20-F 1 v153382_20f.htm Unassociated Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 20-F
(Mark One)
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
   
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 2008
 
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the
transition period from ________________ to ________________
 
OR
   
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Date of event requiring this shell company report ________________
 
Commission file number: 001-33134
 
Yucheng Technologies Limited
(Exact name of Registrant as specified in its charter)
 
Not Applicable
(Translation of Registrant’s name into English)
 
British Virgin Islands
(Jurisdiction of incorporation or organization)
 
Beijing Global Trade Center, Tower D , Floor 9, 36 North Third Ring Road East, Dongcheng District, Beijing
100013, P.R. China
 (Address of principal executive offices)
 
Weidong Hong, Chief Executive Officer, Tel: +86 10 5913 7700, Fax: +86 10 5913 7800
Beijing Global Trade Center, Tower D , Floor 9, 36 North Third Ring Road East, Dongcheng District, Beijing
100013, P.R. China
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of each class
Name of each exchange on which registered
Ordinary shares
The NASDAQ Stock Market LLC
 
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
17,575,685 ordinary shares
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 

 
o  Yes     x  No
 
If this report is an annual or transaction report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
o  Yes     x  No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x  Yes      o  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 c) Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x  Yes      o  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):
o  Large Accelerated Filer     x  Accelerated Filer      o    Non-Accelerated Filer
 
Indicate by check mark which financial statement item the registrant has elected to follow.
o  Item 17      x  Item 18
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.
 
x  U.S. GAAP      o  International Financial Reporting Standards as issued by the International Accounting Standards Board      o  Other
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
 
o  Item 17      o  Item 18
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
o  Yes      x  No
 
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
o  Yes      o  No

 
 

 

YUCHENG TECHNOLOGIES LIMITED
 
TABLE OF CONTENTS
 


     
Page
 
           
ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
    4  
ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
    4  
ITEM 3.
KEY INFORMATION
    4  
ITEM 4.
INFORMATION ON THE COMPANY
    26  
ITEM 4A.
UNRESOLVED STAFF COMMENTS
    51  
ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    51  
ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    74  
ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    83  
ITEM 8.
FINANCIAL INFORMATION
    84  
ITEM 9.
THE OFFER AND LISTING
    86  
ITEM 10.
ADDITIONAL INFORMATION
    87  
ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    97  
ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    97  
ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
    98  
ITEM 14.
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
       
 
AND USE OF PROCEEDS
    98  
ITEM 15.
CONTROLS AND PROCEDURES
    98  
ITEM 16A.
AUDIT COMMITTEE FINANCIAL EXPERT
    100  
ITEM 16B.
CODE OF ETHICS
    100  
ITEM 16C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
    100  
ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
    101  
ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
    101  
ITEM 17.
FINANCIAL STATEMENTS
    101  
ITEM 18.
FINANCIAL STATEMENTS
    101  
ITEM 19.
EXHIBITS
    101  

 
i

 

Introduction
 
 Unless otherwise indicated, references in this annual report to:
 
·
“China” or “PRC” refers to the People’s Republic of China, excluding, for the purpose of this annual report only, Hong Kong SAR, Macau SAR and Taiwan.

·
“NASDAQ” refers to the NASDAQ Global Market.

·
“Renminbi” or “RMB” refers to the legal currency of China.

·
“SEC” refers to the United States Securities and Exchange Commission.

·
“Securities Act” refers to the Securities Act of 1933, as amended.

·
“Shares” or “ordinary shares” refers to our ordinary shares, of no par value.  “USD”, “U.S. dollars”, “dollar” and “US$” refer to the legal currency of the United States.

In addition, unless otherwise indicated, references in this annual report to:

·
“Yucheng” refers to the Yucheng Technologies Limited, as a whole or any portion thereof, unless expressly stated otherwise.

·
“Beijing Sihitech” refers to Beijing Sihitech Technology Co., Ltd. and, unless the context otherwise requires, its subsidiaries.

·
“China Unistone” refers to China Unistone Acquisition Corporation.

·
“Easycon” refers to Beijing Easycon Electronics Limited.

·
“e-Channels” refers to Beijing e-Channels Century Technology Co., Ltd.

