, see note 2 to our audited historical consolidated financial statements. For a description of our reorganization, see “Our Corporate Structure.”

 

     As of or for the three months ended

 
     March 31, 2003

    June 30, 2003

    September 30,
2003


    December 31,
2003


 

Historical Consolidated Statement of Operations Data

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

Revenues:

                        

Wireless value-added services

   8,759     14,883     14,637     17,564  

Advertising(1)

   1,268     1,699     2,279     599  

Commercial enterprise solutions(2)

   3,757     2,849     4,132     3,087  

Internet access(3)

   1,055     385     64     56  
    

 

 

 

Total revenues

   14,839     19,816     21,112     21,306  

Cost of revenues

   (9,636 )   (11,403 )   (12,311 )   (10,735 )
    

 

 

 

Gross profit

   5,203     8,413     8,801     10,571  

Operating expenses

   (3,317 )   (2,804 )   (3,392 )   (3,710 )
    

 

 

 

Income from operations

   1,886     5,609     5,409     6,861  

Other expenses

   (113 )   (111 )   (91 )   (5 )
    

 

 

 

Income before tax

   1,773     5,498     5,318     6,856  

Income tax (expense)/credit

   (8 )   (4 )   166     100  
    

 

 

 

Income after tax

   1,765     5,494     5,484     6,956  

Minority interests

   (2 )   (60 )   (12 )   (53 )
    

 

 

 

Net income attributable to shareholders

   1,763     5,434     5,472     6,903  
    

 

 

 

Other Historical Consolidated Financial Data

                        

Gross profit margin

   35 %   42 %   42 %   50 %

Operating profit margin

   13 %   28 %   26 %   32 %

Net profit margin

   12 %   27 %   26 %   32 %

Depreciation

   646     723     846     801  

Amortization

               629  

Unaudited Operating Data

                        

Registered users (in millions)(4)

   15.8     17.7     22.1     27.4  

SMS subscriptions(5) (in millions)

   5.5     8.7     8.5     9.1  

SMS downloads(6) (in millions)

   83.4     89.1     78.8     72.9  

(1)   Includes offline advertising revenue that is bundled with online advertising revenue.
(2)   Our commercial enterprise solutions revenue is primarily derived from the purchase and installation of computer hardware on behalf of our clients.
(3)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access card expires at the end of 2004.
(4)   Approximate cumulative number of users of our wireless data services that have registered with us since our launch of these services in July 2001, irrespective of activity level.
(5)   Number of paid SMS subscriptions during the relevant period.
(6)   Number of paid SMS downloads during the relevant period, excluding downloads made pursuant to subscriptions.

 

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SUMMARY UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA

 

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

 

Our unaudited pro forma consolidated statement of operations data is presented in order to give pro forma effect to (i) our reorganization, as if the reorganization occurred on January 1, 2003 and (ii) the acquisition of Puccini, which provides wireless IVR services through Wu Ji Network, as if the acquisition occurred on January 1, 2003. As a result, our unaudited pro forma consolidated financial information includes the financial information of the nine companies that are part of our company following our reorganization, but excludes the six companies that were included in our historical consolidated financial information up until September 26, 2003, but are no longer part of our company following our reorganization.

 

Our unaudited pro forma consolidated financial information have been derived from our audited historical consolidated financial statements and the audited historical financial statements of Wu Ji Network, both of which are prepared and presented in accordance with U.S. GAAP. For a description of the basis of presentation and the adjustments made in the preparation of this unaudited pro forma consolidated financial information, see our unaudited pro forma consolidated financial information and supplemental selected unaudited quarterly financial information included elsewhere in this prospectus. For a description of our reorganization, see “Our Corporate Structure.” For a description of our acquisition see “Our Acquisition.”

 

     2003

 
    

(unaudited and in thousands of

U.S. dollars, except percentages)

 

Pro Forma Consolidated Statement of Operations Data

      

Revenues

   79,995  

Cost of revenues

   (42,286 )
    

Gross profit

   37,709  

Operating expenses

   (17,674 )
    

Income from operations

   20,035  

Other expenses

   (260 )
    

Income before tax

   19,775  

Income tax expense

   (107 )
    

Income after tax

   19,668  

Minority interests

   (127 )
    

Net income attributable to shareholders

   19,541  
    

Other Pro Forma Consolidated Financial Data

      

Gross profit margin

   47 %

Operating profit margin

   25 %

Net profit margin

   24 %

Depreciation

   2,979  

Amortization

   5,040  

 

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SUMMARY UNAUDITED PRO FORMA CONSOLIDATED QUARTERLY FINANCIAL DATA

 

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

 

Our summary unaudited pro forma consolidated quarterly financial data is presented in order to give pro forma effect to (i) our reorganization, as if the reorganization occurred on January 1, 2003 and (ii) the acquisition of Puccini, which provides wireless IVR services through Wu Ji Network, as if the acquisition occurred on January 1, 2003. As a result, our unaudited pro forma consolidated quarterly financial data includes until September 26, 2003, the financial information of the nine companies that are part of our company following our reorganization, but excludes the six companies that were included in our historical consolidated financial statements but that are no longer part of our company following our reorganization. In addition, our summary unaudited pro forma consolidated quarterly financial data includes the financial information of Wu Ji Network.

 

Our summary unaudited pro forma consolidated quarterly financial data have been derived from our unaudited management quarterly financial information and unaudited management quarterly financial information of Wu Ji Network, which were prepared on substantially the same basis as our audited historical consolidated financial statements and the audited historical financial statements of Wu Ji Network and include all normal recurring accruals adjustments which the respective management considered necessary for fair presentations of the unaudited consolidated quarterly financial information for the periods presented. For a description of the basis of presentation and the adjustments made in preparation of these unaudited pro forma consolidated financial information, see our unaudited pro forma consolidated financial information and supplemental selected unaudited pro forma quarterly financial information included elsewhere in this prospectus.

 

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Pro Forma Consolidated Quarterly Financial
Data
   For the three months ended

 
   March 31, 2003

    June 30, 2003

    September 30, 2003

    December 31, 2003

 
   (unaudited and in thousands of U.S. dollars except percentages)  

Revenues:

                        

Wireless value-added services(1)

   9,113     16,562     17,929     19,063  

Advertising(2)

   176     411     823     599  

Commercial enterprise solutions(3)

   3,723     2,819     4,130     3,087  

Internet access(4)

   1,055     385     64     56  
    

 

 

 

Total revenues

   14,067     20,177     22,946     22,805  

Cost of revenues

   (8,743 )   (10,621 )   (11,829 )   (11,093 )
    

 

 

 

Gross profit

   5,324     9,556     11,117     11,712  

Operating expenses

   (4,573 )   (4,005 )   (4,500 )   (4,596 )
    

 

 

 

Income from operations

   751     5,551     6,617     7,116  

Other expenses

   (95 )   (92 )   (72 )   (1 )
    

 

 

 

Income before tax

   656     5,459     6,545     7,115  

Income tax (expense)/credit

   (43 )   (336 )   172     100  
    

 

 

 

Income after tax

   613     5,123     6,717     7,215  

Minority interests

   (2 )   (60 )   (12 )   (53 )
    

 

 

 

Net income attributable to shareholders

   611     5,063     6,705     7,162  
    

 

 

 

Other Pro Forma Consolidated Financial Data

                        

Gross profit margin

   38 %   47 %   48 %   51 %

Operating profit margin

   5 %   28 %   29 %   31 %

Net profit margin

   4 %   25 %   29 %   31 %

Depreciation

   610     709     832     828  

Amortization

   1,260     1,260     1,260     1,260  

(1)   Pro forma wireless value-added services includes both wireless data services and wireless IVR services, which are provided through Wu Ji Network.
(2)   Our pro forma advertising revenue primarily consists of online advertising revenue, but also includes revenue from offline advertising services that are bundled together with online advertising services.
(3)   Our commercial enterprise solutions revenue is primarily derived from the purchase and installation of computer hardware on behalf of our clients.
(4)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access card expires at the end of 2004.

 

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RISK FACTORS

 

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 or ordinary shares. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. The trading price of our ADSs or ordinary shares could decline due to any of these risks, and you may lose all or part of your investment.

 

Risks Relating to Our Business

 

A substantial portion of our business depends on mobile telecommunications operators in China, and any loss or deterioration of such relationship may result in severe disruptions to our business operations and the loss of a significant portion of our revenues.

 

We derive a significant portion of our revenues from the provision of wireless value-added services. For the years ended December 31, 2001, 2002 and 2003, wireless value-added services revenue represented approximately 0.5%, 33.2% and 72.5%, respectively, of our total revenues. As our current business plan is to further expand our wireless value-added services and our subscriber base, we will continue to rely on wireless value-added services to generate a significant portion of our revenues.

 

Our wireless value-added services revenue is derived principally from providing mobile phone users with short messaging services, or SMS, such as news subscriptions, mobile e-mail, dating and download products. We also provide multimedia messaging services, or MMS, and wireless application protocol, or WAP, services and wireless interactive voice response, or wireless IVR, services. Through Beijing Lei Ting Wan Jun Network Technology Limited, or Beijing Lei Ting, Shenzhen Freenet Information Technology Company Limited, or Shenzhen Freenet, and Beijing Lei Ting Wu Ji Network Technology Limited, or Wu Ji Network, we have entered into a series of cooperation agreements with a number of mobile telecommunications operators in China, which are subsidiaries of China Mobile Communications Corporation, or China Mobile, and China United Telecommunications Corporation, or China Unicom, the only two mobile telecommunications operators in China that currently provide wireless value-added services to mobile phone users. Pursuant to these agreements, the mobile telecommunications operators bill and collect fees from mobile phone users for the wireless value-added services. Pursuant to our agreements with China Mobile and its subsidiaries, we generally receive 85% of the content fees, less a transmission fee. Pursuant to our agreements with China Unicom, China Unicom charges a fee of up to 12% on the monthly revenue due to us for bad debts and business taxes, and after deduction of such fee from the monthly revenue due to us, charges a further collection fee, ranging from 10% to 40% depending on the volume of messages.

 

We rely entirely on the networks and gateways of China Mobile and China Unicom to provide our wireless value-added services. Thus, we face certain risks in conducting our wireless value-added services business, such as the following:

 

    China Mobile and China Unicom currently are the only mobile telecommunications operators in China that have platforms for wireless value-added services. Our agreements with them are generally for terms of less than a year and generally do not have automatic renewal provisions. If neither of them is willing to continue to cooperate with us, we will not be able to conduct our existing wireless value-added services business;

 

    Our agreements with the mobile telecommunications operators are subject to negotiation upon renewal. If any of the mobile telecommunications operators decides to change its content or transmission fees or its share of revenue, or does not comply with the terms of the agreements, our revenue and profitability could be materially adversely affected; and

 

    The mobile telecommunications operators may launch and may have already launched competing services or could discontinue the use of external content aggregators such as ourselves entirely at any time.

 

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Due to our reliance on the mobile telecommunications operators for our wireless value-added services, any loss or deterioration of our relationship with any of the mobile telecommunications operators may result in severe disruptions to our business operations and the loss of a significant portion of our revenue, and a material adverse effect on our financial condition and results of operations.

 

Our financial condition or results of operations may be materially affected by the changes in policies or guidelines of the mobile telecommunications operators.

 

The mobile telecommunications operators in China may, from time to time, issue certain operating policies or guidelines, requesting or stating its preference for certain actions to be taken by all wireless value-added service providers using their platforms. Due to our reliance on the mobile telecommunications operators, a significant change in their policies or guidelines may have a material effect on us. For example, some mobile telecommunications operators recently revised their billing policies to request all wireless value-added service providers to confirm the subscription status of those users who have not been active for three months. Such change in policies or guidelines may result in lower revenues or additional operating costs for us, and we cannot assure you that our financial condition and results of operation will not be materially adversely affected by any policy or guideline change by the mobile telecommunications operators in the future.

 

We may be subject to adverse actions for any breach or perceived breach by us of the policies or guidelines imposed by the mobile telecommunications operator with respect to content provided on or linked through our websites.

 

The mobile telecommunications operators in China may impose policies or guidelines to govern or restrict the content provided by all wireless value-added service providers, including content developed by us or content supplied by others to us. The mobile telecommunications operators from time to time have requested wireless value-added services providers, including us, to remove objectionable content or links to or from websites with certain categories of content, including content they may deem to be sexually explicit. We aggregate and develop content that we consider attractive to our targeted user base, and we cannot assure you that the mobile telecommunications operators will not from time to time find certain portions of our content to be objectionable. In the case of a breach or perceived breach of such policies or guidelines, the mobile telecommunications operators may require us to reduce or curtail the content on our Internet portal, which may reduce our portal traffic, and the mobile telecommunications operators may have the right to impose monetary fines upon us, or terminate our cooperation with them. In addition, we would be liable to the mobile telecommunications operators for their economic losses pursuant to our agreements with these operators if we were found to be in breach of the policies or guidelines promulgated by them. As a result of the occurrence of any of the above, our financial condition and results of operations may be materially adversely affected. See also “— Risks Relating to Our Industry — Regulation and censorship of information distribution over the Internet in China may adversely affect our business, and we may be liable for information displayed on, retrieved from, or linked to our Internet portal.”

 

Our dependence on the substance and timing of the billing systems of the mobile telecommunications operators may require us to estimate portions of our reported revenue for wireless value-added services from time to time. As a result, subsequent adjustments may have to be made to our wireless value-added services revenue in our financial statements.

 

As we do not bill our wireless value-added services users directly, we depend on the billing systems and records of the mobile telecommunications operators to record the volume of our wireless value-added services provided, charge our users through mobile telephone bills and collect payments from our users and pay us. In addition, we do not generally have the ability to independently verify or challenge the accuracy of the billing systems of the mobile telecommunications operators. Generally, within 20 to 60 days after the end of each month, a statement from each of the mobile telecommunications operators confirming the value of wireless value-added services they bill to users in that month will be delivered to us, and generally within 60 days after

 

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such delivery, we will be paid by the mobile telecommunications operators for the wireless value-added services, net of their revenue share, transmission fees and applicable business taxes, for that month based on such monthly statements.

 

We initially ascertain the value of the wireless value-added services provided based on delivery confirmations sent to us by the networks of the mobile telecommunications operators with respect to the amount of services we deliver to the users. Because there has historically been a discrepancy between this value and the value of the services for which we have a right to receive payments based on the monthly statements provided by the mobile telecommunications operators due to technical issues with the transmission and billing systems, at the end of each month, we will, based on the historical data regarding such discrepancies, our observation of the stability of the various network systems during the month in question and other factors, make an estimate of the collectible wireless value-added services fees for such month. This estimate may be higher or lower than the actual revenue we have a right to receive based on the monthly statements received from the mobile telecommunications operators. In 2003, the average difference between our estimates and our actual revenue, calculated on a quarterly basis, was approximately 5%. By the time we report our financial results, we generally have received well over a majority of the monthly statements from the mobile telecommunications operators and recognized our revenue for the wireless value-added services based on those monthly statements. In the event that a monthly statement for any operator has not been received at the time such financial results are reported, we will report wireless value-added services revenue with respect to the portion that we have not received monthly statements based on the estimate of the collectible wireless value-added services relating to such operator. As a result, we may overstate or understate our wireless value-added services revenue for that reporting period. Any difference between the operator’s monthly statement that is eventually received and our estimate of the collectible wireless value-added services for such operator may result in subsequent adjustments to our wireless value-added services revenue reported in our financial statements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Wireless Value-Added Services Revenue Recognition.”

 

We, including Wu Ji Network, have a limited operating history, which may make it difficult for you to evaluate our business.

 

We launched our Internet portal in China in July 2000 and began providing wireless data services in the second half of 2001, and Wu Ji Network entered into an agreement with China Mobile to provide wireless IVR services in October 2002. As our operating history is limited, the revenue and income potential of our business and markets are unproven. We have not previously operated as a separate, stand-alone company, and we rely on our parent company for support in certain aspects of our operations. See “Related Party Transactions.” In addition, we face numerous risks, uncertainties, expenses and difficulties frequently encountered by companies at an early stage of development. Some of these risks and uncertainties relate to our ability to:

 

    maintain our current, and develop new, cooperation arrangements upon which our business depends;

 

    increase the number of our website page views of our target Internet user base by expanding the type, scope and technical sophistication of the content and services we offer and successfully convert these Internet users to fee-paying wireless value-added services users;

 

    respond effectively to competitive pressures;

 

    increase awareness of our brand and continue to build user loyalty;

 

    attract and retain qualified management and employees; and

 

    successfully integrate Wu Ji Network into our business operations and realize the synergies of our acquisition.

 

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We cannot predict whether we will meet internal or external expectations of our future performance. If we are not successful in addressing these risks and uncertainties, our business, financial condition and results of operations may be materially adversely affected.

 

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

 

The historical and pro forma financial information that we have included in this prospectus may not reflect what our results of operations, financial condition and cash flow would have been if we had been a separate, stand-alone entity during the periods presented, or what our results of operations, financial condition or cash flow will be in the future. This is because:

 

    we have made certain adjustments, such as allocations of head office expenses and imputed interest, in preparing our historical and pro forma financial information since we were not operated as a single, stand-alone entity for the periods presented; and

 

    we have experienced tremendous growth in our business in recent periods in part due to the growth in China’s wireless value-added services industry, which may not be representative of future growth or sustainable. In particular, we experienced rapid growth in our business in the first half of 2003, partially due to the increased use of the Internet during the outbreak of severe acute respiratory syndrome, or SARS, in China in early 2003, and we have since experienced slower growth during the second half of 2003.

 

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

 

We have only recently attained profitability, and we have incurred net losses since inception and may incur losses in the future.

 

We have only recently attained profitability. We recorded a net income in 2003. However, as of December 31, 2003, we had an accumulated deficit of approximately US$64.7 million, US$59.8 million of which were impairment charges we took relating to some of our past acquisitions. In addition, we may incur losses in the future. We cannot assure you that our profitability will be sustained.

 

We may be subject to, and may expend significant resources in defending against, claims based on the content and services we provide through our Internet portal.

 

Due to the manner in which we obtain, collect, produce and aggregate content for our Internet portal and wireless IVR services, and because our services may be used for the distribution of information, claims may be filed against us for defamation, negligence, copyright or trademark infringement or other violations due to the nature and content of such information. In particular, we may be exposed to liability in connection with the content that we provide through our Internet portal and wireless IVR services or that is otherwise accessible through our Internet portal and wireless IVR services. In addition, we may be subject to claims relating to the online activities of our users. Furthermore, we offer web-based e-mail services, which may expose us to liability relating to unsolicited e-mail messages, lost or misdirected e-mail messages, illegal or fraudulent use of e-mail services or interruptions or delays in e-mail services. We may incur significant costs investigating and defending these types of claims even if they do not result in liability. We have not, however, purchased liability insurance for these types of claims.

 

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Our operating results may fluctuate significantly and may differ from market expectations.

 

Our annual and quarterly operating results have varied significantly in the past, and may vary significantly in the future, due to a number of factors, many of which are beyond our control. Our revenues are generally subject to consumer demand. For example, our revenue may increase when there is a surge in usage of wireless value-added services due to major promotional events sponsored by us or the mobile telecommunications operators. In addition, our revenue may also fluctuate due to changes in policies or guidelines implemented by the mobile telecommunications operators. See also “— Our financial conditions or results of operations may be materially affected by the changes in policies or guidelines of the mobile telecommunications operators.” As a result, we believe that year-to-year and quarter-to-quarter comparisons of our past operating results are not indicative of our probable future performance. In addition, our future operating results may not meet the expectations of financial analysts, investors and other market participants, and the trading price of our ADSs or ordinary shares may fall. For a discussion of our results of operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.”

 

PRC laws and regulations restrict foreign investment in China’s telecommunications services industry, and substantial uncertainties exist with respect to our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network due to uncertainties regarding the interpretation and application of current or future PRC laws and regulations.

 

In December 2001, in order to comply with China’s commitments with respect to its entry into the World Trade Organization, or WTO, the State Council promulgated the Administrative Rules for Foreign Investments in Telecommunications Enterprises, or the Telecom FIE Rules. The Telecom FIE Rules set forth detailed requirements with respect to capitalization, investor qualifications and application procedures in connection with the establishment of a foreign invested telecommunications enterprise. Pursuant to the Telecom FIE Rules, the ultimate ownership interest of a foreign investor in a foreign-funded telecommunications enterprise that provides value-added telecommunications services shall not exceed 50%. See “Regulation.”

 

We and our subsidiaries are considered as foreign persons or foreign funded enterprises under PRC laws. PRC laws and regulations restrict foreign ownership of companies that provide value-added telecommunications services and Internet content services in China. As a result, we operate our wireless value-added services and online advertising businesses in China through Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, which are owned by certain PRC citizens. We do not have any equity interest in these operating companies and instead enjoy the economic benefit in such companies through contractual arrangements. Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network conduct substantially all of our operations and generate substantially all of our revenue and hold the licenses and approvals that are essential to our business. For a description of our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, see “Our Corporate Structure” and “Related Party Transactions.”

 

In the opinion of Commerce & Finance Law Offices, our PRC legal counsel, our current ownership structure and the ownership structures of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, the contractual arrangements among our wholly-owned subsidiaries and Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their shareholders, and their business operations as described in this prospectus are in compliance with all existing PRC laws, rules and regulations. There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations, including but not limited to the laws and regulations governing the enforcement and performance of our contractual arrangements in the event of imposition of statutory liens, death, bankruptcy and criminal proceedings. Accordingly, we cannot assure you that PRC regulatory authorities will not take a view contrary to the opinion of our PRC legal counsel.

 

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If we, Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network were found to be in violation of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violation, including, without limitation, the following:

 

    levying fines;

 

    confiscating our, Beijing Lei Ting’s, Shenzhen Freenet’s or Wu Ji Network’s income;

 

    revoking our, Beijing Lei Ting’s, Shenzhen Freenet’s or Wu Ji Network’s business license;

 

    shutting down our, Beijing Lei Ting’s, Shenzhen Freenet’s or Wu Ji Network’s servers or blocking our websites;

 

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

 

    requiring us, Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network to restructure our ownership structure or operations; and/or

 

    requiring us, Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network to discontinue our wireless value-added services and online advertising businesses.

 

Any of these or similar actions could cause significant disruption to our business operations or render us unable to conduct a substantial portion of our business operations and may materially adversely affect our business, financial condition and results of operations.

 

Our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network may not be as effective in providing operational control as direct ownership of these businesses.

 

PRC laws and regulations currently restrict foreign ownership of companies that provide value-added telecommunications services, which includes wireless value-added services and Internet content services. As a result, we conduct substantially all of our operations and generate substantially all of our revenue through Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, each of which is wholly-owned by PRC citizens, pursuant to a series of contractual arrangements with these entities and their respective shareholders. For a description of these contractual arrangements, see “Our Corporate Structure” and “Related Party Transactions.” These arrangements, however, may not be as effective in providing control over our Internet content operations as direct ownership of these businesses as these arrangements will not preserve our control in the occurrence of certain events which may be outside the control of the shareholders and us, including the imposition of statutory liens, judgments, court orders, death or capacity. In particular, Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network could fail to perform or make payments as required under those contractual agreements, and we will have to rely on the PRC legal system to enforce those agreements.

 

The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. Although legislation in China over the past 20 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us. In addition, the PRC government may propose new laws or amend current laws that may be detrimental to our current contractual arrangements with Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network, which may in turn have a material adverse effect on our business operations. Furthermore, as these entities, their shareholders and the assets of these entities and their shareholders are located in China, it may not be possible to effect services of

 

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processes within the United States or elsewhere outside of China upon these entities or assets or enforce judgments of courts in jurisdictions outside of China against these entities or assets. See also “—Risks Relating to the People’s Republic of China — You may experience difficulties in effecting service of legal process and enforcing judgments against us and our management.”

 

We face intense competition, which could reduce our market share, and materially adversely affect our financial condition and results of operations.

 

The PRC wireless value-added services market has seen an increasing number of entrants due to its low barrier of entry. The markets for wireless value-added and Internet services and products, particularly Internet content services, Internet search and retrieval services and online advertising, are intensely competitive. In addition, the wireless value-added services and Internet industries are relatively new and constantly evolving, and as a result, some of our competitors may be able to better position themselves to compete in these markets as they mature.

 

We face intense competition from a number of companies that provide wireless value-added services and online advertising in China. Our primary competitors in the wireless data services and online advertising services are Sina Corporation, or Sina.com, Sohu.com Inc., or Sohu.com, Netease.com Inc., or Netease.com and Tencent Technology Limited, and our competitors in the wireless IVR services are Heng Xin Zhang Hong You, Rock Mobile, Unihub, Hao Tian, Sina.com, Tencent Technology Limited’s QQ and Honglian 95. See “Our Business — Competition” and “Our Acquisition — Competition.” In addition, we may face competition from new entrants in the wireless value-added services and Internet industries. Some of our major competitors have certain advantages over us, including better brand recognition among users, a longer operating track record and ready access to capital markets as listed companies. With these advantages, our competitors may be better able to develop, market and sell their products and services, attract a larger number of new users as well as online advertisers and cooperation arrangements, and attract potential merger and acquisition targets. We cannot assure you that we will be able to compete successfully against our current or future competitors.

 

There are risks associated with our acquisition of Puccini, each of which may result in a material adverse effect on our operating or financial performance.

 

We acquired, on November 19, 2003, the entire issued share capital of Puccini International Ltd., or Puccini, which provides wireless IVR services through Wu Ji Network. Wireless IVR services are relatively new, therefore there are no established markets or proven track record in China. The purchase price for the acquisition includes an earn-out consideration that is equal to either 7.7 times Puccini’s 2004 audited consolidated net profit, or if Puccini’s audited consolidated net profit is less than an agreed amount, the earn-out consideration will be reduced to an amount 6 times Puccini’s 2004 audited consolidated net profit. The total purchase price for the acquisition is subject to a maximum consideration of US$150,000,000, half of which is payable in cash and half in our ordinary shares. See “Our Acquisition” and “Related Party Transactions” for a description of Wu Ji Network’s business and the terms of the acquisition.

 

Wu Ji Network’s business may not be as successful as it has been in the past, and Wu Ji Network’s business may not perform as well as we expect. Moreover, we may not be able to integrate Wu Ji Network’s business with ours, or capitalize on the synergies we expected from this acquisition. If any of these happens, our revenue and profitability may not grow as we expect.

 

In connection with our acquisition of Puccini, we are obligated to make a cash payment to Cranwood in the first half of 2005 of up to US$75,000,000, the exact amount being dependent on Puccini’s 2004 consolidated net profit, representing half of the purchase price of the acquisition. We have a right to borrow up to US$37,500,000, or 50% of the value of such cash payment, back from Cranwood for a loan term of 12 months, but our cash resources may nonetheless be significantly depleted due to such payment or may be insufficient to make such

 

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payment, in which case we may be required to seek additional financing, the terms of which are uncertain. In addition, we are required to pay the remaining half of the purchase price in 2005, less the initial consideration payment of US$18,500,000 that we have paid in the form of our ordinary shares prior to our offering, through the issuance of an equivalent value of our ordinary shares to Cranwood. This issuance of our ordinary shares to Cranwood will result in a reduction of the percentage ownership of our existing shareholders at that time. As a consequence of the above, our shareholders may suffer a dilution in the earnings per ADS and per ordinary share.

 

In addition, we may further increase our goodwill substantially as a result of the future payment of the earn-out consideration for the acquisition of Puccini. As a result, if we are required to take any goodwill impairment charges in future periods, such charges may have a material adverse effect on our net income.

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Contractual Obligations and Commercial Commitments” for a description of the impact on our liquidity and capital resources as a result of the acquisition of Puccini.

 

We are controlled by TOM Group Limited, who may not always act in your best interest and whose business may be in competition with ours.

 

Immediately prior to the global offering, TOM Group Limited (formerly TOM.COM LIMITED) owned a 100% equity interest in us, and immediately after the global offering, TOM Group Limited will own an aggregate of 71.9% equity interest in us. Accordingly, TOM Group Limited is, and will be, able to:

 

    indirectly influence the selection of our senior management;

 

    determine the timing and amount of our dividend payments; and

 

    otherwise control or influence actions that require the approval of our shareholders.

 

The interests of TOM Group Limited as our controlling shareholder could conflict with our interests or with the interests of our minority shareholders. As a result, TOM Group Limited may take actions that may not be in the best interests of us or our other shareholders.

 

In addition, TOM Group Limited’s business may be in competition with ours. We have entered into a deed of non-competition with TOM Group Limited to protect our interests. See “Relationship with our Parent Company — Non-Competition Undertakings” for a description of the deed of non-competition. The terms of the deed of non-competition, however, do not prohibit TOM Group Limited from engaging in limited online activities that may compete with our business. The deed of non-competition will also not preclude TOM Group Limited from engaging in limited online services or activities that are ancillary to its outdoor media, print media, sports and entertainment business, subject to certain revenue caps, or prevent TOM Group Limited from undertaking any ISP business, television or broadcasting business, audio-visual business or investments in listed companies that engage in online activities (provided its interest does not exceed 5%) or any investment funds (provided that any such investment fund does not take a majority interest in any online business and that such online business shall not be operated by TOM Group Limited). In addition, the deed of non-competition will terminate on the later of when TOM Group Limited ceases to hold 30% or more of our issued capital and the second anniversary of the date of the listing of our ordinary shares on GEM. We cannot assure you that such conflict of interests and any overlap of business activities and operations between TOM Group Limited and us will not have a material adverse effect on our business operations, financial condition or results of operations.

 

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As we depend on our parent company for the use of the tom.com trademarks, we would face severe disruptions to our business operations, and our results of operations and financial condition would be materially adversely affected if we fail to reach a trademark license agreement with respect to the use of the tom.com trademarks on acceptable terms after we cease to be less than 30% held by our parent company.

 

We depend on our parent company, TOM Group Limited, for the use of the tom.com trademarks pursuant to non-exclusive trademark license agreements. For a description of the trademark license agreements, see “Related Party Transactions.” Pursuant to these agreements, we may only use the trademarks free of charge for as long as our parent company holds 30% or more of our issued share capital. In the event that our parent company ceases to hold 30% or more of our issued share capital, we will have to renegotiate with our parent company with respect to the license fee and terms of use for the tom.com trademarks. We cannot assure you that the license fee and terms of use, if revised, will be commercially advantageous to us. In the event that we and our parent company cannot agree on the trademark license fee or the terms of use, the free of charge trademark licensing arrangement will continue for one year from the date our parent company ceases to hold more than 30% of our issued share capital, during which period we may have to develop our own brand name and trademark. In such case, we will lose the benefit of the brand recognition of the tom.com trademarks we have developed and there can be no assurance that we can develop a new brand successfully within such a period of time. As a result, we will face severe disruptions to our business operations, and our results of operations and financial condition will be materially adversely affected.

 

In addition, maintaining and further developing the quality associated with and awareness of the tom.com trademarks is critical to our ability to expand our user base and increase our revenue. Our success in promoting and enhancing the brand recognition of the tom.com trademarks, as well as our ability to remain competitive, will depend on our success in offering high quality content, features and functionality. If we fail to promote our brand successfully, or if users, advertisers or potential partners do not perceive our content and services to be of a high quality, we may not be able to continue to attract users, advertisers and business partners, which may have a material adverse effect on our business operations. In addition, we share the tom.com trademarks with our parent company, which may choose to develop the brand in a manner that is not consistent with our own, and such inconsistent development of the same brand may have a material adverse effect on our business operations.

 

We may need additional capital and may not be able to obtain additional capital on acceptable terms.

 

Capital requirements are difficult to plan in our rapidly changing industry. We currently expect that we will need capital to fund the expansion of our Internet portal and computer infrastructure, including acquisitions of complementary assets, technologies or businesses, the expansion of our content and products as well as the expansion of our sales and marketing activities. We believe that our current cash and cash equivalents, cash generated from operations and the proceeds from the global offering will be sufficient to meet our anticipated needs, including working capital, capital expenditures and various contractual obligations, for at least the next twelve months. However, future market or other developments may require us to obtain additional funds.

 

Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:

 

    investors’ perceptions of, and demand for, securities of Internet companies;

 

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

 

    our future results of operations, financial condition and cash flows;

 

    PRC governmental regulation of foreign investment in Internet companies;

 

    economic, political and other conditions in China; and

 

    PRC governmental policies relating to foreign currency borrowings.

 

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Any failure by us to raise additional funds on terms favorable to us, or at all, may have a material adverse effect on our business, financial condition and results of operations. For example, we may not be able to carry out parts of our growth strategy to acquire assets, technologies and businesses that are complementary to our existing business or necessary to maintain our growth and competiveness. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Contractual Obligations and Commercial Commitments.”

 

As a stand-alone entity, we will no longer receive from our parent company the same kind or degree of financial support as we did prior to becoming a stand-alone entity, and as of December 31, 2003, the amount due from us to our parent company was approximately US$20 million.

 

To date, we have primarily financed our operations through capital contributions and advances from our parent company, which amounted to approximately US$6 million, US$12 million, US$26 million for the years ended December 31, 2000, 2001 and 2002, respectively. As of December 31, 2003, the amount due from us to our parent company was approximately US$20 million. Our parent company does not intend to provide us with any additional capital contributions or advances after the completion of this offering and we may need to seek other sources of financing to meet our funding needs.

 

We are not subject to any financial covenants under the terms of the borrowings from our parent company, and we are not required to pay these loans until after December 31, 2004, after which they are payable on demand. Our parent company has, however, agreed not to demand any repayment of these loans prior to December 31, 2006 unless (i) our ordinary shares have been listed on GEM for one year, (ii) in the most recent fiscal year we had positive cash flow from operations and net profit and (iii) each of our independent non-executive directors agree that such repayment will not adversely affect our operations or the implementation of our business objectives. As a result, these loan arrangements were generally more favourable to us than what we would have received in the market as a stand-alone entity. Our future sources of financing may not be as favourable as the financial support we received from our parent company prior to our becoming a stand-alone entity.

 

We depend on certain key executives and employees and our business may be disrupted if we lose the services of our key executives and employees.

 

Our future success is dependent upon the continued service of our key executives and employees. We rely on their expertise in our business operations and on their personal relationships with the regulatory authorities, our partners, and Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network. In particular, we rely heavily on Mr. Wang Lei Lei, our chief executive officer and executive director, for his management skills, technological expertise, experience in the Internet industry and his working relationship with the relevant PRC regulatory authorities, our clients, suppliers and mobile telecommunications operators in China. If one or more of our key executives, in particular, Mr. Wang Lei Lei, were unable or unwilling to continue in their present positions, or if they joined a competitor or formed a competing company in contravention of their employment agreements, we may not be able to replace them easily, our business may be significantly disrupted and our financial condition and results of operations may be materially adversely affected.

 

The dividends and other distributions on equity we may receive from our subsidiaries or other payments we may receive from Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network are subject to restrictions under PRC law or agreements that these entities may enter into with third parties.

 

We are a holding company. Our wholly-owned subsidiaries are Lahiji Vale Limited, or Lahiji, Laurstinus Limited, or Laurstinus, Advanced Internet Services Limited, or Advanced Internet Services, Bright Horizon Enterprises Limited, or Bright Horizon, TOM.COM (China) Investment Limited, or TOM.COM (China), Puccini, Beijing Super Channel Network Limited, or Beijing Super Channel, Shanghai Super Channel Network Limited, or Shanghai Super Channel, and Puccini Network Technology (Beijing) Limited, or Puccini Network,

 

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and our majority-owned subsidiary is Beijing GreaTom United Technology Company Limited, or GreaTom. These subsidiaries have entered into contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, through which we conduct our wireless value-added and other business activities and receive substantially all of our revenues in the form of service fees. We rely on dividends and other distributions on equity paid by our subsidiaries and service fees from Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network for our cash requirements in excess of any cash raised from investors and retained by us. If any of our subsidiaries incurs debt in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us. In addition, PRC law requires that payment of dividends by our subsidiaries that are incorporated in China can only be made out of their net income, if any, determined in accordance with PRC accounting standards and regulations. Under PRC law, those subsidiaries are also required to set aside a portion, of up to 10% of their after-tax net income each year to fund certain reserve funds, and these reserves are not distributable as dividends. See note 13 to our historical consolidated financial statements included in this prospectus. Any limitation on the payment of dividends by our subsidiaries could materially adversely affect our ability to grow, fund investments, make acquisitions, pay dividends, and otherwise fund and conduct our business.

 

Intellectual property is important to our business, and any unauthorized use of our intellectual property by third parties may adversely affect our business.

 

We regard the copyrights, service marks, trademarks, trade secrets and other intellectual property we use as important to our business, and any unauthorized use of such intellectual property by third parties may adversely affect our business and reputation. We rely on the protection of the intellectual property laws and contractual arrangements with our employees, clients, business partners and others to protect such intellectual property rights. Despite precautions taken by us, our parent company and its subsidiaries, third parties may still be able to obtain and use such intellectual property without authorization. Furthermore, the validity, enforceability and scope of protection of intellectual property in Internet-related industries in China is uncertain and still evolving, and these laws may not protect intellectual property rights to the same extent as the laws of some other jurisdictions, such as the United States and Hong Kong. Moreover, litigation may be necessary in the future to enforce such intellectual property rights, which could result in substantial costs and diversion of our resources, and have a material adverse effect on our business, financial condition and results of operations.

 

We may be subject to intellectual property infringement claims, which may force us to incur substantial legal expenses and, if determined adversely against us, materially disrupt our business.

 

We source some of our content from the public domain, including from third party websites for which copyrights may not be clearly identified, and we cannot be certain that our products and services do not or will not infringe upon valid patents, copyrights or other intellectual property rights held by third parties. We have, in the past, been subject to certain legal proceedings and claims relating to intellectual property, and we may in the future be subject to similar or other legal proceedings and claims relating to intellectual property in our ordinary course of business. We do not believe that our business operations have been materially adversely affected by the legal proceedings or claims in which we were previously involved. However, if we are found to have infringed the intellectual property rights of others in the future, we may be enjoined from using such intellectual property, and we may incur licensing fees or be forced to develop alternative intellectual property. We may also incur substantial expenses in defending against third party infringement claims, regardless of their merit. Successful infringement claims against us may result in substantial monetary liability or severe disruptions to our business operations.

 

Any future outbreak of SARS or any other epidemic in China may have a material adverse effect on our business operations, financial condition and results of operations.

 

From December 2002 to June 2003, China and certain other countries experienced an outbreak of a new and highly contagious form of atypical pneumonia now known as SARS. On July 5, 2003, the World Health

 

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Organization declared that SARS had been contained. However, in recent months, a few new cases of SARS have been reported in Asia. While the outbreak of SARS or any other epidemic may have increased the usage of the Internet, as well as the usage of our products and services, an outbreak in the future may disrupt our business operations and have a material adverse effect on our financial condition and results of operations. For instance, a new outbreak of SARS or any other epidemic may reduce the level of economic activity in affected areas, which may lead to a reduction in our advertising revenue if our clients cancel existing contracts or defer future advertising expenditures. In addition, health or other government regulations may require temporary closure of our offices, or the offices of our advertisers, content providers or partners, which will severely disrupt our business operations and have a material adverse effect on our financial condition and results of operations. Though we took some emergency measures during the SARS outbreak in 2003, we have not adopted any written preventive measures or contingency plans to combat any future outbreak of SARS or any other epidemic.

 

Risks Relating to Our Industry

 

The Internet industry is highly regulated by the PRC government. If we fail to obtain or maintain all pertinent permits and approvals, our business operations may be materially adversely affected.

 

The Internet industry is highly regulated by the PRC government. Regulations issued or implemented by the State Council, the Ministry of Information Industry, or the MII, and other relevant regulatory authorities regulate many aspects of the Internet industry, including the provision of value-added telecommunications services, foreign investment in the telecommunications industry, and the scope of permissible online business activities. In September 2000, PRC’s State Council promulgated the Telecommunications Regulations, which categorized all telecommunications businesses as either infrastructure telecommunications businesses or value-added telecommunications businesses, with various Internet-related services and activities classified as value-added telecommunications businesses. According to the Telecommunications Regulations, a commercial operator of any of the telecommunications services must obtain the requisite operating licenses.

 

Since the publication of the Telecommunications Regulations, various administrative measures have been introduced or amended to govern various aspects of the Internet services, such as Internet information services, online news services, Internet publishing, Internet medical, health and drug information services, online advertising services, Internet access services and international connections for computer information networks. We are required to obtain applicable permits or approvals from different PRC regulatory authorities in order to provide those services. For example, an Internet content provider, or ICP, must obtain a Value-Added Telecommunications Business Operations Permit, or ICP license, in order to engage in any commercial ICP operations within China. In addition, an ICP which provides content involving news, publishing, education, health care, medicine and medical devices is required to obtain additional approvals for each area from the relevant authorities. See “Regulation.”

 

If we fail to obtain or maintain any of the required permits or approvals, we may be subject to various penalties, such as fines or suspension or a shut down of operations, which could severely disrupt our business operations. As a result, our financial condition and results of operations may be materially adversely affected.

 

Regulation and censorship of information distribution over the Internet in China may adversely affect our business, and we may be liable for information displayed on, retrieved from, or linked to our Internet portal.

 

In recent years, the PRC government has adopted certain regulations governing Internet access and the distribution of news and other information over the Internet. Under those regulations, ICPs and Internet publishers are prohibited from posting or displaying over the Internet content that opposes the fundamental principles in PRC’s Constitution; compromises state security, divulges state secrets, subverts state power or damages national unity; harms the dignity or interests of the state; incites ethnic hatred or racial discrimination or damages inter-ethnic unity; sabotages PRC’s religious policy or propagates heretical teachings or feudal superstitions; disseminates rumors, disturbs social order or disrupts social stability; propagates obscenity,

 

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pornography, gambling, violence, murder or fear or incites the commission of crimes; insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or includes other content prohibited by laws or administrative regulations. Failure to comply with those requirements may result in the revocation of ICP licenses and the closing down of the concerned websites. In the past, failure to comply with those requirements have resulted in the closing down of certain concerned websites. The website operator may also be held liable for such censored information displayed on, retrieved from or linked to such website.

 

In addition, the MII has published regulations that subject website operators to potential liability for content included on their websites and the actions of users and others using their systems, including liability for violations of PRC laws prohibiting the distribution of content deemed to be socially destabilizing. PRC’s Ministry of Public Security has the authority to order any local Internet service provider, or ISP, to block any Internet website maintained outside China at its sole discretion. Periodically, the Ministry of Public Security has stopped the distribution over the Internet of information which it believes to be socially destabilizing. PRC’s State Secrecy Bureau, which is directly responsible for the protection of State secrets of the PRC government, is authorized to block any website it deems to be leaking State secrets or failing to meet the relevant regulations relating to the protection of State secrets in the distribution of online information.

 

As these regulations are relatively new and subject to interpretation by the relevant authorities, it may not be possible for us to determine in all cases the type of content that could result in liability for us as a website operator. In addition, we may not be able to control or restrict the content of other ICPs that are linked to or accessible through our websites, or content generated or placed on our websites by our users, despite our attempt to monitor such content. To the extent that regulatory authorities find any portion of our content to be objectionable, they may require us to limit or eliminate the distribution of such information or otherwise curtail the nature of such content on our websites, which may reduce our user traffic and have a material adverse effect on our financial condition and results of operations. In addition, we may be subject to significant penalties for violations of those regulations arising from information displayed on, retrieved from or linked to, our websites, including a suspension or shutdown of our operations.

 

The laws and regulations governing the Internet industry in China are developing and subject to future changes, and substantial uncertainties exist as to the interpretation and implementation of those laws and regulations.

 

In recent years, the PRC government has begun to enact laws and regulations applicable to Internet-related services and activities, many of which are relatively new and untested and subject to future changes. In addition, various regulatory authorities of the central PRC government, such as the State Council, the MII, the State Administration of Industry and Commerce, or SAIC, the State News and Publication Administration, or SNPA, and the Ministry of Public Security, are empowered to issue and implement regulations to regulate certain aspects of Internet-related services and activities. See “Regulation.” Furthermore, some local governments have also promulgated local rules applicable to Internet companies operating within their respective jurisdictions. As the Internet industry itself is at an early stage of development in China, there will likely be new laws and regulations adopted in the future to address issues that arise from time to time. As a result of the foregoing, substantial uncertainties exist regarding the interpretation and implementation of current and future PRC Internet laws and regulations. While we have been advised by our PRC legal counsel, Commerce & Finance Law Offices, that we are in compliance with all applicable PRC laws and regulations currently in effect, we cannot assure you that we will not be found in violation of any current or future PRC laws and regulations due to these substantial uncertainties.

 

The Internet infrastructure in China, which is not as well developed as in the United States, Hong Kong or certain other countries, may limit our growth.

 

The Internet infrastructure in China is not as well developed as in the United States, Hong Kong or certain other countries. In particular, we depend significantly on the PRC government and fixed line telecommunications

 

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operators in China to establish and maintain a reliable Internet infrastructure to reach a growing base of Internet users in China. We cannot assure you that the Internet infrastructure in China will support the demands associated with the continued growth of the Internet industry, and in particular the development and growth of services that may require higher bandwidth, such as MMS, WAP and Java, in China. If the necessary infrastructure standards or protocols, or complementary products, services or facilities are not developed in China on a timely basis or at all by these enterprises, our business, financial condition and results of operations could be materially adversely affected.

 

The relatively high cost of Internet access in China may limit the growth of the Internet industry in China and impede our growth.

 

While the cost of Internet access in China has decreased dramatically in recent years due to the decrease in the cost of personal computers and laptops and the introduction and expansion of broadband access in China, it remains relatively high in comparison to the average income in China, which may make it less attractive for users to access, and transact business, over the Internet. Any fee or tariff increase could further decrease our user traffic and our ability to derive revenues from transactions over the Internet, which could have a material adverse effect on our business, financial condition and results of operations.

 

We depend largely on the infrastructure of the telecommunications operators in China, and any interruption of their network infrastructure may result in severe disruptions to our business.

 

Although private Internet service providers exist in China, substantially all access to the Internet in China is maintained through the telecommunications operators, under the administrative control and regulatory supervision of the MII. In addition, local networks connect to the Internet through a government-owned international gateway. This international gateway is the only channel through which a domestic Chinese user can connect to the international Internet network. We rely on this infrastructure and to a lesser extent, certain other Internet data centers in China to provide data communications capacity primarily through local telecommunications lines. In the event of a large-scale infrastructure disruption or failure, we may not have access to alternative networks and services, on a timely basis or at all.

 

We may not be able to lease additional bandwidth from the telecommunications operators in China on acceptable terms, on a timely basis or at all. In addition, we may not have means of getting access to alternative networks and services on a timely basis or at all in the event of any disruption or failure of the network.

 

Our operations could be disrupted by unexpected network interruptions caused by system failures, natural disasters and unauthorized tampering with our system.

 

The uninterrupted availability of our websites and the performance and reliability of our network infrastructure are important to our reputation and our ability to attract and retain users, advertisers and merchants. Any system failure or performance inadequacy that causes an interruption in the availability of our websites or increases the response time of our services could reduce our attractiveness to users, advertisers and merchants. Factors that could disrupt our operations include:

 

    failure of our system;

 

    failure of the systems of our Internet data center backbone;

 

    system failures and outages caused by natural disasters such as fire, flood, typhoon or earthquakes; and

 

    computer viruses and other unauthorized tampering with our system.

 

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We have limited backup systems and have previously experienced system failures, which have disrupted our operations. In addition, we have not purchased business interruption insurance. Interruptions in the availability of our services may adversely affect our business, financial condition and results of operations.

 

Concerns about the security and confidentiality of information on the Internet may increase our costs, reduce the use of our websites and impede our growth.

 

A significant barrier to confidential communications over the Internet has been the need for security. To date, there have been several well-publicized compromises of security as a result of global virus outbreaks. We may incur significant costs to protect against the threat of security breaches or to alleviate problems caused by these breaches. If unauthorized persons are able to penetrate our network security, they could misappropriate proprietary information or cause interruptions in our services. As a result, we may be required to expend substantial costs and divert our other resources to protect against or to alleviate these problems. Security breaches could have a material adverse effect on our business, financial condition and results of operations.