·
“e-Channels BVI” refers to Port Wing Development Co., Ltd.

·
“Fujie” refers to Shanghai Fujie Business Consulting Limited.

·
“Fuyi” refers to Shanghai Fuyi Business Consulting Limited.

·
“Recency” refers to Chengdu Recency Technologies Limited.

·
“Sihitech BVI” refers to Ahead Billion Venture Ltd.

·
“Sunrisk” refers to Beijing Yuxinhengsheng Information Technology Limited.

·
“Yuxinyicheng Information” refers to Beijing Yuxinyicheng Information.

·
“we,” “us,” “our company,” “our,” “the Company” and “Yucheng” refer to Yucheng Technologies Limited and, unless the context otherwise requires, its subsidiaries and predecessors.

·
“Tier I banks” or “Top Four banks” refers to the four largest state-controlled banks in China, namely the Industrial and Commercial Bank of China, the Bank of China, China Construction Bank and the Agricultural Bank of China; “Tier II banks” or “Joint-Stock banks” refers to the other 13 national commercial banks in China; and “Tier III banks” or “SMBs” refers to small and mid-sized banks in China.
 
This annual report contains statistical data relating to the banking industry in China that we obtained from various publications.  These publications generally indicate that they have obtained their information
 

 
from sources believed to be reliable, but we do not guarantee the accuracy and completeness of their information.  Although we believe that these publications are reliable, we have not independently verified their statistical data.  These statistical data may not be comparable to similar statistics collected for the industry in the United States or other countries.
 
Forward-Looking Information
 
This annual report contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about us and our industry.  All statements other than statements of historical fact in this annual report are forward-looking statements.  These forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “believe,” “is /are likely to” or other similar expressions.  The forward-looking statements included in this annual report relate to, among other things:
 
·
our goals and strategies, including how we effect our goals and strategies;

·
our expectations for our future business development, business prospects, results of operations and financial condition;

·
expected changes in our revenue composition, margins and certain costs or expenditures;

·
our future contracting and pricing strategies or policies;

·
our plans to expand our business operations and product offerings;

·
competition from other providers of IT services and products;

·
the time to develop and market new services and products;

·
PRC governmental policies relating to the business development, banking regulation and regulation of the financial services sector; and

·
other “forward-looking” information.
 
We believe it is important to communicate our expectations to our stockholders.  However, there may be events in the future that we are not able to predict accurately or over which we have no control.  The risk factors and cautionary language discussed in this annual report provide examples of risks, uncertainties and events that may cause actual results to differ materially from the expectations in these forward-looking statements, including, among other things:
 
·
changing interpretations of generally accepted accounting principles;

·
outcomes of government reviews, inquiries, investigations and related litigation;

·
continued compliance with government regulations;

·
legislation or regulatory environments, requirements or changes adversely affecting the businesses in which we and our PRC operating companies are engaged;

·
geopolitical events and regulatory changes; and

·
the effect of world recession and declines in global and specific country GDP on the world financial sector and the Chinese economy.
 
These forward-looking statements involve various risks, assumptions and uncertainties.  Although we believe that our expectations expressed in these forward-looking statements are reasonable, we cannot make assurance that our expectations will turn out to be correct.  Our actual results could be materially different from and worse than our expectations.  Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in “Item 3. Key Information — D. Risk factors” and elsewhere in this annual report.
 
2

 
The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report.  You should not place undue reliance on these forward-looking statements, and you should read these statements in conjunction with the risk factors disclosed in “Item 3. Key Information — D. Risk factors” in this annual report.
 
All forward-looking statements included herein attributable to us or other parties or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  Except to the extent required by applicable laws and regulations, we undertake no obligations to update these forward-looking statements to reflect events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated events.

 
3

 

PART I
 
ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
 Not applicable.
 
ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
 
 Not applicable.
 
ITEM 3.
KEY INFORMATION
 
A.    Selected financial data.
 
SELECTED CONSOLIDATED FINANCIAL DATA
 
The following summary consolidated financial data for the three years ended December 31, 2008 are derived from our audited consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles, or US GAAP, and have been audited by BDO Limited, an independent registered public accounting firm.  The report of BDO Limited on those consolidated financial statements is included elsewhere in this annual report.  This information is only a summary and should be read together with the consolidated financial statements, the related notes and other financial information included in this annual report.  Our selected consolidated financial data for the year ended December 31, 2004 and 2005 have been derived from our audited consolidated financial statements, which are not included in this annual report.
 