 

If we are not able to respond successfully to technological or industry developments, our business may be materially adversely affected.

 

The telecommunications market is characterized by rapid advancements in technology, evolving industry standards and changes in customer needs. New services or technologies may render our existing services or technologies less competitive or obsolete. Responding and adapting to technological developments and standard changes in our industry, the integration of new technologies or industry standards or the upgrading of our networks may require substantial time, effort and capital investment. In the event that we are unable to respond successfully to technological industry developments, this may materially adversely affect our business, results of operations and competitiveness.

 

Risks Relating to the People’s Republic of China

 

Substantially all of our assets are located in China and substantially all of our revenue is derived from our operations in China. Accordingly, our results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in China.

 

The PRC’s economic, political and social conditions, as well as government policies, could affect our business.

 

The PRC economy differs from the economies of most developed countries in many respects, including:

 

    amount of government involvement;

 

    level of development;

 

    growth rate;

 

    control of foreign exchange; and

 

    allocation of resources.

 

While the PRC economy has experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.

 

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The PRC economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years, the PRC government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the PRC government. In addition, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. It also exercises significant control over PRC economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.

 

An economic slowdown in China may adversely affect our financial condition and results of operations, as well as our future prospects.

 

We conduct most of our business and generate most of our revenues in China. As a result, economic conditions in China have a significant effect on our business operations, financial condition and results of operations, as well as our future prospects. Since 1978, China has been one of the world’s fastest growing economies in terms of gross domestic product, or GDP, growth. We cannot assure you, however, that such growth will be sustained in the future. Moreover, the recent slowdown in the economies of the United States, the European Union and certain Asian countries may adversely affect economic growth in China. In addition, if an outbreak of SARS recurs, it may cause a decrease in the level of economic activity and may adversely affect economic growth in China, Asia and elsewhere in the world. We cannot assure you that our financial condition and results of operations, as well as our future prospects, will not be adversely affected by an economic downturn in China.

 

Government control of currency conversion may adversely affect our financial condition and results of operations.

 

We receive substantially all of our revenues in Renminbi, which currently is not a freely convertible currency. A portion of these revenues must be converted into other currencies to meet our foreign currency obligations. These foreign currency-denominated obligations include:

 

    payment of interest and principal on foreign currency-denominated debt;

 

    payment for equipment and materials purchased offshore; and

 

    payment of dividends declared, if any, in respect of our ordinary shares.

 

Under China’s existing foreign exchange regulations, we are able to pay dividends in foreign currencies, without prior approval from the State Administration of Foreign Exchange, by complying with certain procedural requirements. 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.

 

Certain foreign exchange transactions under the capital accounts of certain of our subsidiaries and Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, including foreign currency-denominated borrowings from PRC or foreign banks and principal payments in respect of foreign currency-denominated obligations, continue to be subject to significant foreign exchange controls and require the approval of the State Administration of Foreign Exchange. These limitations could affect our ability to obtain foreign exchange through debt or equity financing, or to obtain foreign exchange for capital expenditures.

 

Fluctuation of the Renminbi could materially affect the value of our ADSs or ordinary shares.

 

The value of the Renminbi fluctuates and is subject to changes in PRC political and economic conditions. Since 1994, the conversion of Renminbi into foreign currencies, including Hong Kong dollars and U.S. dollars,

 

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has been based on rates set by the People’s Bank of China, which are set daily based on the previous day’s interbank foreign exchange market rates. Since 1994, the official exchange rate for the conversion of Renminbi to Hong Kong dollars and U.S. dollars has generally been stable. Any devaluation of the Renminbi, however, may adversely affect the value of, and dividends, if any, payable on, our ordinary shares in foreign currency terms, since we will receive substantially all of our revenues, and express our profits, in Renminbi. For further information on our foreign exchange risks and certain exchange rates, see “Exchange Rate Information” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Disclosures about Market Risk — Foreign Currency Risk.”

 

You may experience difficulties in effecting service of legal process and enforcing judgments against us and our management.

 

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

 

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

 

We have been advised by Maples and Calder Asia, our Cayman Islands legal advisers, that the courts of the Cayman Islands are unlikely (i) to recognize or enforce against us judgments of courts of the United States predicated upon certain of the civil liability provisions of the securities laws of the United States or any State thereof and (ii) in original actions brought in the Cayman Islands, to impose liabilities against us predicated upon certain of the civil liability provisions of the securities laws of the United States or any State thereof, if and to the extent that such provisions are penal in nature. However, in the case of laws that are not penal in nature, although there is no statutory enforcement in the Cayman Islands of judgments obtained in the United States, the courts of the Cayman Islands will generally recognize and enforce a judgment of a foreign court of competent jurisdiction without retrial on the merits. A Cayman Islands court may stay proceedings if concurrent proceedings are being brought elsewhere.

 

Risks Relating to Our ADSs

 

Our actual performance could vary materially from the forward-looking statements contained in this prospectus.

 

Our forward-looking statements in the section entitled “Additional Information Disclosed in the Hong Kong Public Offering Regarding Statement of Business Objectives and Strategies” are included for the purpose of listing our ordinary shares on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited, or GEM. This section contains our forward-looking statements and estimates for approximately the next three calendar years. However, all these forward-looking statements are based upon a number of assumptions of future events which by their nature are subject to uncertainty and there is no assurance that our plans will materialize as intended. Furthermore, unanticipated events could adversely affect the actual results that we achieve in 2004 or our implementation schedules in 2005 and 2006. In addition, the financial projections in the sections entitled “Use of Proceeds” represent our intended use of proceeds. It is our current intention to apply the net proceeds from the global offering in the manner as described in that section; however, the actual application of the proceeds may change. As new business opportunities arise or as unforeseen events occur, we may reallocate all or part of the net proceeds to other business plans or new projects or to other uses or hold such funds in bank

 

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accounts or short-term securities. As a result, our actual results may vary materially from these forward-looking statements, and you should not unduly rely on these forward-looking statements. We do not intend to make public other forward-looking statements or revisions to existing forward-looking statements to reflect events or circumstances after the date of this prospectus or to reflect the occurrence of unanticipated events.

 

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

 

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

 

Sales of substantial amounts of ordinary shares or ADSs in the public market, or the perception that such sales may occur, could adversely affect the prevailing market price of the ordinary shares and ADSs.

 

Upon completion of this offering, we will have 3,896,200,000 ordinary shares outstanding (including those represented by ADSs) of which 1,000,000,000 ordinary shares (including those represented by ADSs), or approximately 25.7%, will be publicly held by investors participating in this global offering, and 2,800,000,000 ordinary shares, or approximately 71.9%, will be held by our parent company, TOM Group Limited. The ordinary shares and ADSs sold in this offering will be freely tradeable in the United States without restriction or further registration under the Securities Act, except for ordinary shares held by us or our affiliates, as such term is defined in Rule 144 under the Securities Act. If TOM Group Limited sells or is perceived as intending to sell a substantial amount of our ordinary shares, the market prices for our ordinary shares and ADSs could be adversely affected. For a description of the lock-up arrangements with our shareholders, please see “Shares Eligible for Future Sale.”

 

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

 

The initial public offering price per ADS is higher than the net tangible book value per ADS prior to this offering. Therefore, when you purchase ADSs in the global offering at the initial public offering price, you will incur an immediate dilution of US$11.725 per ADS. If we issue additional ADSs, you may experience further dilution. See “Dilution.”

 

Your interest in our company, or our ADSs or ordinary shares that you purchase, will be diluted as a result of our recent acquisition of Puccini and the pre-initial public offering share option plan.

 

We acquired on November 19, 2003 the entire issued share capital of Puccini, and as part of the initial consideration which is subject to adjustments, 96,200,000 ordinary shares, representing a sum of US$18,500,000, will be issued prior to this offering at the initial public offering price per ordinary share to Cranwood, and kept by an escrow agent. See “Our Acquisition.”

 

In addition, we have in place a pre-initial public offering share option plan and the total number of ordinary shares that is subject to the pre-initial public offering share option plan is 280,000,000 ordinary shares, representing approximately 6.7% of our issued share capital immediately following the completion of the global offering, assuming full exercise of all options granted under our pre-initial public offering share option plan. As of the date of this prospectus, options to subscribe for 280,000,000 ordinary shares at the initial public offering price have been granted under the pre-initial public offering share option plan, of which options to subscribe for a

 

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total of 210,000,000 ordinary shares have been granted to our directors, options to subscribe for a total of 24,929,700 ordinary shares have been granted to our senior management, and options to subscribe for a total of 45,070,300 ordinary shares have been granted to our employees. No options have been granted under the share option scheme. For a description of our pre-initial public offering share option plan and the share option scheme, see “Management — Compensation of Directors and Executive Officers.”

 

The future issuance of ordinary shares to Cranwood as payment of a portion of the earn-out consideration for the acquisition of Puccini and any exercise of options under the share option scheme would result in a reduction in the percentage ownership of the holders of ordinary shares and may result in a dilution in the earnings per ADS and per ordinary share.

 

You may not be able to exercise your right to vote the ordinary shares underlying your ADSs.

 

Under the terms of the ADSs, you have a general right to vote the ordinary shares underlying ADSs that you hold. You may instruct the depositary bank, Citibank N.A., to vote the ordinary shares underlying our ADSs, but only if we request Citibank N.A. to ask for your instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the ordinary shares underlying the ADSs. However, you may not receive voting materials in time to ensure that you are able to instruct Citibank N.A. to vote your shares or receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, Citibank N.A. and its agents may not be able to timely send out your voting instructions or carry out your voting instructions in the manner you have instructed. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested. See “Description of American Depositary Shares — Voting Rights.”

 

Shareholder rights under Cayman Islands law may differ materially from shareholder rights in the United States.

 

Our corporate affairs are governed by our Memorandum and Articles of Association, by the Companies Law (2003 Revision) and the common law of the Cayman Islands. The rights of shareholders to take action against the directors and actions by minority shareholders are to a large extent governed by the common law of the Cayman Islands. The common law in the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands and from English common law, the decisions of whose courts are of persuasive authority but are not binding on a court in the Cayman Islands. Cayman Islands law in this area may not be as established and may differ from provisions under statutes or judicial precedent in existence in jurisdictions in the United States. In addition, Cayman Islands companies may not have standing to initiate shareholder derivative action before the federal courts of the United States. As a result, our public shareholders may face different considerations in protecting their interests in actions against the management, directors or our controlling shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States, and our ability to protect our interests if we are harmed in a manner that would otherwise enable us to sue in a United States federal court may be limited. See “Description of Share Capital — Differences in Corporate Law.”

 

Risks Relating to the Global Offering

 

Stock prices of Internet-related companies have fluctuated widely in recent years, and the trading prices of our ADSs and ordinary shares are likely to be volatile, which could result in substantial losses to investors.

 

The trading prices of our ADSs and ordinary shares are likely to be volatile and could fluctuate widely in response to factors beyond our control. In particular, the market prices for shares of Internet and technology-related companies often reach levels that may bear no established relationship to the operating performance of these companies. The market prices of the securities of Internet-related companies have been especially volatile.

 

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These broad market and industry factors may significantly affect the market prices of ADSs and our ordinary shares, regardless of our actual operating performance. The market prices of our ADSs and ordinary shares following the global offering may be volatile.

 

We have been granted approval to have our ADSs quoted on the Nasdaq National Market and, in principle, to list and deal in our ordinary shares on GEM. However, being listed on the Nasdaq National Market and GEM does not guarantee that an active trading market for our ordinary shares or ADSs will develop following the global offering.

 

The price and trading volumes for our ADSs and ordinary shares may be highly volatile. Factors such as variations in our revenue, earnings and cash flow, announcements of new investments, cooperation arrangements or acquisitions, and fluctuations in market prices for our services could cause the market prices for our ADSs and ordinary shares to change substantially. Any of these factors may result in large and sudden changes in the volume and price at which our ordinary shares and ADSs will trade. We cannot give any assurance that these factors will not occur in the future.

 

GEM is designed to accommodate companies who may possess higher investment risk and the resulting price volatility among the stocks listed there could affect our stock price.

 

GEM has been established as a market designed to accommodate companies to which a high investment risk may be attached. In particular, companies may list on GEM with neither a track record of profitability nor any obligation to forecast future profitability. Given the emerging nature of companies listed on GEM, there is a risk that securities traded on GEM may be more susceptible to high market volatility than securities traded elsewhere.

 

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GENERAL

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. We are not making an offer of these securities in any state where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus.

 

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FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements, including statements regarding, among other items:

 

    our business and operating strategies, including the information set forth in “Additional Information Disclosed in the Hong Kong Public Offering Regarding Statement of Business Objectives and Strategies;”

 

    our network expansion and capital expenditure plans;

 

    our planned use of proceeds from this offering;

 

    our operations and business prospects;

 

    the industry regulatory environment as well as the industry outlook generally; and

 

    future developments in the Internet industry in China.

 

The words “forecast,” “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” “will,” “would” and similar expressions, as they relate to us, are intended to identify a number of these forward-looking statements.

 

These forward-looking statements are subject to risks, uncertainties and assumptions, some of which are beyond our control. In addition, these forward-looking statements reflect our current views with respect to future events and are not a guarantee of future performance. Actual results may differ materially from the information contained in the forward-looking statements as a result of a number of factors, including, without limitation, the risk factors set forth in “Risk Factors” and the following:

 

    any changes in the regulatory policies of the MII and other relevant government authorities relating to, among other matters, the granting and approval of licenses and the restrictions on Internet content;

 

    the effects of competition on the demand for and price of our services;

 

    the future growth of the mobile telecommunications and Internet industries in China;

 

    the development of new technologies and applications or services affecting our current and future business;

 

    changes in political, economic, legal and social conditions in China, including the PRC government’s specific policies with respect to foreign investment in the telecommunications industry, economic growth, inflation, foreign exchange and the availability of credit; and

 

    changes in population growth and GDP growth and the impact of those changes on the demand for our services.

 

We do not intend to update or otherwise revise the forward-looking statements in this prospectus, whether as a result of new information, future events or otherwise. Because of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus might not occur in the way we expect, or at all. Accordingly, you should not place undue reliance on any forward-looking information.

 

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OUR CORPORATE STRUCTURE

 

We were incorporated in 2001 under the laws of the Cayman Islands and became a wholly-owned subsidiary of our parent company, TOM Group Limited. We did not, however, have any material assets or business operations until shortly before our reorganization. TOM Group Limited, a Cayman Islands company, is listed on GEM and is principally engaged in four business segments: online media, publishing, outdoor media, and sports and entertainment. Our business operations consist of a significant part of the online media segment of our parent company, TOM Group Limited. Prior to our reorganization, TOM Group Limited online media segment consisted of twenty-five entities as follows:

 

  (i)   Core Internet business entities: nine entities providing a wide range of Internet services, wireless value-added services, online advertising and commercial enterprises solutions in the PRC.

 

  (ii)   Non-core Internet business entities: six entities that conducted certain portal and advertising businesses in the PRC. Most of their operations have been integrated with or moved to our core Internet business entities.

 

  (iii)   Excluded business entities: ten entities engaging in either non-portal businesses within the PRC, online businesses outside the PRC or passive investments of TOM Group Limited.

 

Both the core Internet business entities and non-core Internet business entities discussed above have been operating under the same management team led by Wang Lei Lei since their inception or acquisition, as the case may be.

 

Our Reorganization

 

In connection with our reorganization, TOM Group Limited transferred to us nine core Internet business entities. The six non-core Internet business entities were not transferred to us primarily due to the fact that most of their operations have been moved to the nine core Internet business entities, and they are expected to be wound down or used by our parent company for other purposes. In addition, as these six entities were managed by the management group of the nine core Internet business entities prior to our reorganization, they are included in our historical consolidated financial statements up until September 26, 2003.

 

Our reorganization was consummated pursuant to a series of agreements, all of which were duly executed on or by September 26, 2003. All other entities of TOM Group Limited that were not transferred to us remained with our parent company, including the ten excluded business entities within the online media segment, publishing, outdoor media, and sports and entertainment.

 

In addition, on November 19, 2003, we acquired Puccini from Cranwood, a 24.6% shareholder of our parent company. Puccini provides wireless IVR services through Wu Ji Network, and Puccini and its wholly-owned subsidiary, Puccini Network, have entered into a series of contractual arrangements with Wu Ji Network as discussed below. For a detailed discussion of the terms of the acquisition of and the business of Wu Ji Network, see “Our Acquisition” and “Related Party Transactions.”

 

In connection with our reorganization, we have also entered into various agreements with our parent company and a number of its subsidiaries, including a deed of non-competition. For a detailed discussion of those agreements, see “Relationship with Our Parent Company” and “Related Party Transactions.”

 

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Our Corporate Structure

 

Following our reorganization and our acquisition of Puccini, our corporate structure consists of fourteen entities, which include the nine core Internet business entities of the online media segment of TOM Group Limited.

 

The chart below sets forth our corporate and share ownership structure as of the date of this prospectus, after giving effect to our reorganization, our acquisition of Puccini and this global offering, and assuming that the over-allotment option is not exercised, but without taking into account the preferential offering. See “Our Acquisition — Terms of the Acquisition” for a description of the terms of the acquisition.

 

LOGO


(1)   If the over-allotment option is exercised in full, the equity interest held by public investors in us will be increased by approximately 3.8% to approximately 29.5% and the equity interest held by TOM Group Limited will be decreased correspondingly to approximately 68.0%.
(2)   We do not have any ownership interest in Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network. Through certain of our subsidiaries, we have entered into a series of contractual arrangements with these entities and their respective shareholders.
(3)   Mr. Wang Lei Lei, our chief executive officer and an executive director of our company, owns 20% of the equity interest in Beijing Lei Ting and 80% of the equity interest in Wu Ji Network. He is also the chairman of the board of directors and president of Beijing Lei Ting.
(4)     The remaining 10% equity interest in GreaTom is held by Great Wall Technology Company Ltd., a PRC company whose shares are listed on the main board of the Hong Kong Stock Exchange.

 

PRC regulations currently restrict foreign ownership of companies that provide value-added telecommunications services, which include wireless value-added services and Internet content services. See also “Regulation.” To comply with PRC regulations, we conduct substantially all of our operations through Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, each of which is wholly owned by PRC citizens and incorporated in the PRC. In addition, we do not have any equity interest in these three operating companies but instead enjoy the economic benefits of these companies through a series of contractual arrangements, which certain of our wholly-owned subsidiaries have entered into with these companies and their respective

 

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shareholders as described below. For a description of each of those agreements, see “Related Party Transactions — Other Related Party Agreements.”

 

As part of these contractual arrangements, our intermediary holding companies entered into loan agreements with certain shareholders of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, pursuant to which long-term loans were provided to those shareholders to be invested exclusively in the working capital of those companies. The shareholders have also agreed to repay those loans only in the form of the transfer of all of their interest in those companies to either our intermediary holding companies or their designees, including in the circumstances when (i) current restrictions on foreign ownership in those entities are lifted under PRC law, (ii) Wang Lei Lei resigns from or is removed from office by our intermediary holding companies or their affiliates, (iii) those shareholders commit a criminal offense, (iv) any third party raises against those shareholders a claim over RMB500,000, or (v) the shareholders die or become incapacitated. We currently do not plan to extend any additional loans to the shareholders of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network in the future.

 

Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their shareholders have also entered into exclusive share option agreements with the intermediary holding companies. Pursuant to these agreements, the shareholders of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network granted an exclusive option to the relevant intermediary holding company to purchase all or part of the shareholder’s equity interest in Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network in accordance with PRC laws, and covenanted not to encumber those equity interest in any way other than as permitted by our intermediary holding companies.

 

In addition, our wholly-owned subsidiaries entered into certain business operation agreements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their shareholders. Pursuant to these agreements, our wholly-owned subsidiaries agreed to guarantee the performance of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network under their operation-related contractual arrangements with third parties. In return, Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network pledged to our wholly-owned subsidiaries their accounts receivables and assets. In addition, Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their shareholders agreed to appoint individuals designated by our wholly-owned subsidiaries to the management team of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, and to refrain from taking certain actions that may materially affect those companies’ operations, including lending or assuming any obligation from any third parties or sell or transfer any assets to any third parties, without the prior written consent from our wholly-owned subsidiaries or their designees. Each of the shareholders of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network also executed an irrevocable power of attorney in favor of individuals designated by our wholly-owned subsidiaries, some of whom also hold senior management positions at those companies as appointed by our wholly-owned subsidiaries under the business operations agreements. Pursuant to those powers of attorney, those individuals have full power and authority to exercise all of the shareholder’s rights with respect to those shareholders’ interests in Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network.

 

Our wholly-owned subsidiaries entered into exclusive technical and consulting services agreements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network. Pursuant to these exclusive technical and consulting services agreements, our wholly-owned subsidiaries provide technical and consulting services to Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network in exchange for services fees, which amount to substantially all of the net income of those companies. The shareholders of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network also entered into equity pledge agreements with our wholly-owned subsidiaries. Pursuant to these equity pledge agreements, these shareholders pledged their interest in Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network for the performance of these companies’ payment obligations under the respective exclusive technical and consulting services agreements.

 

As a result of these contractual arrangements, we bear the risks of, and enjoy the rewards associated with, and therefore are the primary beneficiary of our investments in Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, and we consolidate their results of operations in our historical consolidated financial statements. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview.”

 

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Set forth below is a chart illustrating the different benefits and obligations between our intermediary holding companies, our wholly-owned subsidiaries, Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their shareholders under those agreements.

 

LOGO


(1)   In addition, GreaTom also provides technical and consulting services to Shenzhen Freenet in exchange for services fees.

 

In the opinion of our PRC legal counsel, Commerce & Finance Law Offices, the ownership structures of, and contractual agreements among, certain of our wholly-owned subsidiaries and Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their shareholders, and the businesses and operations of our wholly-owned subsidiaries and Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network as described in this prospectus, are in compliance with all existing PRC laws, rules and regulations and are fully enforceable in accordance with their terms and conditions. In addition, our PRC legal counsel is of the opinion that no consent, approval or license, other than those already obtained, is required under any of the existing PRC laws, rules and regulations for the effectiveness and enforceability of the ownership structures, contractual agreements and businesses and operations of our subsidiaries and those companies. However, there are substantial uncertainties regarding the interpretation and implementation of current PRC laws and regulations. See “Risk Factors — Risks Relating to Our Business — PRC laws and regulations restrict foreign investment in China’s telecommunications services industry, and substantial uncertainties exist with respect to our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network due to uncertainties regarding the interpretation and application of current or future PRC laws and regulations,” and “ — Our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network may not be as effective in providing operational control as direct ownership of these businesses” and “Regulation.” As discussed in those risk factors, there may be certain circumstances that will cause us to lose the benefit and control intended to be created by these arrangements.

 

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USE OF PROCEEDS

 

The aggregate net proceeds that we will receive from the global offering, after deducting the estimated underwriting fees and expenses payable by us in the global offering, is approximately US$170 million. We currently intend to use these net proceeds as follows, though the allocation of use of proceeds may change along with evolving business conditions and other management considerations:

 

    up to US$7 million for enhancing and expanding our content and applications for wireless value-added services;

 

    up to US$15 million for research and development of new technologies and future upgrading of our existing technologies and infrastructure;

 

    up to US$8 million for sales and marketing activities;

 

    up to US$10 million for any contingent payments owed in connection with the acquisition of Puccini (however, if at the time of such payments, we have sufficient internal or other resources, all or a portion of such payments may be satisfied by such resources). For a description of the terms of our acquisition of Puccini, see “Our Acquisition;”

 

    up to US$85 million for funding future potential acquisitions and strategic alliances in the wireless value-added services, content and Internet industries in the PRC, although no material future potential acquisitions or strategic investments are pending other than as described in this prospectus. The timing for the application of the proceeds for future potential acquisitions has not yet been determined; and

 

    any remaining balance for general corporate purposes.

 

We will not receive any proceeds from the sale of ordinary shares by TOM Group Limited upon the exercise of the over-allotment option by the underwriters. All of the net proceeds from such sale will be for the account of TOM Group Limited.

 

To the extent that the net proceeds that we receive from the global offering are not immediately applied for the above purposes, we intend to use them for our working capital, to purchase U.S. Treasury debt securities and other short-term investment grade debt securities or to deposit the proceeds into interest-bearing bank accounts.

 

Our industry is evolving rapidly and could cause significant and rapid changes to our strategies and business plans. Accordingly, the actual application of the proceeds may change. As new business opportunities arise or circumstances change, we may reallocate all or part of the net proceeds to other business plans or new projects or hold such funds in temporary investments.

 

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DIVIDEND POLICY

 

We currently intend to retain future earnings, if any, to finance our business and to fund growth and expansion of our business and, therefore, may not pay any cash dividends in the foreseeable future. Any future determination to pay dividends will be made at the discretion of our board of directors and will be based upon our financial results, shareholders’ interests, general business conditions and strategies, capital requirements, contractual restrictions on the payment of dividends and any other conditions our board of directors deems relevant.

 

As we had an accumulated deficit of approximately US$64.7 million as of December 31, 2003, we did not have a reserve available for distribution to our shareholders.

 

If any dividends are declared, such dividend for a fiscal year will be subject to shareholders’ approval. Under the law of the Cayman Islands and our articles of association, all of our shareholders have equal rights to dividends and distributions. The holders of our ordinary shares will share proportionately on a per share basis in all dividends and other distributions declared by our board of directors. The holders of our ADSs will be required to pay a service fee to the depositary bank upon the distribution of cash dividends or other cash distributions. See “Description of American Depositary Shares — Fees and Charges.”

 

For a description of certain risks associated with our ability to pay dividends, see “Risk Factors — Risks Relating to Our Business — The dividends and other distributions on equity we may receive from our subsidiaries or other payments we may receive from Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network are subject to restrictions under PRC law or agreements that these entities may enter into with third parties. For a description of our holding company structure and its potential impact upon our ability to pay dividends, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

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DILUTION

 

As of December 31, 2003, our net tangible book value per ADS was US$0.28. Net tangible book value per ADS represents our total tangible assets minus our total liabilities and minority interests, which are derived from our audited historical consolidated financial statements, divided by the total number of ADS equivalents outstanding upon the incorporation of our company.

 

After giving effect to the sale of our ADSs and ordinary shares offered in the global offering at the initial public offering price of US$15.552 per ADS, or per ADS equivalent to purchasers of ordinary shares set forth below, and after deducting underwriting discounts and commissions and other estimated expenses of the global offering, but without taking into account any other changes in such tangible book value after December 31, 2003, our net tangible book value per ADS would increase to US$3.827 per ADS. This represents an immediate increase of US$3.547 in net tangible book value per ADS to TOM Group Limited and an immediate dilution of US$11.725 in net tangible book value per ADS to investors purchasing at the initial public offering price.

 

The following table illustrates such dilution immediately after the global offering.

 

The initial public offering price per ADS or per ADS equivalent to purchaser of ordinary shares before deducting underwriting discounts and commissions and other estimated expenses of the global offering

   US$ 15.552

Net tangible book value per ADS before initial consideration shares issued to Cranwood and the global offering

   US$ 0.280

Increase in net tangible book value per ADS attributable to the sale of ADSs and ordinary shares

   US$ 3.547

Pro forma net tangible book value per ADS after the global offering

   US$ 3.827

Dilution in net tangible book value per ADS to purchasers of ADSs or ADS equivalent to purchasers of ordinary shares

   US$ 11.725

 

The following table sets forth for TOM Group Limited, Cranwood and for purchasers of ADSs or ordinary shares the numbers and percentage of total outstanding shares purchased, the total consideration and percentage of total consideration paid and the average price per ordinary share immediately after the global offering, before deducting the underwriting discounts and commissions and estimated expenses payable by us.

 

     Ordinary Shares
Purchased


    Total Consideration

    Average Price Per
Ordinary Share
Equivalent


   Average Price Per
ADS Equivalent


     Number

   Percent

    Amount

   Percent

      
                (U.S. dollars)          (U.S. dollars)    (U.S. dollars)

TOM Group Limited(1)

   2,800,000,000    71.86 %   7,444,000    3.38 %   0.003    0.213

Cranwood(2)

   96,200,000    2.47 %   18,500,000    8.40 %   0.192    15.385

Purchasers of ADSs or ordinary shares(3)

   1,000,000,000    25.67 %   194,400,000    88.22 %   0.194    15.552
    
  

 
  

        

Total

   3,896,200,000    100.00 %   220,344,000    100.00 %   0.057    4.524
    
  

 
  

        

(1)   Total consideration paid by TOM Group Limited is based on net tangible book value for the net assets transferred to us as of September 30, 2003.
(2)   Total consideration deemed to be paid by Cranwood equals to US$18,500,000, being the initial consideration for the acquisition of Puccini.
(3)   Computed based on the initial public offering price per ADS, which includes levies, trading fees and brokerage fees.

 

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The above information does not include ordinary shares issuable to Cranwood pursuant to the payment of the earn-out consideration for the acquisition of Puccini, 280,000,000 shares issuable at the initial public offering price under the Hong Kong public offering upon exercise of the share options granted pursuant to our pre-initial public offering share option plan, or the ordinary shares reserved for issuance upon the exercise of options to be granted in the future pursuant to our share option plan. To the extent that any of the outstanding option is exercised or the earn-out consideration to Cranwood is paid, there will be further dilution to new investors.

 

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CAPITALIZATION

 

The following table sets forth our long-term debt and capitalization as of December 31, 2003. Our capitalization is presented:

 

    on an actual basis, derived from our audited historical consolidated financial statements; and

 

    on a pro forma as adjusted basis to reflect the global offering, based on an initial public offering price of US$15.552 per ADS, after deducting underwriting discounts and commissions and other estimated expenses payable by us in relation to the global offering, as if such sale occurred.

 

You should read this table in conjunction with our audited historical consolidated financial statements and our unaudited pro forma consolidated financial information and supplemental selected unaudited quarterly pro forma financial information included elsewhere in this prospectus.

 

     As of December 31, 2003

 
     Actual
consolidated


    Pro forma
as adjusted
consolidated


 
     (in thousands of U.S.
dollars)
 

Long-term liabilities due to related parties(1)

   19,983     19,983  

Shareholder’s equity:

            

(HK$0.01 par value per ordinary share, 2,800,000,000 ordinary shares issued

and 3,896,200,000 ordinary shares issued and outstanding following our reorganization and the global offering, respectively)

            

Ordinary shares, par value HK$0.01(2)(3)

   3,590     4,995  

Paid-in capital(3)

   75,551     262,646  

Accumulated other comprehensive loss

   (55 )   (55 )

Accumulated deficit

   (64,676 )   (64,676 )
    

 

Total shareholder’s equity

   14,410     202,910  
    

 

Total capitalization

   34,393     222,893  
    

 


(1)   None of the long term liabilities due to related parties are guaranteed or secured.
(2)   Does not include (i) 280,000,000 shares issuable upon exercise of the share options granted at the initial public offering price under the Hong Kong public offering of HK$1.500 per ordinary share pursuant to our pre-initial public offering share option plan, (ii) ordinary shares issuable to Cranwood as the payment of a portion of the earn-out consideration for the acquisition of Puccini, or (iii) the ordinary shares reserved for issuance upon the exercise of options to be granted in the future pursuant to our share option plan.
(3)   Includes the initial consideration for the acquisition of Puccini.

 

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EXCHANGE RATE INFORMATION

 

We present our historical consolidated financial statements in U.S. dollars. In addition, certain pricing information is presented in U.S. dollars and certain contractual amounts that are in Renminbi and Hong Kong dollars include a U.S. dollar equivalent solely for the convenience of the reader. Except as otherwise specified, this pricing information and these contractual amounts are translated at RMB8.2767 = US$1.00 and HK$7.7640=US$1.00, the prevailing rates on December 31, 2003. The translations are not a representation that the Renminbi amounts could actually be converted to U.S. dollars at this rate. For a discussion of the exchange rates used for the presentation of our financial statements, see note 4(o) to our financial statements.

 

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

 

The noon buying rates in New York City for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York were RMB8.2770 = US$1.00 and HK$7.7930 = US$1.00 on March 4, 2004. The following table sets forth, for the period indicated, information concerning the number of Renminbi or Hong Kong dollars for which one U.S. dollar could be exchanged based on the noon buying rate for cable transfers in Renminbi or Hong Kong dollars, respectively as certified for customs purposes by the Federal Reserve Bank of New York.

 

     Noon Buying Rate

     RMB per US$1.00

   HK$ per US$1.00

     High

   Low

   High

   Low

September 2003

   8.2775    8.2768    7.7999    7.7444

October 2003

   8.2776    8.2765    7.7684    7.7085

November 2003

   8.2772    8.2766    7.7692    7.7475

December 2003

   8.2772    8.2765    7.7670    7.7628

January 2004

   8.2772    8.2767    7.7775    7.7632

February 2004

   8.2773    8.2769    7.7845    7.7686

March 2004 (up to March 4)

   8.2770    8.2768    7.7933    7.7842

 

The following table sets forth the average noon buying rates between Renminbi and U.S. dollars and between Hong Kong dollars and U.S. dollars for each of 1999, 2000, 2001, 2002 and 2003, calculated by averaging the noon buying rates on the last day of each month during the relevant year.

 

     Average Noon Buying Rate

     RMB per US$1.00

   HK$ per US$1.00

1999

   8.2785    7.7599

2000

   8.2784    7.7936

2001

   8.2772    7.7997

2002

   8.2772    7.7996

2003

   8.2771    7.7864

 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following selected historical consolidated financial data should be read in conjunction with our audited historical consolidated financial statements, the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The selected historical consolidated statement of operations data for the years ended December 31, 2001, 2002 and 2003, and the selected historical consolidated balance sheet data as of December 31, 2001, 2002 and 2003 set forth below are derived from our audited historical consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated statement of operations data for the year ended December 31, 2000 and the summary historical consolidated balance sheet as of December 31, 2000 set forth below are derived from our audited historical consolidated financial statements that are not included in this prospectus. Our historical consolidated financial data reflects the effects of our reorganization from September 26, 2003 and of our acquisition of Puccini from November 19, 2003. Our audited historical consolidated financial statements have been prepared and presented in accordance with U.S. GAAP and audited by PricewaterhouseCoopers. For a description of the basis of presentation of these financial statements, see note 2 to our audited historical consolidated financial statements. For a description of our reorganization, see “Our Corporate Structure.”

 

    For the year ended December 31,

 
    2000

    2001

    2002

        2003    

 
    (in thousands of U.S. dollars)  

Historical Consolidated Statement of Operations Data

                       

Revenues:

                       

Wireless value-added services

      30     9,958     55,843  

Advertising(1)

  321     2,950     4,228     5,845  

Commercial enterprise solutions(2)

  2,289     1,479     11,244     13,825  

Internet access(3)

      1,974     4,545     1,560  
   

 

 

 

Total revenues

  2,610     6,433     29,975     77,073  

Cost of revenues:

                       

Cost of goods sold

      (59 )   (8,143 )   (11,291 )

Cost of services

  (5,483 )   (10,849 )   (16,731 )   (32,794 )
   

 

 

 

Total cost of revenues

  (5,483 )   (10,908 )   (24,874 )   (44,085 )
   

 

 

 

Gross (loss)/profit

  (2,873 )   (4,475 )   5,101     32,988  
   

 

 

 

Operating expenses:

                       

Selling and marketing expenses

  (5,031 )   (5,755 )   (3,069 )   (2,772 )

General and administrative expenses

  (8,196 )   (8,808 )   (7,356 )   (9,133 )

Product development expenses

  (597 )   (1,085 )   (692 )   (689 )

Amortization of intangibles

  (474 )   (8 )   (88 )   (629 )

Provision for impairment of goodwill, intangibles and property and equipment

  (57,568 )   (2,960 )   (2,215 )    
   

 

 

 

Total operating expenses

  (71,866 )   (18,616 )   (13,420 )   (13,223 )
   

 

 

 

(Loss)/income from operations

  (74,739 )   (23,091 )   (8,319 )   19,765  

Other expense:

                       

Net interest expense

  (17 )   (347 )   (408 )   (320 )
   

 

 

 

(Loss)/income before tax

  (74,756 )   (23,438 )   (8,727 )   19,445  

Income tax (expense)/credit

          (16 )   254  
   

 

 

 

(Loss)/income after tax

  (74,756 )   (23,438 )   (8,743 )   19,699  

Minority interests

  72     294     389     (127 )
   

 

 

 

Net (loss)/income attributable to shareholders

  (74,684 )   (23,144 )   (8,354 )   19,572  

Other comprehensive income/(loss):

                       

Foreign currency translation adjustment

  9     (21 )   (43 )         —    
   

 

 

 

Comprehensive (loss)/income

  (74,675 )   (23,165 )   (8,397 )   19,572  
   

 

 

 


(1)   Includes offline advertising revenue that is bundled with online advertising revenue.
(2)   Our commercial enterprise solutions revenue is primarily derived from the purchase and installation of computer hardware on behalf of our clients.
(3)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access card expires at the end of 2004.

 

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     As of or for the year ended December 31,

 
     2000

    2001

    2002

        2003    

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

Historical Consolidated Balance Sheet Data

                        

Cash and cash equivalents

   8,278     5,320     6,752     22,636  

Restricted cash

       4,030     —       —    

Other current assets

   3,411     9,925     12,310     32,182  

Property and equipment, net

   5,413     2,960     5,518     7,094  

Other assets

       3,391     994     5,464  
    

 

 

 

Total assets

   17,102     25,626     25,574     67,376  
    

 

 

 

Current liabilities

   3,941     14,445     8,498     32,831  

Long-term liabilities

   6,100     11,801     26,316     19,983  
    

 

 

 

Total liabilities

   10,041     26,246     34,814     52,814  

Minority interests

       613     224     152  

Total shareholders’ equity/(deficit)

   7,061     (1,233 )   (9,464 )   14,410  
    

 

 

 

Total liabilities and shareholders’ equity/(deficit)

   17,102     25,626     25,574     67,376  
    

 

 

 

Other Historical Consolidated Financial Data

                        

Gross (loss)/profit margin

   (110 %)   (70 %)   17 %   43 %

Operating (loss)/profit margin

   (2,864 %)   (359 %)   (28 %)   26 %

Net (loss)/profit margin

   (2,861 %)   (360 %)   (28 %)   25 %

Depreciation

   533     2,360     1,865     3,016  

Amortization

   3,270     8     88     629  

Capital expenditure

   2,581     2,749     4,451     4,790  

Unaudited Operating Data

                        

Registered users (millions)(1)

       0.4     10.1     27.4  

(1)   Approximate cumulative number of users of our wireless data services that have registered with us since our launch of these services in July 2001, irrespective of activity level.

 

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SELECTED FINANCIAL DATA OF WU JI NETWORK

 

The following selected historical financial data for Wu Ji Network should be read in conjunction with Wu Ji Network’s historical financial statements, the notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Our Acquisition” included elsewhere in this prospectus. The selected Wu Ji Network historical statement of operations data for the period from July 31, 2002, the date of incorporation, to December 31, 2002 and for the period from January 1, 2003 to November 19, 2003, the date of the acquisition, and the selected historical balance sheet data as of December 31, 2002 and as of November 19, 2003 set forth below are derived from Wu Ji Network’s audited financial statements, which have been prepared and presented in accordance with U.S. GAAP and audited by PricewaterhouseCoopers. The selected Wu Ji Network historical statement of operations data for the period from November 20, 2003 to December 31, 2003 and the selected historical balance sheet data as of December 31, 2003 is derived from our unaudited management financial information, which was prepared on substantially the same bases as our audited historical consolidated financial statements. For a description of the basis of presentation of these financial statements, see note 2 to the financial statements of Wu Ji Network.

 

    

For the period from
July 31, 2002 to

December 31, 2002


    For the period from
January 1, 2003 to
November 19, 2003


   

For the period from
November 20, 2003 to
December 31, 2003

(unaudited)


 
     (in thousands of U.S. dollars)  

Wu Ji Network Statement of Operations Data

                  

Revenues

   15     6,824     2,307  

Cost of revenues

   (15 )   (1,664 )   (502 )
    

 

 

Gross profit

       5,160     1,805  
    

 

 

Operating expenses:

                  

Selling and marketing expenses

       (547 )   (171 )

General and administrative expenses

   (6 )   (184 )   (30 )

Amortization of intangibles

           (629 )

Other operating expense

       (1,842 )    
    

 

 

Total operating expenses

   (6 )   (2,573 )   (830 )
    

 

 

(Loss)/income from operations:

   (6 )   2,587     975  

Interest income

       6     3  
    

 

 

(Loss)/income before tax

   (6 )   2,593     978  

Income tax expense

       (399 )    
    

 

 

Net (loss)/income and comprehensive (loss)/income

   (6 )   2,194     978  
    

 

 

    


As of

December 31, 2002


    As of
November 19, 2003


   

As of

December 31, 2003

(unaudited)


 
     (in thousands of U.S. dollars)  

Wu Ji Network Balance Sheet Data

                  

Cash and cash equivalents

   57     4,129     4,726  

Other current assets

   9     273     1,342  

Non-current assets

   144     457     4,878  
    

 

 

Total assets

   210     4,859     10,946  
    

 

 

Current liabilities

   156     2,551     2,620  

Total owners’ equity

   54     2,308     8,326  
    

 

 

Total liabilities and owners’ equity

   210     4,859     10,946  
    

 

 

 

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SELECTED UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA

 

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

 

Our unaudited pro forma consolidated statement of operations data is presented in order to give pro forma effect to (i) our reorganization, as if our reorganization occurred on January 1, 2003 and (ii) our acquisition of Puccini as if the acquisition occurred on January 1, 2003. As a result, our unaudited pro forma consolidated financial information includes the financial information of the nine companies that are part of our company following our reorganization, but excludes the six companies that were included in our historical consolidated financial statements up until September 26, 2003, but will no longer be part of our company following our reorganization.

 

Our unaudited pro forma consolidated financial information have been derived from our audited historical consolidated financial statements and the audited historical financial statements of Wu Ji Network, both of which are prepared and presented in accordance with U.S. GAAP. For a discussion of the basis of presentation and the adjustments made in the preparation of the unaudited pro forma consolidated financial information, see our unaudited pro forma consolidated financial information and supplemental selected unaudited quarterly financial information included elsewhere in this prospectus. For a description of our reorganization, see “Our Corporate Structure,” and for a description of our acquisition, see “Our Acquisition.”

 

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    For the year ended December 31, 2003

 
    Historical
consolidated


    Reorganization
adjustments


    Post
reorganization


   

Historical

Wu Ji
Network


    Wu Ji
Network
adjustments


    Pro
forma


 

Pro Forma Consolidated Statement of Operations Data

  (unaudited and in thousands of U.S. dollars)  

Revenues:

                                   

Wireless value-added services

  55,843         55,843     6,824         62,667  

Advertising(1)

  5,845     (3,836 )   2,009             2,009  

Commercial enterprise solutions(2)

  13,825     (66 )   13,759             13,759  

Internet access(3)

  1,560         1,560             1,560  
   

 

 

 

 

 

Total revenues

  77,073     (3,902 )   73,171     6,824         79,995  

Cost of revenues:

                                   

Cost of goods sold

  (11,291 )       (11,291 )           (11,291 )

Cost of services

  (32,794 )   3,673     (29,121 )   (1,664 )   (210 )   (30,995 )
   

 

 

 

 

 

Total cost of revenues

  (44,085 )   3,673     (40,412 )   (1,664 )   (210 )   (42,286 )
   

 

 

 

 

 

Gross profit

  32,988     (229 )   32,759     5,160     (210 )   37,709  
   

 

 

 

 

 

Operating expenses:

                                   

Selling and marketing expenses

  (2,772 )   134     (2,638 )   (547 )       (3,185 )

General and administrative expenses

  (9,133 )   557     (8,576 )   (184 )       (8,760 )

Product development expenses

  (689 )       (689 )           (689 )

Amortization of intangibles

  (629 )       (629 )       (4,411 )   (5,040 )

Other operating expense

              (1,842 )   1,842      
   

 

 

 

 

 

Total operating expenses

  (13,223 )   691     (12,532 )   (2,573 )   (2,569 )   (17,674 )
   

 

 

 

 

 

Income from operations

  19,765     462     20,227     2,587     (2,779 )   20,035  

Other (expense)/income:

                                   

Net interest (expense)/income

  (320 )   54     (266 )   6         (260 )
   

 

 

 

 

 

Income before tax

  19,445     516     19,961     2,593     (2,779 )   19,755  

Income tax credit/(expense)

  254     18     272     (399 )   20     (107 )
   

 

 

 

 

 

Income after tax

  19,699     534     20,233     2,194     (2,759 )   19,668  

Minority interests

  (127 )       (127 )           (127 )
   

 

 

 

 

 

Net income attributable to shareholders

  19,572     534     20,106     2,194     (2,759 )   19,541  
   

 

 

 

 

 

Earnings per share-basic (cents)

  0.699           0.718                 0.698  
   

       

             

Number of shares (in billions)

  2.8           2.8                 2.8  
   

       

             


(1)   Our pro forma advertising revenue primarily consists of online advertising revenue, but also includes revenue from offline advertising services that are bundled together with online advertising services.
(2)   Our commercial enterprise solutions revenue is primarily derived from the purchase and installation of computer hardware on behalf of our clients.
(3)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access cards expire at the end of 2004.

 

     For the year ended
December 31, 2003


 

Other Pro Forma Consolidated Financial Data

      

Gross profit margin

   47 %

Operating profit margin

   25 %

Net profit margin

   24 %

Depreciation (in thousands)

   2,979  

Amortization (in thousands)

   5,040  

 

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

 

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

 

Our audited historical consolidated financial statements and the audited historical financial statements of Wu Ji Network have been prepared in accordance with U.S. GAAP.

 

Our unaudited pro forma financial information has been derived from our audited historical consolidated financial statements and the audited historical financial statements of Wu Ji Network. Our supplemental selected unaudited pro forma consolidated quarterly financial information has been derived from our unaudited management financial information and the unaudited management financial information of Wu Ji Network, which were prepared on substantially the same basis as our audited historical consolidated financial statements and the audited historical financial statements of Wu Ji Network, and include all normal recurring accruals and adjustments that the respective management considered necessary for a fair presentation of the unaudited consolidated quarterly financial information for the periods presented.

 

Our audited historical consolidated financial statements and the discussion and analysis herein reflect the effects of our reorganization from September 26, 2003, and the effects of our acquisition from November 19, 2003. As a result, our historical consolidated financial statements and the discussion and analysis herein include up until September 26, 2003, the results of operation of the six companies that have historically been managed together with our business but are not be part of our company following our reorganization. Most of the business operations of these six companies were, however, moved to our company. In addition, our audited historical consolidated financial statements and the discussion and analysis herein only include the financial position and results of operations of Wu Ji Network following completion of our acquisition on November 19, 2003. For a discussion of our reorganization, see “Our Corporate Structure,” and for a description of our acquisition, see “Our Acquisition.”

 

Overview

 

We are one of the leading Internet companies in China providing value-added multimedia products and services. We deliver our products and services from our Internet portal to our users both through their mobile phones and through our websites. Our primary business activities include wireless value-added services, online advertising and commercial enterprise solutions.

 

In July 2000, we launched our Internet portal, www.tom.com, and focused our business upon providing Internet-based content and services to users through our websites. In 2000 and 2001, China Mobile and China Unicom, respectively, launched platforms for the delivery of wireless value-added services to users through their mobile phones, and began allowing third parties to use their billing and collection systems to charge fees for products and services that are delivered through these platforms. This created an opportunity for Internet companies, such as us, to deliver their Internet portal products and services to users in China through their mobile phones and to utilize these billing and collection systems to collect fees for these services. Previously, due to low credit card penetration and the lack of alternative Internet payment methods in China, our Internet content generated revenue primarily through online advertising. In the second half of 2001, however, we launched our wireless data services business and have subsequently experienced significant revenue growth. Our revenues increased to US$77.1 million in 2003 from US$30.0 million in 2002. Our wireless value-added services revenues accounted for 72.5% of our total revenues in 2003.

 

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In prior periods, our offline advertising revenue accounted for the majority of our advertising revenue. In the first quarter of 2003, we shifted the focus of our internal sales team to developing our relatively high gross profit margin online advertising business, from developing our lower gross profit margin offline advertising business. In addition, following our reorganization, which was consummated pursuant to a series of agreements, all of which were duly executed on or by September 26, 2003, Shenzhen Freenet Super Channel Advertising Company Limited, or Shenzhen Freenet Advertising, and Beijing Tom International Advertising Limited, or Beijing Tom, the companies which historically recorded the majority of our offline advertising revenues, are no longer be part of our company. As a result, we expect our online advertising revenue to account for substantially all of our advertising revenue in future periods, and we will continue to provide offline advertising services, only to the extent that they are bundled with online advertising services. Our pro forma advertising revenue excludes offline advertising revenue recognized by Shenzhen Freenet Advertising and Beijing Tom to reflect the effects of our reorganization. Based on our pro forma adjustments, our online advertising revenue, which continues to include a small component of bundled offline advertising revenue, was US$2,009,000 in 2003. Our online advertising revenue accounted for 2.6% of our total revenue in 2003.

 

Our commercial enterprise solutions business includes providing technical services for the Internet-related computer hardware and software needs of our clients. In 2003, computer hardware sales accounted for the majority of our commercial enterprise solutions revenue, which in turn accounted for 17.9% of our total revenues. We intend to reduce our focus on our relatively low gross profit margin computer hardware sales and to increase our focus on providing our higher gross profit margin integrated computer software solutions.

 

In August 2001, we were incorporated under the laws of the Cayman Islands as a wholly-owned subsidiary of our parent company, which is listed on GEM. Initially, we did not have any material assets or business operations. As part of our reorganization, our parent company transferred to us its wireless data services, online advertising and commercial enterprise solutions businesses in China. For a discussion of our reorganization, see “Our Corporate Structure.” For a discussion of the effect of our reorganization upon our historical consolidated financial statements and our pro forma financial statements, see “— Pro Forma Adjustments and Unaudited Pro Forma Quarterly Financial Information.”

 

On November 19, 2003, we acquired from Cranwood, a 24.6% shareholder of our parent company, Puccini, which provides wireless IVR services through Wu Ji Network. The financial results of Wu Ji Network are included in our audited historical consolidated financial statements following completion of our acquisition. In addition, the results of Wu Ji Network are included in our unaudited pro forma consolidated financial information for all periods presented. For a description of our acquisition of Wu Ji Network, see “Our Acquisition.”

 

PRC regulations currently restrict foreign ownership of companies that provide value-added telecommunications services, which includes wireless value-added services and Internet content services. As a result, we conduct substantially all of our operations through Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, which are owned by PRC citizens. In addition, we have entered into a series of contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, and their respective shareholders, pursuant to which we are entitled to receive service fees in an amount equal to substantially all of the net income of these companies and under certain contractual arrangements, our wholly-owned subsidiaries agreed to guarantee the performance of these companies in connection with the operations-related agreements they entered into with third parties. As a result of these contractual arrangements, under U.S. GAAP we are the primary beneficiary of the investments in Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and we consolidate their results of operations in our historical consolidated financial statements. For a description of the PRC regulations restricting foreign ownership of companies that provide value-added telecommunications services and Internet content services in China, see “Regulation.” For a description of the contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, see “Our Corporate Structure,” and “Related Party Transactions.” For a discussion of the tax implications of charging service fees pursuant to the contractual

 

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arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, see “— Income Taxation.” See “Risk Factors — Risks Relating to Our Business — PRC laws and regulations restrict foreign investment in China’s telecommunications services industry, and substantial uncertainties exist with respect to our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network due to uncertainties regarding the interpretation and application of current or future PRC laws and regulations,” and “ — Our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet or Wu Ji Network may not be as effective in providing operational control as direct ownership of these businesses.”

 

Revenues

 

Our revenues are derived from our three primary operating segments: wireless value-added services, advertising, and commercial enterprise solutions, as well as Internet access, an operating segment from which we derive a limited portion of our revenue. Currently, our revenues are primarily derived from our wireless value-added services, which include SMS, MMS and WAP services. Through these services we provide download, information and community-oriented products, such as news headlines, sports information, games, ring tones, wallpaper and dating. We also derive revenues from our advertising services, commercial enterprise solutions and Internet access services. In the fourth quarter of 2002, however, we stopped selling Internet access cards.

 

Our revenues represent our total revenues from operations net of certain business and value-added taxes. Our revenues are primarily derived from Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and our subsidiaries that are incorporated in the PRC. Our wireless data services revenue is subject to a 3.3% business tax and our advertising revenue is subject to a business tax of up to 8.5%. In addition, our computer hardware sales revenue is subject to a 17.0% value-added tax, which is partially offset by value-added taxes paid on purchases, and our other non-computer hardware related commercial enterprise solutions revenue is subject to a 5.5% business tax. Furthermore, any service fees that Beijing Super Channel charges and subsequently collects pursuant to the exclusive technical and consulting service agreements with Beijing Lei Ting and Shenzhen Freenet will be subject to a 5.0% business tax. Likewise, any service fees that Puccini Network charges and subsequently collects pursuant to the exclusive technical and consulting service agreements with Wu Ji Network will be subject to a 5.0% business tax.

 

The following table sets forth certain historical consolidated revenue data in terms of amount and as a percentage of our total revenues for the periods indicated:

 

     For the year ended December 31,

 
     2002

    2003

 
     Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


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

Wireless value-added services(1)

   9,958   33.2 %   55,843   72.5 %

Advertising(2)

   4,228   14.1 %   5,845   7.6 %

Commercial enterprise solutions(3)

   11,244   37.5 %   13,825   17.9 %

Internet access(4)

   4,545   15.2 %   1,560   2.0 %
    
 

 
 

Total revenues

   29,975   100.0 %   77,073   100.0 %
    
 

 
 


(1)   Includes revenue from our download products, information products and community-oriented products that we provide through the wireless value-added services platforms of China Mobile and China Unicom. Revenue from Wu Ji Network’s wireless value-added services is included following the completion of our acquisition on November 19, 2003.
(2)   Includes offline advertising revenue that is bundled with online advertising revenue.
(3)   Includes revenue from computer hardware sales, integrated enterprise solutions services, e-commerce and fee-based e-mail boxes. Our commercial enterprise solutions revenue is, however, primarily derived from computer hardware sales.
(4)   Although stopped selling Internet access cards in the fourth quarter of 2002 we continue to recognize revenue and related costs with respect to outstanding Internet access cards in subsequent periods. We do not, however, expect to recognize revenue or costs with respect to this business once the last Internet access card expires at the end of 2004.

 

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The following table sets forth certain unaudited historical consolidated revenues data in terms of amount and as a percentage of our total revenues for the periods indicated:

 

    For the three months ended

 
    March 31, 2003

    June 30, 2003

    September 30, 2003

    December 31, 2003

 
    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


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

Wireless value-added services(1)

  8,759   59.1 %   14,883   75.1 %   14,637   69.3 %   17,564   82.4 %

Advertising(2)

  1,268   8.5 %   1,699   8.6 %   2,279   10.8 %   599   2.8 %

Commercial enterprise solutions(3)

  3,757   25.3 %   2,849   14.4 %   4,132   19.6 %   3,087   14.5 %

Internet access(4)

  1,055   7.1 %   385   1.9 %   64   0.3 %   56   0.3 %
   
 

 
 

 
 

 
 

Total revenues

  14,839   100.0 %   19,816   100.0 %   21,112   100.0 %   21,306   100.0 %
   
 

 
 

 
 

 
 


(1)   Includes revenue from our download products, information products and community-oriented products that we provide through the wireless value-added services platforms of China Mobile and China Unicom. Revenue from Wu Ji Network’s wireless value-added services are included following the completion of our acquisition on November 19, 2003.
(2)   Includes offline advertising revenue that is bundled with online advertising revenue.
(3)   Includes revenue from computer hardware sales, integrated enterprise solutions services, e-commerce and fee-based e-mail boxes. Our commercial enterprise solutions revenue is, however, primarily derived from computer hardware sales.
(4)   We stopped selling our Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once our last Internet access cards expire at the end of 2004.

 

Wireless value-added services.    Our wireless value-added services revenue is derived from products and services that we provide through China Mobile’s Monternet platform and China Unicom’s UNI-Info platform. We recognize revenue derived from our wireless value-added services before deducting the share of revenue due to, and the transmission fees paid to, the mobile telecommunications operators. For a description of our revenue recognition policies, see “ — Critical Accounting Policies,” and for a description of our revenue sharing arrangements with the mobile telecommunications operators, see “Our Business — Our Business — Wireless Value-Added Services — Fees and Revenue Sharing.”

 

Our wireless value-added services include our wireless data services and, following our acquisition of Puccini, Wu Ji Network’s wireless IVR services. Our wireless data services include SMS, MMS and WAP services. SMS is our primary wireless data service, accounting for approximately 91% of our wireless value-added services revenue in 2003. However, we intend to increase promotion of our newer services, such as our MMS and WAP services. In the fourth quarter of 2003, our MMS and WAP services accounted for approximately 2% and 7%, respectively, of our wireless value-added services revenue. The primary factors affecting our wireless value-added services revenue are the number of subscriptions, the number of downloads and the pricing of our subscriptions and downloads. Because subscription-based services include a bundle of downloads for a monthly price, which we believe provides a more stable source of revenue than single downloads, we focus upon promoting our subscription-based services. In 2003, revenue from our subscription-based services accounted for over half of our wireless value-added services revenue.

 

The following table sets forth certain SMS data for the periods indicated:

 

     For the three months ended

    

March 31,

2003


  

June 30,

2003


  

September 30,

2003


  

December 31,

2003


     (in millions)

SMS subscriptions(1)

   5.5    8.7    8.5    9.1

SMS downloads(2)

   83.4    89.1    78.8    72.9

(1)   Number of paid SMS subscriptions during the relevant period.
(2)   Number of paid SMS downloads during the relevant period, excluding downloads made pursuant to subscriptions.

 

 

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Our operating data, which includes SMS subscriptions and SMS download data, is generated by an internal operating system that tracks the delivery confirmations provided to us by the mobile telecommunications operators. Due to the nature of our billing arrangements, however, the revenue that we recognize is based upon the monthly revenue statements provided to us that the mobile telecommunications operators generate from their own internal operating data, which we do not independently verify. Generally, differences exist between the value of our revenue calculated from our own internal operating data and the monthly revenue statements provided to us by the mobile telecommunications operators. We believe, however, that these differences were not material in 2003. For a discussion of the difference between our internally calculated revenue and our actual revenue, see “— Critical Accounting Policies — Wireless Value-Added Services Revenue Recognition,” and “Risk Factors — Risks Relating to Our Business — Our dependence on the substance and timing of the billing systems of the mobile telecommunications operators may require us to estimate portions of our reported revenue for wireless value-added services from time to time. As a result, subsequent adjustments may have to be made to our wireless value-added services revenue in our financial statements.”

 

Advertising.    Our advertising revenue is derived from both online and offline advertising services. Due to our shift in focus from offline advertising to online advertising in the first quarter of 2003, however, we expect that our online advertising revenue will account for the majority of our advertising revenue subsequent to our reorganization. We sell online advertisements through our direct sales force and through advertising agencies. The primary factors affecting our advertising revenues are the number of our advertising clients that contribute revenue during the relevant period and the average revenue per client.

 

Commercial enterprise solutions.     Our commercial enterprise solutions revenue is primarily derived from providing technical and consulting services with respect to the Internet-related computer hardware and software needs of our clients, with the purchase and installation of computer hardware generating a substantial portion of this revenue. We recognize our commercial enterprise solutions revenue on a gross basis, inclusive of computer hardware purchase costs that are passed through to our clients. The majority of our commercial enterprise solutions revenue is derived from large contracts, where large contracts are those with a value of RMB 500,000 (US$60,411) or above. The remaining revenue is derived from numerous smaller enterprise solutions contracts and other revenue such as small fee-based e-mail contracts. As a result, the primary factors affecting our commercial enterprise solutions revenue are the number of our large contracts and our average revenue per large contract.

 

Internet access.    Our Internet access revenues are derived from the sale of prepaid cards that provide access to the Internet through various telecommunications operators located throughout China. In the fourth quarter of 2002, however, we stopped selling our Internet access cards. We decided to stop selling our Internet access cards because we believed that increasing competition as well as the increasing penetration of broadband Internet access would gradually reduce the profit margins on the sale of cards that facilitated dial-up Internet access. Nonetheless, in subsequent periods we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not, however, expect to recognize revenue or costs with respect to this business once the last Internet access card expires at the end of 2004.

 

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Cost of Revenues

 

The following table sets forth certain historical consolidated cost of revenues data in terms of amount and as a percentage of our total revenues for the periods indicated:

 

     For the year ended December 31,

 
     2002

    2003

 
     Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


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

Cost of goods sold

   8,143   27.2 %   11,291   14.6 %

Cost of services

   16,731   55.8 %   32,794   42.6 %
    
 

 
 

Total cost of revenues

   24,874   83.0 %   44,085   57.2 %
    
 

 
 

 

The following table sets forth certain unaudited historical consolidated cost of revenues data in terms of amount and as a percentage of our total revenues for the periods indicated:

 

     For the three months ended

 
     March 31, 2003

    June 30, 2003

    September 30, 2003

    December 31, 2003

 
     Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


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

Cost of goods sold

   3,132   21.1 %   2,126   10.7 %   3,689   17.5 %   2,344   11.0 %

Cost of services

   6,504   43.8 %   9,277   46.8 %   8,622   40.8 %   8,391   39.4 %
    
 

 
 

 
 

 
 

Total cost of revenues

   9,636   64.9 %   11,403   57.5 %   12,311   58.3 %   10,735   50.4 %
    
 

 
 

 
 

 
 

 

Cost of Goods Sold.    Cost of goods sold consists primarily of the cost of computer hardware and software that we purchase and install on behalf of our commercial enterprise solutions clients. The sale of computer hardware to our commercial enterprise solutions clients has been a low profit margin business and we do not intend to expand this business in the future. As a result, we expect that our sales of computer hardware and the related cost of goods sold, will decline as a percentage of revenues in future periods.

 

Cost of Services.    Cost of services include direct cost of services and common cost of services. Our wireless value-added services direct costs include the share of revenue due to, and the transmission fees paid to, the mobile telecommunications operators, the share of revenue due to our industry cooperation partners, certain content costs and product promotion and marketing expenses. Our advertising direct costs include the cost of acquiring rights to outdoor media assets, such as billboards, and sales commissions and staff bonuses that are based on revenues. Our Internet access direct costs include the cost of Internet access time purchased from Internet service providers for resale. Our common costs include bandwidth leasing charges, portal content acquisition costs, costs for our portal content production staff and wireless value-added services staff, and depreciation and maintenance costs relating to equipment used to provide services. We allocate our common costs to our wireless value-added services business and our advertising business in proportion to the gross profits from these businesses prior to the allocation of common costs. Our direct cost of services and our common cost of services accounted for 70.0% and 30.0%, respectively, of our cost of services in the fourth quarter of 2003. We expect that our cost of services will continue to increase as our wireless value-added services and online advertising businesses continue to expand in future periods.

 

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Gross Profit Margin

 

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

 

     For the year ended December 31, 

 
     2002

    2003

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

Gross Profits(1):

            

Wireless value-added services

   2,326     28,549  

Advertising(2)

   314     1,494  

Commercial enterprise solutions

   2,006     2,052  

Internet access(3)

   455     893  
    

 

Total gross profits

   5,101     32,988  
    

 

Gross Profit Margin:

            

Wireless value-added services

   23.4 %   51.1 %

Advertising(2)

   7.4 %   25.6 %

Commercial enterprise solutions

   17.8 %   14.8 %

Internet access(3)

   10.0 %   57.2 %

Total gross profit margin

   17.0 %   42.8 %

(1)   For the purpose of calculating our gross profits, certain costs that are common to both our wireless value-added services business and our advertising business are allocated to these businesses in proportion to gross profits from these businesses prior to the allocation of these common costs. In addition, gross profits are calculated without any deduction or allocation of operating expenses.
(2)   Advertising gross profits include both online and offline advertising gross profits.
(3)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access card expires at the end of 2004.

 

The following table sets forth the unaudited historical consolidated gross profits and gross profit margin of our business activities for the periods indicated:

 

     For the three months ended

 
     March 31, 2003

    June 30, 2003

    September 30, 2003

    December 31, 2003

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

Gross Profits(1):

                        

Wireless value-added services

   3,916     7,232     7,794     9,607  

Advertising(2)

   181     349     616     348  

Commercial enterprise solutions

   502     657     333     560  

Internet access(3)

   604     175     58     56  
    

 

 

 

Total gross profits

   5,203     8,413     8,801     10,571  
    

 

 

 

Gross Profit Margin:

                        

Wireless value-added services

   44.7 %   48.6 %   53.2 %   54.7 %

Advertising(2)

   14.3 %   20.5 %   27.0 %   58.1 %

Commercial enterprise solutions

   13.4 %   23.1 %   8.1 %   18.1 %

Internet access(3)

   57.3 %   45.5 %   90.6 %   100.0 %

Total gross profit margin

   35.1 %   42.5 %   41.7 %   49.6 %

(1)   For the purpose of calculating our gross profits, certain costs that are common to both our wireless value-added services business and our advertising business are allocated to these businesses in proportion to gross profits from these businesses prior to the allocation of these common costs. In addition, gross profits are calculated without any deduction or allocation of operating expenses.
(2)   Advertising gross profit include both online and offline advertising gross profits.
(3)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access card expires at the end of 2004.

 

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The primary costs of revenue that affect our gross profit margins include direct costs such as the share of revenue due to, and the transmission fees paid to, the mobile telecommunications operators in connection with our wireless value-added services and the cost of computer hardware and software that we purchase and install on behalf of our commercial enterprise solutions clients as well as common costs such as portal content acquisition costs and depreciation and maintenance with respect to equipment used to provide our services. For the purpose of calculating our gross profits, common costs are allocated to our wireless value-added services business and our advertising business in proportion to the gross profits from these businesses prior to the allocation of these common costs.

 

The increase in our wireless value-added services gross profit margin in recent periods is due to an increase in the revenue derived from this business at a more rapid rate than the increase in the cost of revenue associated with this business. This difference in the rate of increase is primarily because a significant component of the cost of revenue is the allocated portion of fixed common costs, which do not increase in proportion to increases in wireless value-added services revenue.

 

The increase in our advertising gross profit margin in recent periods is primarily due to the decrease in the allocation of common costs to this business as well as the exclusion of our relatively lower gross profit margin offline advertising business following completion of our reorganization on September 26, 2003. As our wireless value-added services business has expanded and gross profits attributable to this business have increased, the common costs allocated to our advertising business have decreased.

 

The fluctuation in our commercial enterprise solutions gross profit margin is primarily due to the fluctuation in the proportions of our commercial enterprise solutions revenue that are generated from our relatively lower gross profit margin computer hardware sales and our relatively higher gross profit margin integrated computer software solutions.

 

The increase in our Internet access business gross profit margin in recent periods is primarily due to our revenue recognition policy with respect to certain of our Internet access cards that were outstanding in 2003. See “— Critical Accounting Policies — Internet Access Revenue Recognition.”

 

Operating Expenses

 

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

 

     For the year ended December 31, 

 
     2002

    2003

 
     Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


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

Selling and marketing expenses

   3,069   10.2 %   2,772   3.6 %

General and administrative expenses

   7,356   24.5 %   9,133   11.8 %

Product development expenses

   692   2.3 %   689   0.9 %

Amortization of intangibles

   88   0.3 %   629   0.8 %

Provision for impairment of goodwill, intangibles and property and equipment

   2,215   7.4 %     0 %
    
 

 
 

Total operating expenses

   13,420   44.7 %   13,223   17.1 %
    
 

 
 

 

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The following table sets forth certain unaudited historical consolidated operating expense data in terms of amount and as a percentage of our total revenues for the periods indicated:

 

     For the three months ended

 
     March 31, 2003

    June 30, 2003

    September 30, 2003

    December 31, 2003

 
     Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


    Amount

  Percentage
of revenues


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

Selling and marketing expenses

   531   3.6 %   486   2.5 %   671   3.2 %   1,084   5.1 %

General and administrative expenses

   2,621   17.7 %   2,151   10.9 %   2,537   12.0 %   1,824   8.6 %

Product development expenses

   165   1.1 %   167   0.8 %   184   0.9 %   173   0.8 %

Amortization of intangibles

     0 %     0 %     0 %   629   2.9 %
    
 

 
 

 
 

 
 

Total operating expenses

   3,317   22.4 %   2,804   14.2 %   3,392   16.1 %   3,710   17.4 %
    
 

 
 

 
 

 
 

 

Selling and Marketing Expenses.    Selling and marketing expenses primarily consist of advertising, sales and marketing expenses, including expenses associated with sponsoring promotional events, and salaries and benefits for our direct sales force. We expect that our selling and marketing expenses will increase as we promote the brand recognition of the tom.com trademarks in future periods.

 

General and Administrative Expenses.    General and administrative expenses primarily consist of compensation and benefits for general management, finance and administrative personnel costs, professional fees, lease expenses, other office expenses, provisions for bad debts and depreciation with respect to equipment used for general corporate purposes. We expect our general and administrative expenses to increase as our business expands in future periods.

 

Product Development Expense.    Product development expenses primarily consist of research and development staff costs.

 

Amortization of Intangibles.    Amortization of intangibles primarily relates to the amortization of intangible assets acquired in connection with our purchase of Puccini, which provides wireless IVR services through Wu Ji Network, in November 2003.

 

Provision for Impairment of Goodwill, Intangible Assets and Property and Equipment.    Provision for impairment of goodwill, intangible assets and property and equipment consists of impairment charges for goodwill recorded in connection with acquisitions and impairment charges relating to intangible assets and property and equipment that have suffered a decline in value.

 

Critical Accounting Policies

 

The preparation of financial statements often requires the selection of specific accounting methods and policies from several acceptable alternatives. Further, significant estimates and judgments may be required in selecting and applying those methods and policies in the recognition of the assets and liabilities in our consolidated balance sheet, the revenues and expenses in our consolidated statement of operations and comprehensive (loss)/income, the information that is contained in the significant accounting policies and notes to our consolidated financial statements. Management bases its estimates and judgments on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates and judgments under different assumptions or conditions. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that affect our financial condition and results of operation.

 

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Wireless Value-Added Services Revenue Recognition

 

Our wireless data services revenue is derived from fees charged for providing users with SMS, MMS and WAP services. Fees for our wireless data services are charged on a per message basis or on a monthly subscription basis, and vary according to the type of products and services delivered.

 

Our services are delivered to users through the wireless data platforms of the mobile telecommunications operators, and we rely upon these operators to provide us with billing and collection services. We have, however, developed an internal system that records the number of messages that are sent from our Internet portal, the related fees and the delivery confirmations that the mobile telecommunications operators separately provide us with respect to messages sent from our Internet portal once the messages are received by the users. Generally, within 20 to 60 days after the end of each month, a statement from each of the mobile telecommunications operators confirming the value of wireless value-added services they bill to users in that month will be delivered to us, and usually within 60 days after such delivery, we will be paid by the mobile telecommunications operators for the wireless value-added services, net of their revenue share, transmission fees and applicable business taxes, for that month based on such monthly statements.

 

We initially ascertain the value of the wireless value-added services provided based on delivery confirmations sent to us by the networks of the mobile telecommunications operators with respect to the amount of services we deliver to the users. Because there has historically been a discrepancy between this value and the value of the services based on the monthly statements provided by the mobile telecommunications operators due to technical issues with the transmission and billing systems, at the end of each month, we will, based on the historical data regarding such discrepancies, our observation of the stability of the various network systems during the month in question and other factors, make an estimate of the collectible wireless value-added services fees for such month. This estimate may be higher or lower than the actual revenue we have a right to receive based on the monthly statements from the mobile telecommunications operators. In 2003, the average difference between our estimates and our actual revenue, calculated on a quarterly basis, was approximately 5%. By the time we report our financial results, we would generally have received well over a majority of the monthly statements from the mobile telecommunications operators and would have recognized our revenue for the wireless value-added services based on those monthly statements. In the event that a monthly statement for any mobile telecommunication operator has not been received at the time such financial results are reported, we will report wireless value-added services revenue based on the estimate of the collectible wireless value-added services relating to such mobile telecommunication operator. As a result, we may overstate or understate our wireless value-added services revenue for that reporting period. Any difference between the operator’s monthly statement that is eventually received and our estimate of the collectible wireless value-added services for such operator may result in subsequent adjustments to our wireless value-added services revenue reported in our financial statements. However, such billing discrepancies have had no impact on the historical financial statements for 2001 and 2002, since we recorded our revenue in accordance with the received monthly statements from the mobile operators.

 

We evaluated our revenue sharing arrangements with the mobile telecommunications operators and content providers to determine whether to recognize our wireless data revenue gross or net of the shared revenues. Our determination was based upon an assessment of whether we act as principal or agent when providing wireless data services. We believe that the primary factors with respect to this assessment are whether we are the primary obligor to the user with respect to the provision of the wireless data services. Based on our assessments, we have decided to recognize our revenue based upon the gross amounts billed to our users.

 

Online Advertising Revenue Recognition

 

Our online advertising revenues are generally earned pursuant to contracts that include specific fee arrangements and payment terms, and that provide persuasive evidence that an arrangement exists. Revenue earned pursuant to these contracts is generally recognized either at the time that advertisements are displayed on

 

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our websites or when a specific number of website impressions are delivered. Certain of our contracts, however, do not include a fixed advertisement delivery pattern. Revenue earned pursuant to these contracts is deferred until the contract is completed. The timing with respect to revenues earned pursuant to these types of contracts could be materially different if the contracts included a fixed delivery pattern and a portion of the revenues could be recognized for services that are provided during periods prior to the period in which the contract is completed. In the fourth quarter of 2003, we deferred recognition of revenues from certain online advertising contracts that did not include a fixed delivery pattern in the terms of the arrangement. The total value of these contracts, all of which will be completed in 2004, is approximately US$1,500,000.

 

Internet Access Revenue Recognition

 

Internet access revenue is derived from the sale of prepaid cards that provide access to the Internet through various companies located throughout China. We sold cards that offer unlimited usage over a fixed period of time and cards that offer the use of a fixed amount of value of access prior to an expiration date. With respect to our unlimited usage cards that were not sold together with fixed value cards, we recognize revenue ratably over the fixed period during which the cards are valid. With respect to fixed value cards, and in situations where we sold both our unlimited usage cards and our fixed value cards to a single purchaser, we recognize revenue to the extent of costs incurred for providing Internet access to users. Any remaining revenue with respect to a particular card is recognized upon the expiration date of the card. If information was available to record revenue based on actual card usage, we would recognize revenue based upon actual usage. The timing of our Internet access revenue recognition could be materially different from what it would be if we recorded revenue based on actual usage.

 

Impairment of Intangible Assets and Goodwill

 

We assess the carrying value of our intangible assets and goodwill on an annual basis and when factors are present that indicate an impairment may have occurred.

 

During the year ended December 31, 2002, we recorded impairment charges of US$2,215,000, to write off the remaining book value of the intangible assets and goodwill related to certain of our acquisitions and certain intangible assets.

 

During the year ended December 31, 2002, due to the continued weak performance of our online advertising business and our annual assessment of the recoverability of our intangible assets, we considered the need for an impairment of the identifiable intangible assets and goodwill recognized in connection with our acquisition of China Travel Network. We determined the amount of the impairment charge by using a future discounted cash flow methodology.

 

In both years where we recorded our impairments, it was management’s judgment that an event and change in circumstances triggering the evaluation of goodwill and intangibles for impairment had occurred. If different judgments or estimates had been utilized, material differences could have resulted in the amount and timing of the impairment charges.

 

Impairment of Property and Equipment

 

We assess the carrying value of our property and equipment on an annual basis and when factors are present that indicate an impairment may have occurred. If the total of the expected future undiscounted cash flow is less than the carrying value, impairment is present and a loss is recognized in the statement of income for the difference between the fair value and the carrying value of the assets. The future undiscounted cash flow is based on management’s estimates and assumptions with respect to future revenues, cost of revenues and operating expenses. We cannot provide you with any assurances that actual results will be equal to our estimates. If

 

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management makes different judgments or adopts different assumptions, material differences could result in the amount and timing of any impairment charge that is recorded.

 

For the year ended December 31, 2001, we recognized impairment charges of US$2,960,000 mainly to write off certain computer hardware and software equipment owned by Shenzhen Freenet due to the overall decline in industry growth rates and negative industry and economic trends.

 

Deferred Tax Valuation Allowance

 

We record a valuation allowance to reduce our deferred tax assets if, based on an estimate of our future taxable income, it is more likely than not that some portion of, or all of, our deferred tax assets will not be realized. If unanticipated future events allow us to realize more of our deferred tax assets than the previously recorded net amount, an adjustment to the deferred tax asset would increase our net income when those events occur. As of December 31, 2003, we had deferred tax assets of US$5,386,000 and a valuation allowance of US$5,112,000. Our largest deferred tax asset item relates to our loss carry forwards.

 

Allowances for Doubtful Accounts

 

We establish provisions for bad debts on a quarterly basis. We maintain allowances for doubtful accounts receivable based on various information, including aging analysis of accounts receivable balances, historical bad debt rates, repayment patterns, client credit worthiness and industry trend analysis. Generally, when an accounts receivable is 180, 270 and 360 days overdue, we establish a provision for bad debts equal to 25%, 50% and 100% of the amount of the accounts receivable, respectively. We also make specific provisions for bad debts if there is strong evidence showing that the receivable is likely to be irrecoverable. If the financial conditions of our clients were to deteriorate, resulting in their potential inability to make payments, we may require additional allowance for doubtful accounts.

 

Consolidation of Variable Interest Entities

 

PRC laws and regulations restrict foreign ownership of companies that provide value-added telecommunications services and Internet content services in China. As a result, we conduct substantially all of our operations through Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, which are owned by PRC citizens. In addition, we have entered into a series of contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and their respective shareholders, pursuant to which we guarantee any obligations undertaken by these companies under their contractual arrangements with third parties and are entitled to receive service fees in an amount equal to substantially all of the net income of these companies. Accordingly, we bear the risks of, and enjoy the rewards associated with, the investments in Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network. As a result, we have determined that under U.S. GAAP we are the primary beneficiary of Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network and we consolidated the financial statements of these companies when preparing our consolidated financial statements.

 

Purchase Price Allocations

 

We account for our acquisitions using the purchase method. This method requires not only ascertaining the total cost of the acquisition but also allocating that cost to the individual assets and liabilities that we acquired based upon their fair values. We make judgments and estimates in determining the fair value of the acquired assets and liabilities. We base our determination upon independent appraiser valuation reports, our experience with similar assets and liabilities based upon our industry expertise, and forecasted future cash flows. The excess of the cost of the acquisition over the sum of the amounts allocated to identifiable assets and liabilities is recorded as goodwill. If we were to use different assumptions in determining fair value, the amounts assigned to the individual acquired assets and liabilities could be materially different.

 

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Pro Forma Adjustments and Unaudited Pro Forma Quarterly Financial Information

 

We have prepared unaudited pro forma financial data to reflect the effects of our reorganization and our acquisition of Puccini, which provides wireless IVR services through Wu Ji Network. We believe that our reorganization and our acquisition will have a material impact on our overall results of operations and that the presentation of unaudited pro forma financial data is necessary to supplement our audited historical consolidated financial data. For a description of our specific pro forma adjustments, see our unaudited pro forma consolidated financial information and supplemental selected unaudited pro forma consolidated quarterly financial information included elsewhere in this prospectus.

 

Our Reorganization

 

Our audited historical consolidated financial statements and the discussion and analysis herein reflect the effects of our reorganization from September 26, 2003. As a result, our audited historical consolidated financial statements include the financial results of the nine core Internet business entities for all periods presented and also include financial results of the six non-core Internet business entities up until September 26, 2003. The nine core Internet business entities and the six non-core Internet business entities together formed our parent company’s online media business in the PRC, which includes our wireless data service business, online advertising business and commercial enterprise solutions business. As part of our reorganization, our parent company transferred its interest in the nine core Internet business entities to us. The six non-core Internet business entities were not transferred to us primarily due to the fact that most of their business operations were moved to the nine core Internet business entities that form our company, and they are expected to be wound down or used by our parent company for other purposes. The six entities that were not transferred to us are Shenzhen Freenet Advertising, Sharkwave Information Technology (Beijing) Company Limited, or Sharkwave Technology, China Travel Network Company Limited, or China Travel Network, Beijing Oriental China Travel Agency Limited, Beijing Tom, and Beijing Planet Network Travel Information Technology Limited, or Beijing Planet Network.

 

Our unaudited pro forma consolidated statement of operations information gives effect to our reorganization as if our reorganization occurred on January 1, 2003. As a result, our unaudited pro forma consolidated statement of operations information includes the financial results of the nine companies that are part of our company following our reorganization, but excludes the financial results of the six companies that were included in our audited historical consolidated financial statements, but are no longer part of our company following our reorganization. For a discussion of our reorganization, see “Our Corporate Structure.”

 

Our Acquisition

 

We acquired on November 19, 2003 from Cranwood, a 24.6% shareholder of our parent company, the entire issued share capital of Puccini, which provides wireless IVR services through Wu Ji Network. Our audited historical consolidated financial statements include the financial results of Wu Ji Network following the completion of our acquisition. Our unaudited pro forma consolidated statement of operations information also gives pro forma effect to our acquisition of Puccini and the resulting consolidation of Wu Ji Network’s results of operations, as if the acquisition occurred on January 1, 2003. For a description of our acquisition, see “Our Acquisition.” For a description of our contractual arrangements with Wu Ji Network, see “Our Corporate Structure” and “Related Party Transactions.” For the financial results of Wu Ji Network, see “Selected Financial Data of Wu Ji Network,” and the financial statements of Wu Ji Network included elsewhere in this prospectus.

 

Pro Forma Adjustments

 

As a result of our pro forma adjustments, for the year ended December 31, 2003, our revenues would have increased 3.8% from US$77,073,000 on a historical basis to US$79,995,000 on a pro forma basis. This increase is due to the inclusion of Wu Ji Network’s revenues for the period from January 1, 2003 to November 19, 2003, the date of the acquisition, partially offset by the exclusion of the full year of revenues from the six entities not transferred to us as a result of our reorganization, which historically recognized most of our offline advertising

 

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revenue. In addition, our net income attributable to shareholders would have decreased 0.2% from US$19,572,000 on a historical basis to US$19,541,000 on a pro forma basis. This decrease is primarily due to the additional amortization of US$4,411,000 resulting from the recognition of identifiable intangible assets pursuant to our acquisition, partially offset by (i) the inclusion of Wu Ji Network’s net income of US$2,194,000 for the period from January 1, 2003 to November 19, 2003, the date of the acquisition, (ii) the exclusion of a non-recurring expense of US$1,842,000 recorded by Wu Ji Network for a donation to Shantou University made in connection with the acquisition of Puccini and (iii) the exclusion of the net losses of US$534,000 incurred by the business not transferred to us as a result of our reorganization for the full year of 2003.

 

Unaudited Pro Forma Quarterly Financial Information

 

The following table sets forth our supplemental selected unaudited pro forma quarterly results of operations for the periods indicated. We derived our quarterly results of operations from our unaudited pro forma financial information and, in our management’s opinion, we have prepared them on substantially the same basis as our unaudited pro forma consolidated financial information and included all adjustments necessary for a fair statement of the financial results for the periods presented. This information should be read in conjunction with our unaudited pro forma financial information included elsewhere in this prospectus. Our results of operations in any quarter are not necessarily indicative of the results that may be expected for any future periods.

 

     For the three months ended

 
     March 31, 2003

    June 30, 2003

    September 30, 2003

    December 31, 2003

 
ProForma Statement of
Operations Data
   Amount

    Percentage
of
revenues


    Amount

    Percentage
of
revenues


    Amount

    Percentage
of
revenues


    Amount

    Percentage
of
revenues


 
Revenues:    (unaudited and in thousands of U.S. dollars, except percentages)  

Wireless value-added services(1)

   9,113     64.8%     16,562     82.1%     17,929     78.1%     19,063     83.6%  

Advertising(2)

   176     1.2%     411     2.0%     823     3.6%     599     2.6%  

Commercial enterprise solutions(3)

   3,723     26.5%     2,819     14.0%     4,130     18.0%     3,087     13.5%  

Internet access(4)

   1,055     7.5%     385     1.9%     64     0.3%     56     0.3%  
    

 

 

 

 

 

 

 

Total revenues

   14,067     100.0%     20,177     100.0%     22,946     100.0%     22,805     100.0%  

Cost of revenues:

                                                

Cost of goods sold

   (3,132 )   (22.3% )   (2,126 )   (10.5% )   (3,689 )   (16.1% )   (2,344 )   (10.2% )

Cost of services

   (5,611 )   (39.9% )   (8,495 )   (42.1% )   (8,140 )   (35.5% )   (8,749 )   (38.4% )
    

 

 

 

 

 

 

 

Total cost of revenues

   (8,743 )   (62.2% )   (10,621 )   (52.6% )   (11,829 )   (51.6% )   (11,093 )   (48.6% )
    

 

 

 

 

 

 

 

Gross profit

   5,324     37.8%     9,556     47.4%     11,117     48.4%     11,712     51.4%  

Operating expenses(5)

   (4,573 )   (32.5% )   (4,005 )   (19.8% )   (4,500 )   (19.6% )   (4,596 )   (20.2% )
    

 

 

 

 

 

 

 

Income from operations

   751     5.3%     5,551     27.6%     6,617     28.8%     7,116     31.2%  

Other expenses

   (95 )   (0.7% )   (92 )   (0.5% )   (72 )   (0.3% )   (1 )   0.0%  
    

 

 

 

 

 

 

 

Income before tax

   656     4.6%     5,459     27.1%     6,545     28.5%     7,115     31.2%  

Income tax (expense)/credit

   (43 )   (0.3% )   (336 )   (1.7% )   172     0.7%     100     0.4%  
    

 

 

 

 

 

 

 

Income after tax

   613     4.3%     5,123     25.4%     6,717     29.2%     7,215     31.6%  

Minority interests

   (2 )   (0.0% )   (60 )   (0.3% )   (12 )   (0.1% )   (53 )   (0.2% )
    

 

 

 

 

 

 

 

Net income attributable to shareholders

   611     4.3%     5,063     25.1%     6,705     29.1%     7,162     31.4%  
    

 

 

 

 

 

 

 


(1)   Pro forma wireless value-added services includes both wireless data services and wireless IVR services, which are provided through Wu Ji Network.
(2)   Our pro forma advertising revenue primarily consists of online advertising revenue, but also includes revenue from offline advertising services that are bundled together with online advertising services.
(3)   Our commercial enterprise solutions revenue is primarily derived from the purchase and installation of computer hardware on behalf of our clients.
(4)   We stopped selling Internet access cards in the fourth quarter of 2002. In subsequent periods, however, we continue to recognize revenue and related costs with respect to outstanding Internet access cards. We do not expect to recognize revenue or costs from this business once the last Internet access card expires at the end of 2004.
(5)   Includes amortization expenses of US$1,260,000 per quarter.

 

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     For the three months ended

 
     March 31,
2003


    June 30,
2003


    September 30,
2003


    December 31,
2003


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

Other Pro Forma Financial Data

                        

Depreciation

   610     709     832     828  

Amortization

   1,260     1,260     1,260     1,260  

Gross Profit:

                        

Wireless value-added services

   4,139     8,423     10,207     10,748  

Advertising

   113     331     521     348  

Commercial enterprise solutions

   468     627     331     560  

Internet access

   604     175     58     56  
    

 

 

 

Total gross profits

   5,324     9,556     11,117     11,712  
    

 

 

 

Gross Profit Margin:

                        

Wireless value-added services

   45.4 %   50.9 %   56.9 %   56.4 %

Advertising

   64.2 %   80.5 %   63.3 %   58.1 %

Commercial enterprise solutions

   12.6 %   22.2 %   8.0 %   18.1 %

Internet access

   57.3 %   45.5 %   90.6 %   100.0 %

Total gross profit margin

   37.8 %   47.4 %   48.4 %   51.4 %

 

Revenues.    Our pro forma revenues decreased by 0.6% in the fourth quarter of 2003 from the third quarter of 2003. This decrease was primarily due to a decrease in our commercial enterprise solutions revenue and our online advertising revenue, partially offset by an increase in our wireless value-added services revenue. Our pro forma revenues increased by 13.7% and 43.4%, respectively, from the second quarter of 2003 to the third quarter of 2003, and from the first quarter of 2003 to the second quarter of 2003. These increases were primarily due to an increase in our wireless data services revenue and an increase in Wu Ji Network’s wireless IVR services revenue.

 

Cost of Revenues.    Our pro forma cost of revenues decreased by 6.2% in the fourth quarter of 2003 from the third quarter of 2003. This decrease was due to a decrease in the cost of goods sold as a result of a decrease in computer hardware sales to our commercial enterprise solutions clients, partially offset by an increase in costs attributable to our wireless value-added service business. Our pro forma costs of revenues increased by 11.4% in the third quarter of 2003 from the second quarter of 2003. This increase was primarily due to an increase in the costs of goods sold as a result of an increase in computer hardware sales to our commercial enterprise solutions clients, partially offset by a decrease in costs attributable to our wireless value-added services business. Our pro forma costs of revenues increased by 21.5% in the second quarter of 2003 from the first quarter of 2003. This increase was primarily due to an increase in costs attributable to our wireless value-added services business, partially offset by a decrease in the cost of goods sold as a result of a decrease in computer hardware sales to our commercial enterprise solutions clients. Our cost of revenues as a percentage of our revenues decreased to 48.6%, 51.6% and 52.6%, respectively, in the fourth, third and second quarter of 2003 from 62.2% in the first quarter of 2003. These decreases were primarily due to an increase in our wireless value-added services revenue and the relatively low marginal costs associated with this business.

 

Operating Expenses.     Our pro forma operating expenses increased by 2.1% and 12.4%, respectively, in the fourth quarter of 2003 from the third quarter of 2003 and in the third quarter of 2003 from the second quarter of 2003. These increases were primarily due to increases in our selling and marketing expenses. Our pro forma operating expenses decreased by 12.4% in the second quarter of 2003 from the first quarter of 2003. This decrease was primarily due to the provision for bad debts established in the first quarter of 2003 and the lack of any such provision in the second quarter of 2003.

 

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Results of Operations

 

The following discussion of our quarterly results of operations is based upon our unaudited historical quarterly consolidated statement of operations set forth in the footnotes to our supplemental selected unaudited pro forma consolidated quarterly financial information included elsewhere in this prospectus. The following discussion of our results of operations for the years ended December 31, 2001, 2002 and 2003 is based upon our audited historical consolidated financial statements included elsewhere in this prospectus.

 

We acquired Advanced Internet Services, Sharkwave Asia Pacific Limited and China Travel Network on November 1, 2000, December 1, 2000 and December 1, 2001, respectively. We acquired Advanced Internet Services and its controlled entities, including Shenzhen Freenet, which operated the 163.net business and provided free e-mail services in China, for a total consideration of US$46,293,000. In December 2000, we completed the acquisition of Sharkwave Asia Pacific Limited and its controlled entities, including Sharkwave Technology, which operated a major popular sports website in China, for a total consideration of US$14,893,000. We acquired China Travel Network, which owned a travel website specialized in providing domestic travel for the Chinese market, for a total consideration of shares in our parent company equivalent to US$2,062,000. Each of these acquisitions was accounted for as a purchase business combination and the results of operations for the acquired entities have been included in our consolidated financial statements from the date of the respective acquisitions. We have integrated the operations of these companies into our operations, although China Travel Network and Sharkwave Asia Pacific Limited are not part of our company following our reorganization.

 

Unaudited Quarterly Results of Operation

 

Wireless Value-Added Services.    Revenue from our wireless value-added services increased 20.0% to US$17,564,000 for the fourth quarter of 2003 from US$14,637,000 for the third quarter of 2003. This increase was primarily due to an increase in our WAP revenue and the consolidation of Wu Ji Network in our financial results following completion of our acquisition on November 19, 2003. Our WAP revenue increased by approximately US$780,000 from the third quarter to the fourth quarter of 2003, primarily due to improvements in the quality of networks due to investments in WAP services by China Mobile as well as an increase in marketing of WAP services by China Mobile. Wu Ji Network’s revenues from November 20, 2003 to December 31, 2003 were US$2,307,000. In addition, in the fourth quarter of 2003, our SMS subscriptions increased and our SMS downloads decreased, in part due to our increased marketing efforts for subscriptions as opposed to downloads and an increase in subscriptions sold through our alliances with mobile phone producers.

 

Revenue from our wireless value-added services decreased 1.7% to US$14,637,000 in the third quarter of 2003 from US$14,883,000 in the second quarter of 2003. This decrease was primarily due to a decrease in our SMS revenue as a result of a decline in both our SMS subscriptions and our SMS downloads. Our SMS subscriptions decreased 2.3% to 8.5 million in the third quarter of 2003 from 8.7 million in the second quarter of 2003. Our SMS downloads decreased 11.6% to 78.8 million in the third quarter of 2003 from 89.1 million in the second quarter of 2003. The primary reason for these decreases is a decrease in subscriptions and downloads purchased through our alliances with third party websites.

 

Revenue from our wireless value-added services increased 70.0% to US$14,883,000 for the second quarter of 2003 from US$8,759,000 for the first quarter of 2003. This increase was primarily due to an increase in our SMS revenue as a result of an increase in our SMS subscriptions and our SMS downloads, as well as increased sales of certain more expensive subscription products. Our SMS subscriptions increased 58.2% to 8.7 million in the second quarter of 2003 from 5.5 million in the first quarter of 2003, primarily due to an increase in subscriptions purchased through our alliances with third party websites. Our SMS downloads increased 6.8% to 89.1 million in the second quarter of 2003 from 83.4 million in the first quarter of 2003, primarily due to the general expansion of the SMS market in China.

 

Advertising.    Revenue from our advertising services decreased 73.7% to US$599,000 in the fourth quarter of 2003 from US$2,279,000 in the third quarter of 2003. This decrease was due to a 43.2% decrease in the

 

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number of advertising clients to 50 in the fourth quarter of 2003 from 88 in the third quarter of 2003, and a 53.8% decrease in the average revenue per client to US$12,000 in the fourth quarter of 2003 from US$26,000 in the third quarter of 2003. The decrease in the number of advertising clients as well as the average revenue per client was primarily due to the completion of our reorganization on September 26, 2003, and the resulting exclusion of the offline advertising operations of Shenzhen Freenet Advertising and Beijing Tom from our fourth quarter historical consolidated results of operations. Revenue from our online advertising services, which includes bundled offline advertising services, decreased 27.2% to US$599,000 in the fourth quarter of 2003 from US$823,000 in the third quarter of 2003. This decrease was due to a 14.3% decrease in our average revenue per online advertising client to US$12,000 in the fourth quarter of 2003 from US$14,000 in the third quarter of 2003 and a 12.3% decrease in our number of online advertising clients to 50 in the fourth quarter of 2003 from 57 in the third quarter of 2003. The decrease in the average revenue per online advertising client was primarily due to the fact that we deferred revenues earned with respect to certain online advertising contracts that we provided services under in the fourth quarter of 2003 because the contracts did not include a fixed delivery pattern. The total value of these contracts, all of which will be completed in 2004, is approximately US$1,500,000. See “— Critical Accounting Policies — Online Advertising Revenue Recognition.” Online advertising revenue accounted for all of our advertising revenue in the fourth quarter of 2003.

 

Revenue from our advertising services increased 34.1% to US$2,279,000 for the third quarter of 2003 from US$1,699,000 for the second quarter of 2003. This increase was due to a 2.3% increase in the number of our advertising clients to 88 in the third quarter of 2003 from 86 in the second quarter of 2003, and a 30.0% increase in the average revenue per client to US$26,000 in the third quarter of 2003 from US$20,000 in the second quarter 2003. Due to our increased focus on online advertising and our enhanced attractiveness to advertisers as the number of page views of our websites increased, our online advertising revenue, which includes revenue from bundled offline advertising services, increased to US$823,000 for the third quarter of 2003 from US$411,000 for the second quarter of 2003. This increase was due to a 75.0% increase in our average revenue per online advertising client to US$14,000 in the third quarter of 2003 from US$8,000 in the second quarter of 2003 and an 11.8% increase in our number of online advertising clients to 57 in the third quarter of 2003 from 51 in the second quarter of 2003. Our online advertising revenue accounted for 36.1% of our total advertising revenue in the third quarter of 2003.

 

Revenue from our advertising services increased 34.0% to US$1,699,000 for the second quarter of 2003 from US$1,268,000 for the first quarter of 2003. This increase was due to a 16.2% increase in the number of our advertising clients to 86 in the second quarter of 2003 from 74 in the first quarter of 2003 and a 17.6% increase in our average revenue per client to US$20,000 in the second quarter of 2003 from US$17,000 in the first quarter of 2003. The increase in our advertising revenue was partially due to an increase in our online advertising revenue, which includes revenue from bundled offline advertising services, to US$411,000 in the second quarter of 2003 from US$176,000 in the first quarter of 2003. This increase was due to an increase in our average revenue per online advertising client to US$8,000 in the second quarter of 2003 from US$4,000 in the first quarter of 2003 and an 18.6% increase in our number of online advertising clients to 51 in the second quarter of 2003 from 43 in the first quarter of 2003. Our online advertising revenue accounted for 24.2% and 13.9%, respectively, of our total advertising revenue in the second quarter and the first quarter of 2003.

 

Commercial Enterprise Solutions.    Revenue from our commercial enterprise solutions decreased 25.3% to US$3,087,000 in the fourth quarter of 2003 from US$4,132,000 in the third quarter of 2003. This decrease was primarily due to a 36.6% decrease in our average revenue per large contract to US$142,000 in the fourth quarter of 2003 from US$224,000 in the third quarter of 2003, partially offset by a 5.9% increase in our number of large contracts to 18 in the fourth quarter of 2003 from 17 in the third quarter of 2003. Large commercial enterprise solutions contracts, which are those contracts with a value of RMB500,000 (US$60,411) or above, accounted for 82.8% of our commercial enterprise solutions revenue in the fourth quarter of 2003. Our commercial enterprise solutions revenue is dependent upon the size and timing of our client’s projects. As a result, our commercial enterprise solutions revenue has fluctuated from period to period. Generally, however, we intend to reduce our

 

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focus on our relatively low gross profit margin computer hardware sales and to increase our focus on providing our higher gross profit margin integrated computer software solutions.

 

Revenues from our commercial enterprise solutions increased 45.0% to US$4,132,000 in the third quarter of 2003 from US$2,849,000 in the second quarter of 2003. This increase was primarily due to an increase in our number of large contracts to 17 in the third quarter of 2003 from 6 in the second quarter of 2003, partially offset by a 45.2% decrease in our average revenue per large contract to US$224,000 in the third quarter of 2003 from US$409,000 in the second quarter of 2003. Large commercial enterprise solutions contracts, which are those contracts with a value of RMB500,000 (US$60,411) or above, accounted for 92.2% of our commercial enterprise solutions revenue in the third quarter of 2003.

 

Revenues from our commercial enterprise solutions decreased 24.2% to US$2,849,000 in the second quarter of 2003 from US$3,757,000 in the first quarter or 2003. This decrease was primarily due to a 62.5% decrease in our number of large contracts to 6 in the second quarter of 2003 from 16 in the first quarter of 2003, partially offset by an increase in our average revenue per large contract to US$409,000 in the second quarter of 2003 from US$190,000 in the first quarter of 2003. Large commercial enterprise solutions contracts, which are those contracts with a value of RMB500,000 (US$60,411) or above, accounted for 86.1% and 80.8%, respectively, of our commercial enterprise solutions revenue in the second and first quarters of 2003.

 

Cost of Revenues.    Our cost of revenues decreased 12.8% to US$10,735,000 in the fourth quarter of 2003 from US$12,311,000 in the third quarter of 2003. This decrease was partially due to a 36.5% decrease in our costs of goods sold to US$2,344,000 in the fourth quarter of 2003 from US$3,689,000 in the third quarter of 2003, as a result of a decrease in computer hardware sales to our commercial enterprise solutions clients. This decrease was also partially due to a 2.7% decrease in our cost of services to US$8,391,000 in the fourth quarter of 2003 from US$8,622,000 in the third quarter of 2003, due to the completion of our reorganization on September 26, 2003 and the resulting exclusion of the cost of services from the offline advertising operations of Shenzhen Freenet Advertising and Beijing Tom from our fourth quarter historical consolidated results of operations. The cost of services for these companies in the third quarter of 2003 was US$1,359,000.

 

Our cost of revenues increased by 8.0% to US$12,311,000 for the third quarter of 2003 from US$11,403,000 for the second quarter of 2003. This increase was primarily due to an increase in the cost of goods sold to US$3,689,000 in the third quarter of 2003 from US$2,126,000 in the second quarter of 2003, as a result of an increase in computer hardware sales to our commercial enterprise solutions clients. This increase was partially offset by a decrease in the cost of services to US$8,622,000 in the third quarter of 2003 from US$9,277,000 in the second quarter of 2003. This decrease was primarily due to a decrease in the direct costs of our wireless value-added services as a result of our decision to reduce our cooperation with certain Internet companies with which we have established promotion arrangements and the resulting reduction in revenue shared with these companies. The direct costs of our wireless value-added services decreased to US$4,811,000 in the third quarter of 2003 from US$5,712,000 in the second quarter of 2003.

 

Our cost of revenues increased by 18.3% to US$11,403,000 for the second quarter of 2003 from US$9,636,000 for the first quarter of 2003. This increase was primarily due to a 76.2% increase in the direct costs of our wireless value-added services business to US$5,712,000 in the second quarter of 2003 from US$3,242,000 in the first quarter of 2003 as a result of our expansion in this business. This increase was partially offset by a 32.1% decrease in the cost of goods sold to US$2,126,000 in the second quarter of 2003 from US$3,132,000 in the first quarter of 2003 as a result of a decrease in computer hardware sales to our commercial enterprise solutions clients.

 

Gross Profits.    As a result of the foregoing, our gross profits increased 20.1% to US$10,571,000 for the fourth quarter of 2003 from US$8,801,000 for the third quarter of 2003. Our gross profits as a percentage of revenues, or gross profit margin, increased to 49.6% for the fourth quarter of 2003 from 41.7% for the third quarter of 2003.

 

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As a result of the foregoing, our gross profits increased 4.6% to US$8,801,000 for the third quarter of 2003 from US$8,413,000 for the second quarter of 2003. Our gross profit margin decreased to 41.7% for the third quarter of 2003 from 42.5% for the second quarter of 2003.

 

As a result of the foregoing, our gross profits increased 61.7% to US$8,413,000 for the second quarter of 2003 from US$5,203,000 for the first quarter of 2003. Our gross profit margin, increased to 42.5% for the second quarter of 2003 from 35.1% for the first quarter of 2003. This increase was primarily due to an increase in our wireless value-added services revenue and the relatively low marginal costs associated with this business.

 

Operating Expenses.    Our operating expenses increased 9.4% to US$3,710,000 for the fourth quarter of 2003 from US$3,392,000 for the third quarter of 2003. This increase was primarily due to a 61.5% increase in our selling and marketing expenses to US$1,084,000 in the fourth quarter of 2003 from US$671,000 in the third quarter of 2003 as a result of an increase in marketing events for our wireless value-added services as well as the initiation of marketing for the launch of our online game business.

 

Our operating expenses increased 21.0% to US$3,392,000 for the third quarter of 2003 from US$2,804,000 for the second quarter of 2003. This increase was primarily due to a 38.1% increase in our selling and marketing expenses to US$671,000 for the third quarter of 2003 from US$486,000 for the second quarter of 2003 as a result of our increased expenses incurred to promote our Internet websites and build our brand name.

 

Our operating expenses decreased 15.5% to US$2,804,000 for the second quarter of 2003 from US$3,317,000 for the first quarter of 2003. This decrease was primarily due to a US$1,004,000 provision for bad debts, mainly relating to our Internet access business, that was established in the first quarter of 2003, and our determination that no additional provision was necessary in the second quarter of 2003. Our operating expenses as a percentage of our revenues decreased to 14.2% for the second quarter of 2003 from 22.4% for the first quarter of 2003. This decrease was primarily due to an increase in our revenues and a decrease in our operating expenses. Our increase in revenues and decrease in operating expenses were primarily a result of the economies of scale associated with our wireless data services business and our continuing efforts to control our costs and expenses.

 

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

 

Our revenues increased to US$77,073,000 in 2003 from US$29,975,000 in 2002. This increase was primarily due to an increase in revenues from our wireless value-added services business.

 

Wireless Value-Added Services.    Our wireless value-added services revenue increased to US$55,843,000 in 2003 from US$9,958,000 in 2002. This increase was primarily due to an increase in our SMS revenue due to an increase in both our SMS subscriptions and SMS downloads. In 2003, we had 31.8 million SMS subscriptions and 324.2 million SMS downloads. The increase in our SMS subscriptions was primarily due to the full year effect of this service, which we launched in the third quarter of 2002. The increase in SMS subscriptions as well as SMS downloads was also due to our increased focus upon developing our wireless value-added services business, which included increasing promotional efforts as well as expanding our product portfolio, and the general expansion of the SMS market in China.

 

Advertising.    Our advertising revenue increased 38.2% to US$5,845,000 in 2003 from US$4,228,000 in 2002. This increase was due to a 73.7% increase in the average revenue per client to US$33,000 in 2003 from US$19,000 in 2002, partially offset by a 19.5% decrease in the number of our advertising clients to 178 in 2003 from 221 in 2002. In 2003, due to our increased focus on online advertising and our enhanced attractiveness to advertisers as the number of page views of our websites increased, our online advertising revenue, including bundled offline advertising revenue, reached US$2,009,000 in 2003 and accounted for 34.4% of our total advertising revenue. In 2003, we had 122 online advertising clients and our average revenue per online advertising client was US$16,000.

 

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Commercial Enterprise Solutions.    Our commercial enterprise solutions revenue increased 23.0% to US$13,825,000 in 2003 from US$11,244,000 in 2002. This increase was primarily due to a 38.6% increase in our average revenue per large contract to US$244,000 in 2003 from US$176,000 in 2002, partially offset by a 4.0% decrease in our number of large contracts to 48 in 2003 from 50 in 2002. Large commercial enterprise solutions contracts, which are those contracts with a value of RMB500,000 (US$60,411) or above, accounted for 84.8% and 78.1%, respectively, of our commercial enterprise solutions revenue in 2003 and 2002. Our commercial enterprise solutions revenue is dependent upon the size and timing of our client’s projects. As a result, the number of our commercial enterprise solutions contracts and the average revenue per contract has fluctuated from period to period. Generally, however, we intend to reduce our focus on our relatively low gross profit margin computer hardware sales and to increase our focus on providing our higher gross profit margin integrated computer software solutions.

 

Internet Access.    Our Internet access revenue decreased 65.7% to US$1,560,000 in 2003 from US$4,545,000 in 2002. This decrease was due to the fact that we stopped selling our Internet access cards in the fourth quarter of 2002. We did, however, continue to recognize revenue and incur costs with respect to our Internet access business in 2003 because Internet access cards that were sold in prior periods were used during this period. We do not expect to recognize a material amount of revenue or incur a material amount of costs with respect to our Internet access business in future periods.

 

Total Revenues.    As a result of the foregoing, our total revenues increased to US$77,073,000 in 2003 from US$29,975,000 in 2002.

 

Cost of Goods Sold.    Our cost of goods sold increased 38.7% to US$11,291,000 in 2003 from US$8,143,000 in 2002. This increase was due to an increase in our computer hardware sales to commercial enterprise solutions clients and the resulting increase in the cost of computer hardware sold.

 

Cost of Services.    Our cost of services increased 96.0% to US$32,794,000 in 2003 from US$16,731,000 in 2002. This increase was primarily due to an increase in the costs of our wireless value-added services as a result of the expansion of this business. The direct costs of our wireless value-added services increased to US$18,851,000 in 2003 from US$2,976,000 for the same period in 2002.

 

Total Cost of Revenues.    As a result of the increase in our costs of goods sold and our costs of services, our total cost of revenues increased 77.2% to US$44,085,000 in 2003 from US$24,874,000 in 2002.

 

Gross Profit.    As a result of the foregoing, our gross profit increased to US$32,988,000 in 2003 from US$5,101,000 in 2002.

 

Selling and Marketing Expenses.    Our selling and marketing expenses decreased 9.7% to US$2,772,000 in 2003 from US$3,069,000 in 2002. This decrease was primarily due to the fact that we were able to eliminate 14 sales and marketing positions as a result of our decision to stop selling Internet access cards in the fourth quarter of 2002. In addition, our marketing expenses in 2002 included a US$134,000 advertising campaign that we conducted in connection with the Soccer World Cup that was hosted by Korea and Japan. We did not conduct a comparable campaign in 2003.

 

General and Administrative Expenses.    Our general and administrative expenses increased 24.2% to US$9,133,000 in 2003 from US$7,356,000 in 2002. This increase was primarily due to an increase in our provisions for bad debts and an increase in our compensation and benefits expenses. In 2003 we increased our provisions for bad debts to US$1,487,000 from US$781,000 in 2002 as a result of outstanding receivables from wholesale purchasers of our Internet access cards. For a discussion of our allowances for doubtful accounts policy, see “—Critical Accounting Policies.” We discontinued our Internet access business in the fourth quarter of 2002. Our compensation and benefits expenses increased 53.2% to US$3,563,000 from US$2,325,000 in 2002 as a result of an increase in the number of our general management, finance and administrative personnel to 97

 

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on December 31, 2003 from 85 on December 31, 2002, as well as an increase in the average compensation and benefits paid to our personnel.

 

Amortization of Intangibles.    Our amortization of intangibles increased to US$629,000 in 2003 from US$88,000 in 2002. This increase was primarily due to amortization of a contract between Wu Ji Network and China Mobile for the provision of wireless IVR services, which was acquired on November 19, 2003 in connection with our acquisition of Puccini. As a result of our acquisition, our amortization of intangibles will increase in future periods.

 

Total Operating Expenses.    As a result of the foregoing, our total operating expenses decreased 1.5% to US$13,223,000 in 2003 from US$13,420,000 in 2002.

 

Income/(Loss) from Operations.    As a result of the foregoing, our income from operations was US$19,765,000 in 2003 compared to a loss of US$8,319,000 in 2002.

 

Income Tax (Expense)/Credit.    We recorded an income tax credit of US$254,000 in 2003 as opposed to an income tax expense US$16,000 in 2002. The primary reason for this tax credit was the recognition of a US$274,000 deferred tax asset by Beijing Lei Ting.

 

Minority Interests.    The portion of income attributable to minority interests was US$127,000 in 2003 compared with a portion of loss attributable to minority interests of US$389,000 in 2002. This change was due to a change in the net income of GreaTom. We recognize the entire net income or net loss of GreaTom in our consolidated financial statements and then deduct the portion of that net income, or add back the portion of the net loss, attributable to Great Wall Computer Software and Systems Co., Ltd. and Great Wall Technology Company, Ltd., which owned 20% and 10%, respectively, of GreaTom in 2001. In November 2003, Shenzhen Freenet purchased a 20% interest in GreaTom from Great Wall Computer Software and Systems Co. Ltd. Accordingly, from the date of this acquisition, only 10% of the net income or net loss of GreaTom will be attributed to minority interests.

 

Net Income.    As a result of the foregoing, our net income attributable to shareholders was US$19,572,000 in 2003 compared to a net loss of US$8,354,000 in 2002.

 

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

 

Our revenues increased to US$29,975,000 in 2002 from US$6,433,000 in 2001. This increase was primarily due to an increase in revenues from our commercial enterprise solutions, wireless value-added services, advertising and Internet access businesses.

 

Wireless Value-added Services.    Our wireless value-added services revenue increased to US$9,958,000 in 2002 from US$30,000 in 2001. In 2002, all of our wireless value-added services revenue was SMS revenue, which increased due to an increase in our SMS downloads and the launch of our SMS subscription service in the third quarter of 2002. The increase in our SMS downloads was primarily due to full year effect of this service, which we launched in the second half of 2001, and the general expansion of the SMS market in China.

 

Advertising.    Our advertising revenue increased 43.3% to US$4,228,000 in 2002 from US$2,950,000 in 2001. This increase was due to a 54.5% increase in the number of our advertising clients to 221 in 2002 from 143 in 2001, partially offset by an 9.5% decrease in the average revenue per client to US$19,000 in 2002 from US$21,000 in 2001. The increase in advertising clients was partially due to an increase in the advertising market in China in connection with the 2002 Soccer World Cup.

 

Commercial Enterprise Solutions.    Our commercial enterprise solutions revenue increased to US$11,244,000 in 2002 from US$1,479,000 in 2001. This increase was primarily due to an increase in revenue

 

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increase was primarily due to the establishment of a dedicated management team in 2002 that initiated an organized marketing effort to promote our commercial enterprise solutions business, as well as an increase in computer hardware sales to our commercial enterprise solutions clients. As a result, the number of our large contracts increased to 50 in 2002 from 9 in 2001 and our average revenue per large contract increased 35.4% to US$176,000 in 2002 from US$130,000 in 2001. Large commercial enterprise solutions contracts, which are those contracts with a value of RMB500,000 (US$60,411) or above, accounted for 78.1% and 79.2%, respectively, of our commercial enterprise solutions revenue in 2002 and 2001. Our dedicated management team focused its marketing efforts upon key industries such as telecommunications, financial services and transportation, and succeeded in entering into contracts with new clients in each of these industries. Pursuant to these contracts, we worked with our clients to develop new customized products such as a broadband billing system and an automated camera traffic ticketing system.

 

Internet Access.    Our Internet access revenue increased to US$4,545,000 in 2002 from US$1,974,000 in 2001. This increase was primarily due to the full year effect of revenue from our Internet access business, which we launched in the second half of 2001.

 

Total Revenues.    As a result of the foregoing, our total revenues increased to US$29,975,000 in 2002 from US$6,433,000 in 2001.

 

Cost of Goods Sold.    Our cost of goods sold increased to US$8,143,000 in 2002 from US$59,000 in 2001. This increase was due to an increase in computer hardware sales to our commercial enterprise solutions clients and the resulting increase in the cost of computer hardware sold.

 

Cost of Services.    Our cost of services increased 54.2% to US$16,731,000 in 2002 from US$10,849,000 in 2001. This increase was primarily due to an increase in the direct cost associated with our wireless data services business to US$2,976,000 in 2002 from US$14,000 in 2001 as a result of the full year effect of revenue from this business and an increase in the direct cost associated with our advertising business to US$3,500,000 in 2002 from US$1,332,000 in 2001. In addition, costs associated with our Internet access business increased to US$4,090,000 in 2002 from US$1,867,000 in 2001. However, we stopped selling our Internet access cards in the fourth quarter of 2002.

 

Total Cost of Revenues.    As a result of the increase in our cost of goods sold and our cost of services, our total cost of revenues increased to US$24,874,000 in 2002 from US$10,908,000 in 2001.

 

Gross Profit/(Loss).    As a result of the foregoing, our gross profit was US$5,101,000 in 2002 compared to a gross loss of US$4,475,000 in 2001.

 

Selling and Marketing Expenses.    Our selling and marketing expenses decreased 46.7% to US$3,069,000 in 2002 from US$5,755,000 in 2001. This decrease was primarily due to a reduction in brand promotion expenses, which were greater during 2001 due to our efforts to promote our Internet portal that was newly launched at that time.

 

General and Administrative Expenses.    Our general and administrative expenses decreased 16.5% to US$7,356,000 in 2002 from US$8,808,000 in 2001. This decrease was primarily due to a net reduction in staff to 461 at the end of 2002 from 503 at the end of 2001 and the resulting reduction in compensation and benefit expenses of US$1,158,000.

 

Product Development Expenses.    Our product development expenses decreased 36.2% to US$692,000 in 2002 from US$1,085,000 in 2001. This decrease was primarily due to our efforts to reduce expenses, which included reducing the number of our research and development staff.

 

Provision for Impairment of Goodwill, Intangibles and Property and Equipment.    Our provision for impairment of goodwill, intangibles and property and equipment decreased to US$2,215,000 in 2002 from

 

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US$2,960,000 in 2001. This decrease was primarily due to a US$2,960,000 provision for impairment of property and equipment that we established in 2001 and the lack of any such provision in 2002. This decrease was partially offset by a US$1,949,000 provision for impairment of goodwill that we established in 2002 in connection with the goodwill that we recorded from our acquisition of China Travel Network. Following our reorganization, however, China Travel Network is not part of our company. For a discussion of our policy for recognizing impairment of property and equipment and impairment of goodwill, see “— Critical Accounting Policies.”

 

Total Operating Expenses.    As a result of the foregoing, our total operating expenses decreased 27.9% to US$13,420,000 in 2002 from US$18,616,000 in 2001.

 

Loss from Operations.    As a result of the foregoing, our loss from operations decreased 64.0% to US$8,319,000 in 2002 from US$23,091,000 in 2001.

 

Income Tax Expense.    Our income tax expense was US$16,000 in 2002 compared with no income tax expense in 2001. This increase was due to income tax expense of US$16,000 assessed with respect to the net income of Beijing Tom. Following our reorganization however, Beijing Tom is no longer a part of our company.

 

Minority Interests.    The portion of loss attributable to minority interests increased 32.3% to US$389,000 in 2002 from US$294,000 in 2001. This increase was due to an increase in the loss made by GreaTom, and the resulting increase in the amount of GreaTom’s net loss that was attributed to the minority shareholders, which collectively owned 30.0% of GreaTom during these periods.

 

Net Loss.    As a result of the foregoing, our net loss attributable to shareholders decreased by 63.9% to US$8,354,000 in 2002 from US$23,144,000 in 2001.

 

Liquidity and Capital Resources

 

Cash Flows and Working Capital

 

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

 

     For the year ended December 31,

 
     2001

    2002

    2003

 
     (in thousands of U.S. dollars)  

Net cash (used in)/provided by operating activities

   (12,381 )   (4,564 )   19,669  

Net cash used in investing activities

   (2,598 )   (4,935 )   (2,758 )

Net cash provided by/(used in) financing activities

   12,042     10,974     (1,027 )
    

 

 

Net (decrease)/increase in cash and cash equivalents

   (2,937 )   1,475     15,884  
    

 

 

 

To date, we have primarily financed our operations through capital contributions and advances from our parent company. Our parent company does not, however, intend to provide us with capital contributions or advances in future periods. As of December 31, 2003, our amounts due to related parties was US$19,983,000 and our cash and cash equivalents was US$22,636,000.

 

Net cash provided by operating activities was US$19,669,000 in 2003 compared to net cash used in operating activities of US$4,564,000 in 2002. This increase was primarily due to an increase in our net income, partially offset by an increase in our accounts receivable. Prior to 2003, we experienced significant negative cash flows from our operating activities.

 

Our net accounts receivable have experienced a steady increase from US$5,370,000 as of December 31, 2001, to US$8,003,000 as of December 31, 2002, and to US$14,689,000 as of December 31, 2003. This increase

 

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is primarily due to an increase in our revenues and the resulting increase in net accounts receivable at any given point in time. The average collection time for our accounts receivable has, however, decreased from 156 days in 2001 to 81 days in 2002 and to 54 days in 2003. This decrease was primarily due to our decision to stop selling of our Internet access cards, the expansion of our wireless data services business and the fact that our wireless data service business has a shorter payment cycle than our Internet access business. We establish provisions for bad debts in accordance with our provisioning policy, which is based upon several factors including the amount of time that a receivable has been overdue. For a discussion of our allowances for doubtful accounts policy, see “— Critical Accounting Policies.”

 

Currently, the majority of our net accounts receivable consist of fees due to us from mobile telecommunications operators pursuant to our revenue sharing arrangements for wireless value-added services. We have entered into separate revenue sharing arrangements with the various subsidiaries of the mobile telecommunications operators. In 2003, the majority of our wireless value-added services revenue was contributed by five separate entities of the mobile telecommunications operators, upon whom we rely for billing and collection services. In the event that any of the subsidiaries of the mobile telecommunications operators should withhold, suspend or delay the payment of such fees to us, we may experience cash flow difficulties, in that our net cash from operating activities may not be sufficient to meet our cash needs. See “Risk Factors — Risks Relating to Our Business — A substantial portion of our business depends on mobile telecommunications operators in China, and any loss or deterioration of such relationship may result in severe disruptions to our business operations and the loss of a significant portion of our revenues.”

 

Net cash used in investing activity was US$2,758,000 in 2003 compared to US$4,935,000 in 2002. This decrease was primarily due to the acquisition of Wu Ji Network’s cash and cash equivalents in connection with our acquisition of Puccini, partially offset by the exclusion of the cash and cash equivalents from the six non-core Internet business entities in connection with our reorganization. Our net cash used in investing activity has primarily been used to purchase servers and other computer hardware in connection with the expansion of our business. Our total capital expenditures for computer hardware for the years ended December 31, 2003, 2002 and 2001 was US$4,111,000, US$3,020,000 and US$2,151,000, respectively. Our total capital expenditures completed after December 31, 2003 and prior to January 20, 2004 was US$238,000. We currently have US$710,000 worth of capital expenditures in progress, all of which will be located in Beijing. Our capital expenditures in progress are financed from retained earnings. Our principal capital divestitures consist of servers and other computer hardware. We do not have any material capital divestitures in progress.

 

The following table sets forth our capital expenditures and divestitures for the periods indicated:

 

     For the year
ended December 31,


     2001

   2002

   2003

     (in thousands of U.S. dollars)

Capital expenditures

   2,749    4,451    4,790

Capital divestitures (cost)

   19    302    479

Capital divestitures (book value)

   8    195    91

 

Net cash used in financing activities was US$1,027,000 in 2003. These amounts related to the repayment of advances from related parties. In prior periods, net cash flows from financing activities have primarily been due to advances from related parties, which have been used to finance capital expenditures and other costs and expenses relating to our operations.

 

We believe that our current cash and cash equivalents, cash flow from operations and the proceeds from the global offering will be sufficient to meet our anticipated cash needs, including for working capital, capital expenditures and various contractual obligations, 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

 

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investments or acquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirements, we may seek to sell debt securities or additional equity or to obtain a credit facility. The sale of convertible debt securities or additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financial covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

 

Indebtedness

 

As of December 31, 2003, our amounts due to related parties was US$19,983,000, which is the aggregate amount of several loans from our parent company that bear interest at the rate of 1.65% per annum over the Hong Kong dollar interbank offered rate and that do not have fixed repayment terms, but will become repayable on demand after December 31, 2004. Our parent company has, however, agreed not to demand repayment of these loans prior to December 31, 2006 unless (i) our ordinary shares have been listed on GEM for one year, (ii) in the most recent fiscal year we had positive cash flow from operations and net profit and (iii) each of our independent non-executive directors agree that such repayment will not adversely affect our operations or the implementation of our business objectives. As of December 31, 2003, we did not have any other indebtedness, and we did not have any material debt securities or material mortgages or liens. In addition, other than our obligations in connection with our acquisition of Puccini, as of December 31, 2003, we did not have any material contingent liabilities.

 

The following table sets forth our indebtedness as of the dates indicated:

 

     As of December 31,

     2001

   2002

   2003

     (in thousands of U.S. dollars)

Short-term debt

   3,615      

Long-term liabilities due to related parties

   11,801    26,316    19,983
    
  
  

Total debt

   15,416    26,316    19,983
    
  
  

 

Except as otherwise disclosed herein and apart from intra-group liabilities, as of December 31, 2003, we did not have any outstanding loan capital issued or agreed to be issued, bank overdrafts, loans, debt securities or other similar indebtedness, liabilities under acceptance (other than normal trade bills) or acceptance credits, debentures, mortgages, charges, finance leases or hire purchase commitments, guarantees or other material contingent liabilities. In addition there has not been any material change in our indebtedness, commitments and contingent liabilities since December 31, 2003.

 

Contractual Obligations and Commercial Commitments

 

The following table sets forth our contractual obligations as of December 31, 2003:

 

     Payments due by period

     Total

   Within 1
year


   2005

   2006

   Thereafter

     (in thousands of U.S. dollars)

Long-term debt

   19,983       19,983      —      —

Operating lease commitments

   3,120    1,244    1,180    696   

Other contractual commitments

   1,842    1,842         
    
  
  
  
  

Total contractual obligations

   24,945    3,086    21,163    696   
    
  
  
  
  

 

In addition to the contractual obligations set forth in the table above, we are obligated to make a cash payment of up to US$75,000,000 in the first half of 2005 in connection with our acquisition of Puccini, which

 

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provides wireless IVR services through Wu Ji Network. This cash payment represents only half of the purchase price of Puccini, as the other half of the purchase price will be paid with our ordinary shares. The purchase price consists of (a) an initial consideration of (i) US$1.00 at the time of completion and (ii) a sum of US$18,500,000 in the form of our shares at the initial public offering price, which will be placed with an escrow agent and (b) an earn-out consideration that is equal to (i) 7.7 times Puccini’s 2004 audited consolidated net profit, or (ii) if such 2004 audited consolidated net profit is less than an amount equal to 1.2 times the greater of Puccini’s 2003 audited consolidated net profit and RMB40,000,000 (US$4,832,844), an amount equal to 6 times Puccini’s 2004 audited consolidated net profit. In addition, the total purchase price will be subject to a maximum consideration of US$150,000,000. The payment of the cash portion of the purchase price will be due within 30 days of our agreement of Puccini’s 2004 accounts with Cranwood. Cranwood has, however, agreed to provide us, upon request, within 10 business days following the final payment, an unsecured, twelve-month loan at an interest rate of 0.5% over LIBOR, in an amount equal to half of the cash consideration actually received by Cranwood. Furthermore, Cranwood has exercised its right under the agreement to distribute substantially all of the retained earnings of Wu Ji Network accumulated prior to September 25, 2003, the date of the acquisition agreement by donating a sum of US$1,842,000 to Shantou University in China and confirmed that this donation satisfied such right in full. We have accrued a liability for this donation, and expect to make the donation in 2004. For a description of the terms of our acquisition, see “Our Acquisition — Terms of the Acquisition.” We plan to use our internal resources, including cash generated from operations, to fund this payment and if necessary, will seek other financial resources, including bank borrowings.

 

Holding Company Structure

 

We are a holding company with no operations of our own. Our operations are conducted through Beijing Lei Ting, Shenzhen Freenet, Wu Ji Network and our subsidiaries. As a result, our ability to pay dividends and to finance any debt that we may incur is dependent upon license and service fees paid by Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, and dividends and other distributions paid by our subsidiaries. If our subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends to us. In addition, PRC legal restrictions permit payment of dividends to us by our subsidiaries only out of the net income from our subsidiaries, if any, determined in accordance with PRC accounting standards and regulations. Under PRC law, our subsidiaries are also required to set aside a portion, up to 20%, of their after tax net income, if any, each year to fund certain reserve funds. These reserve funds are not distributable as cash dividends. See note 13 to our audited historical consolidated financial statements included in this prospectus and “Risk Factors — Risks Relating to Our Business — We rely on dividends and other distributions on equity paid by our subsidiaries and other payments by Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network to fund any cash requirements we may have.”

 

Off-Balance Sheet Arrangements

 

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered into any derivative contracts that are indexed to our own shares and classified as shareholder’s equity, or that are not reflected in our financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

Quantitative and Qualitative Disclosures About Market Risk

 

Interest Rate Risk

 

Our exposure to market risk for changes in interest rates relates primarily to the interest income generated by our cash deposits in banks. We have not used derivative financial instruments in our investment portfolio. Interest earning instruments carry a degree of interest rate risk. We have not been exposed, nor do we anticipate

 

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being exposed, to material risks due to changes in interest rates. However, our future interest income may fall short of expectations due to changes in interest rates.

 

Foreign Currency Risk

 

While our reporting currency is the U.S. dollar, to date virtually all of our revenues and costs are denominated in Renminbi and substantially all of our assets and liabilities are denominated in Renminbi. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be impacted by fluctuations in the exchange rate between U.S. dollars and Renminbi. If the Renminbi depreciates against the U.S. dollar, the value of our Renminbi revenues and assets as expressed in our U.S. dollar financial statements will decline. See “Risk Factors — Risks Relating to the People’s Republic of China — Fluctuation of the Renminbi could materially affect the value of our ADSs or ordinary shares.”

 

Inflation

 

In recent years, China has not experienced significant inflation, and thus inflation has not had a significant effect on our business during the past three years. According to the China Statistical Bureau, China’s overall national inflation rate, as represented by the general consumer price index, was approximately 0.7% and 0.4% in 2001 and 2000, respectively. China experienced slight deflation in 2002 at a rate of 0.8%.

 

Income Taxation

 

The Cayman Islands currently do not levy any taxes on individuals or corporations based upon profits, income, gains or appreciations and there is no taxation in the nature of inheritance tax or estate duty. In addition, pursuant to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, we have obtained an undertaking from the Governor-in-Council that (i) no law which is enacted in the Cayman Islands imposing any tax to be levied on profits or income or gains or appreciation shall apply to us or our operations and (ii) no tax to be levied on profits, income gains or appreciations or which is in the nature of estate duty or inheritance tax shall be payable by us on or in respect of our shares, debentures or other obligations or by way of withholding in whole or in part of any relevant payment as defined in Section 6(3) of the Tax Concessions Law (1999 Revision). This undertaking is for a period of 20 years from September 25, 2001.

 

Advanced Internet Services, our 100% owned subsidiary, is subject to income tax in Hong Kong. Hong Kong companies are generally subject to a 17.5% corporate income tax. Advanced Internet Services has not, however, paid any income taxes in Hong Kong because it is a holding company and does not receive any revenue.

 

In future periods, we expect that substantially all of our revenues will be attributable to Shenzhen Freenet, Beijing Lei Ting, Wu Ji Network, GreaTom, Beijing Super Channel and Shanghai Super Channel, each of which is incorporated in the PRC. Shenzhen Freenet and Beijing Lei Ting have entered into technical and consulting service agreements with GreaTom and Beijing Super Channel, pursuant to which GreaTom and Beijing Super Channel are entitled to receive service fees in an amount equal to substantially all of the net income of Shenzhen Freenet and Beijing Lei Ting, respectively. In addition, Wu Ji Network has entered into a technical and consulting service agreement with Puccini Network, pursuant to which Puccini Network is entitled to receive service fees in an amount equal to substantially all of the net income of Wu Ji Network. However, due to tax efficiency considerations, Beijing Super Channel, GreaTom and Puccini Network may separately choose not to charge a service fee, or to reduce the service fee that they charge, pursuant to these technical and consulting service agreements in any year, and to increase the amount of the service fee that they charge in subsequent years by corresponding amounts. In addition, any service fees that are paid pursuant to these technical and consulting service agreements will be subject to a 5% business tax. Beijing Super Channel has begun charging a service fee to Beijing Lei Ting pursuant to their technical and consulting service agreement as of January 1, 2004. GreaTom may begin charging a service fee to Shenzhen Freenet pursuant to their technical and consulting service

 

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agreement in the future. Currently, we do not intend to have Puccini Network charge a service fee pursuant to the technical and consulting service agreements until Puccini Network applies for, and receives, the high technology enterprise preferential tax treatment. If Puccini Network does not receive the preferential tax treatment, it will choose to either not charge a service fee or charge a service fee and incur any resulting enterprise income tax liability at a rate of 33%. For a discussion of these technical and consulting service agreements and our relationship with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network, see “Our Corporate Structure,” and “Related Party Transaction.” Also see, “Risk Factors — Risks Relating to Our Business — PRC laws and regulations restrict foreign investment in China’s telecommunications services industry, and substantial uncertainties exist with respect to our contractual arrangements with Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network due to uncertainties regarding the interpretation and application of current or future PRC laws and regulations,” and “— We rely on dividends and other distributions on equity paid by our subsidiaries and other payments by Beijing Lei Ting, Shenzhen Freenet and Wu Ji Network to fund any cash requirement we may have.”

 

Generally, PRC companies are subject to an enterprise income tax of 33%. However, Beijing Lei Ting, Shenzhen Freenet, Wu Ji Network and certain of our subsidiaries benefit from preferential tax treatment pursuant to PRC law due to the location of their registered offices inside special economic zones or special development zones, or due to their status as high technology enterprises.

 

The table below sets forth the tax rates applicable to Beijing Lei Ting, Shenzhen Freenet, Wu Ji Network and certain of our subsidiaries for the periods indicated:

 

     For the year ended December 31,

     2003

   2004

   2005

   2006

   2007

Shenzhen Freenet (Shenzhen)

   15%    15%    15%    15%    15%

Shenzhen Freenet (Guangzhou)

   33%    33%    33%    33%    33%

Beijing Lei Ting

   0%    7.5%    7.5%    7.5%    15%

Wu Ji Network(1)

   33%/0%    0%    0%    7.5%    7.5%

GreaTom

   0%    7.5%    7.5%    7.5%    15%

Beijing Super Channel

   7.5%    7.5%    7.5%    15%    15%

Shanghai Super Channel

   33%    33%    33%    33%    33%

Puccini Network(2)

   33%    33%/0%         

(1)   On August 18, 2003, Wu Ji Network received a high technology enterprise preferential tax treatment, pursuant to which its net income is exempt from taxation until December 31, 2005, subject to a 7.5% income tax rate for the following three years, and subject to a 15% income tax rate thereafter.
(2)   We intend to have Puccini Network apply for the high technology enterprise preferential tax treatment. If Puccini Network receives this preferential tax treatment, it will be exempt from the enterprise income tax until December 31, 2006, subject to a 7.5% enterprise income tax for the following three years and subject to a 15% enterprise income tax thereafter. If Puccini Network does not receive this preferential tax treatment, it will continue to be subject to a 33% income tax rate.

 

Income attributable to Shenzhen Freenet’s head office is subject to a 15% preferential income tax rate because it is located in the Shenzhen Special Economic Zone. Beijing Lei Ting and GreaTom benefit from a high technology enterprise preferential tax treatment, pursuant to which their net income was tax exempt until December 31, 2003, and became subject to a 7.5% enterprise income tax for the following three years and to a 15% enterprise income tax thereafter. In addition, Wu Ji Network benefits from the high technology enterprise beneficial tax treatment, pursuant to which its net income is tax exempt until December 31, 2005, subject to a 7.5% enterprise income tax for the following three years and subject to a 15% enterprise income tax thereafter. Beijing Super Channel also benefits from a high technology enterprise preferential tax treatment, pursuant to which its net income is subject to a 7.5% income tax until December 31, 2005 and subject to a 15% income tax thereafter.

 

 

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Shenzhen Freenet, Wu Ji Network and certain of our subsidiaries have recorded net losses in the past, which they may carry forward for five years from the end of the period in which the loss was recorded to offset future net income for tax purposes. We cannot, however, give any assurances that Shenzhen Freenet, Wu Ji Network or our subsidiaries will record sufficient net income within the carry forward periods to realize the full tax benefit of these past net losses. For a discussion of our deferred tax valuation allowance accounting policy, see “— Critical Accounting Policies.”

 

The table below sets forth the tax loss carry forward with respect to Beijing Lei Ting, Shenzhen Freenet, Wu Ji Network and certain of our subsidiaries as of December 31, 2003:

 

     Expiring on December 31,

     Total

   2005

   2006

   2007

   2008

     (in thousands of U.S. dollars)

Shenzhen Freenet (Shenzhen)

              

Shenzhen Freenet (Guangzhou)

   9,771    2,353    3,563    2,069    1,786

Beijing Lei Ting

              

Wu Ji Network

              

GreaTom

   1,785       805    980   

Beijing Super Channel

   829             829

Shanghai Super Channel

   771       277    206    288

Puccini Network

              

 

We intend to have Puccini Network apply for the high technology enterprise preferential tax treatment. If Puccini Network receives this preferential tax treatment, it will be exempt from the enterprise income tax until December 31, 2006, subject to a 7.5% enterprise income tax for the following three years and subject to a 15% enterprise income tax thereafter.

 

In addition, our revenues are subject to business taxes and value-added taxes. For a summary of these taxes, see “— Revenues.”

 

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INDUSTRY OVERVIEW

 

The development of wireless value-added services has been encouraged by mobile telecommunications operators in China who have promoted the development of a market for wireless value-added products and services. This development created an opportunity for Internet companies to deliver content from their Internet portals to mobile phone users and to charge a fee for such content.

 

The PRC Internet and Mobile Telecommunications Industries

 

The Internet industry in China has experienced rapid growth in recent years. According to the China Internet Network Information Center, or CNNIC, the number of Internet users in China has grown from approximately 9 million as of December 31, 1999 to approximately 80 million as of December 31, 2003, making China the second largest Internet market in the world. Factors contributing to the rapid growth of the Internet industry in China include increased investment in information technology infrastructure, more affordable and diversified means of Internet access, expanding computer ownership and the development of more sophisticated Internet content. The Internet market is expected to continue to experience rapid growth over the next few years. The International Data Corporation, or IDC, estimated that China will have 154 million Internet users by 2007.

 

According to China’s MII, China is now the world’s largest mobile telecommunications market with approximately 269 million mobile phone users as of December 31, 2003. The table below sets forth certain Internet and telephone users and demographic data with respect to China for the periods indicated:

 

     As of December 31,

     2000

   2001

   2002

   2003

Population (millions)

   1,262.5    1,271.9    1,281.0   

GDP per capita (U.S. dollars)

   855.8    911.3    965.8   

Internet users (millions)

   22.5    33.7    59.1    79.5

Mobile phone users (millions)(1)

   85.3    144.8    206.6    268.7

(1)   Number of mobile phone numbers.

 

Sources:   Data in respect of China’s population and GDP is derived from information published by the World Bank; data in respect of Internet users is derived from information published by CNNIC; data in respect of mobile phone users is derived from information from MII.

 

Mobile phone penetration in China is still low compared to other countries. The table below sets forth mobile telecommunications market data indicated as of December 31, 2003 and GDP per capita for certain countries indicated as of December 31, 2002:

 

     As of December 31,

     2003

   2003

   2002

     Mobile
telephone
users(1)


   Mobile
telephone
penetration


   GDP
per
capita


     (millions)    (%)    (US$)

United Kingdom

   50.4    83.9    26,376

South Korea

   34.2    71.0    10,006

Japan

   81.2    64.0    31,293

United States

   153.9    54.4    36,123

China

   268.7    20.3    966

India

   20.7    2.0    491

(1)   Number of mobile phone numbers.

 

Sources:   World Bank for GDP per capita data. MII and IDC for mobile phone users data. IDC for mobile telephone penetration data.

 

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Compared to other countries, China has a very low credit card penetration rate, and relies heavily on cash-on-demand as the primary payment method. As a result, it has been very difficult for ISPs in China to collect fees directly from users through personal computers. On the other hand, Chinese mobile telecommunications services operators, such as China Mobile, have established an internal payment system that enables them to collect payments from their users. As a result, it has been more convenient for Internet portals in China to collect payments from their users through arrangements with mobile telecommunications operators.

 

The PRC Wireless Value-Added Services Industry

 

The wireless value-added services business is a new and rapidly growing sector of the mobile telecommunications industry that allows mobile phone users to receive and transmit text, images and other forms of digital and voice data on their handsets. Wireless value-added services providers have utilized the billing and payment collection system for Internet portals to deliver their products and services over the mobile telecommunications infrastructure. Furthermore, mobile telecommunications operators in China have promoted the development of a wireless value-added services market to increase the traffic volume through their networks and maintain their average revenue per user, which has steadily decreased in recent years.

 

The wireless value-added services industry in China is similar to NTT DoCoMo, Inc.’s i-mode model. According to this model, each of the mobile telecommunications operators in China provides a service platform, which allows third parties to provide wireless value-added products and services, such as ring tones, greeting cards, news, sports updates, weather, games and dating services to mobile phone users. The operators generate revenue by acting as billing and fee collection agents, thereby retaining a portion of the revenue generated from the sale of these products and services, as well as any transmission or air-time fees.

 

The wireless value-added services are provided to the end user through the cooperation of several players in the value chain. Content providers, such as the media, create the content to be delivered to the end user. Internet portals and service providers, such as ourselves, aggregate and repackage such content to be delivered through platforms of mobile telecommunications operators, such as China Mobile and China Unicom. End users receive content and services through mobile phone manufactured by mobile phone producers, such as Nokia and Bird. The following figure illustrates the wireless value-added services industry value chain:

 

LOGO

 

China Mobile launched its Monternet platform for wireless value-added services in the fourth quarter of 2000, while China Unicom launched its UNI-Info platform in 2001. Currently, these mobile telecommunications operators rely on content and service providers to provide the wireless value-added services and produce relatively little content of their own. However, they may, either on their own or in collaboration with other partners, develop or aggregate content in the future. See “Risk Factors — Risks Relating to Our Business — A substantial portion of our business depends on the mobile telecommunications operators in China, and any loss or deterioration of such relationship may result in severe disruptions to our business operations and the loss of a significant portion of our revenues.”

 

Products and Services

 

Wireless value-added services include wireless data services and wireless IVR services. Wireless data is any form of digital data transmitted to or from a mobile phone, including SMS messages, MMS messages, Internet transmissions based on WAP technology, and interactive games based on Java technology. Wireless IVR services allows users to access voice content from their mobile phones.

 

   

SMS.    China is rapidly adopting SMS and registered the biggest growth in terms of message volume in Asia Pacific in 2002. SMS allows mobile phone users to send and receive text messages as well as

 

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download and transmit ring tones, e-mail alerts, news information and other content. The most common application for SMS is sending traditional text messages from one mobile phone to another, commonly referred to as “point-to-point SMS,” where the user sends a text message directly to the receiver through the mobile telecommunications operator’s network. In addition to point-to-point SMS, mobile phone users can purchase from wireless value-added service providers SMS products, including news headlines, sports, games, ring tones, ring back tones, jokes and horoscopes. According to Norson Telecom Consulting, the total number of SMS messages transmitted in China in 2003 was approximately 180 billion, compared to approximately 90 billion in 2002. In addition, in 2002, point-to-point SMS accounted for approximately 78.6% of the total number of SMS messages sent through China Mobile’s platform, while the remaining approximately 21.4% was accounted for by other SMS-based wireless data services, such as mobile-banking, info-on-demand, mobile stock trading and other Monternet services, according to Norson Telecom Consulting. According to a survey conducted in June 2003 by CNNIC, approximately 50.1% of wireless value-added services users use portal-based SMS products and services on a daily basis. More than 51.0% of such users generally choose SMS products and services from the portals that they are already familiar with.

 

    MMS.    This service allows users to enhance their messages with sound and images. China Mobile introduced MMS services in October 2002. Its ability to integrate text, visual and audio messages makes it more attractive than traditional SMS, which is limited to 160 characters.

 

    WAP and Java.    WAP allows users to directly access and browse the Internet on their mobile phones and download specially configured information from Internet portals. Another category of wireless products are based on Java technology, which allows mobile phone users to play interactive games and download applications to customize their mobile phone settings.

 

    Wireless IVR Services.    Wireless IVR services allows users to access voice content from their mobile phones. For example, users can choose to send songs to other users, chat in voice chat rooms, use voice-dating services and receive information through voice rather than data. The dating and chat-room services allow users to talk to each other.

 

Mobile telecommunications operators in China have plans to upgrade their networks to offer third generation, or 3G, wireless telecommunications services, which will enable users to transmit larger amounts of data more quickly, including more sophisticated content, such as streaming media and multi-user games. The PRC government is conducting tests of internationally recognized standards for 3G wireless telecommunications services as a preliminary step before issuing 3G telecommunications operator licenses. No timetable for issuing 3G licenses has been announced by the PRC government. The greater ease of data transmission, as facilitated by new and upgraded technologies and networks, is expected to lead to increased demand for enhanced wireless value-added services, including services that utilize more sophisticated content such as streaming media and multi-user games. See “Forward-Looking Statements.”

 

The PRC Online Advertising Industry

 

Companies in China are spending an increasing amount on advertisements through Internet portals to promote their products and services to the large Internet user base. According to IDC, the online advertising market in China will grow from approximately US$63 million in