Yucheng Technologies Limited, or Yucheng, was incorporated on November 17, 2005 as a subsidiary of China Unistone.  After completion of a redomestication merger of China Unistone with and into Yucheng and the acquisition by Yucheng of Sihitech BVI and e-Channels BVI on November 24, 2006, Yucheng became the holding company of our business.  Sihitech BVI was our predecessor from an accounting perspective, and the purchase method of accounting was used in consolidating e-Channels BVI and China Unistone into Sihitech BVI.
 
Revenues represented in this section are net of business tax.

The following table sets forth our selected consolidated statement of income data.
 
   
Year Ended December 31,
 
   
2004
   
2005
   
2006
   
2007
   
2008
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
USD
 
   
(in thousands, except earnings per share and share numbers)
 
       
Revenues
   
244,882
     
177,327
     
289,650
     
435,519
     
676,819
     
99,028
 
                                                 
Cost of revenues
   
(192,260
)
   
(133,085
)
   
(215,332
)
   
(277,826
)
   
(449,277
)
   
(65,735
)
                                                 
Gross profit
   
52,622
     
44,242
     
74,318
     
157,693
     
227,542
     
33,293
 
                                                 
Operating expenses:
                                               
Research and development
   
(695
)
   
(352
)
   
(902
)
   
(8,370
)
   
(10,148
)
   
(1,485
)
Selling and marketing
   
(14,453
)
   
(11,181
)
   
(13,990
)
   
(29,053
)
   
(49,383
)
   
(7,225
)
General and administrative
   
(14,423
)
   
(13,913
)
   
(14,170
)
   
(50,668
)
   
(95,425
)
   
(13,962
)
Total operating expenses
   
(29,571
)
   
(25,446
)
   
(29,062
)
   
(88,091
)
   
(154,956
)
   
(22,672
)
                                                 
Income from operations
   
23,051
     
18,796
     
45,256
     
69,602
     
72,586
     
10,621
 
                                                 
Other income (expenses):
                                               
Interest income
   
157
     
142
     
117
     
1,818
     
1,259
     
184
 
Interest expense
   
(224
)
   
(617
)
   
(1,263
)
   
(1,937
)
   
(3,783
)
   
(554
)
 
4

 
Income (loss) from short-term investment
   
     
     
     
3,494
     
(529)
     
(77)
 
Loss from equity method investee
   
(445
)
   
(759
)
   
(135
)
           
(1,280)
     
(187)
 
Other income, net
   
112
     
431
     
27
     
1,078
     
493
     
72
 
Total other income (expenses)
   
(400
)
   
(803
)
   
(1,254
)
   
4,453
     
(3,840)
     
(562)
 
                                                 
Income before minority interests and income taxes
   
22,651
     
17,993
     
44,002
     
74,055
     
68,746
     
10,059
 
Income tax (expenses) benefits
   
(1,810
)
   
(3,462
)
   
(3,271
)
   
(5,528
)
   
9,538
     
1,395
 
                                                 
Income before minority interests
   
20,841
     
14,531
     
40,731
     
68,527
     
78,284
     
11,454
 
Minority interests
   
(260
)
   
     
     
(1,813)
     
2,711
     
397
 
Net income
   
20,581
     
14,531
     
40,731
     
66,714
     
80,995
     
11,851
 
                                                 
Earnings per share (basic)
   
5.48
     
3.87
     
5.02
     
5.08
     
4.61
     
0.67
 
                                                 
Earnings per share (fully diluted)
   
5.48
     
3.87
     
3.96
     
4.34
     
4.33
     
0.63
 
                                                 
Weighted average ordinary shares outstanding (basic)
   
3,754,484
     
3,754,484
     
8,118,335
     
13,144,681
     
17,566,898
     
17,566,898
 
                                                 
Weighted average ordinary shares outstanding (fully diluted)
   
3,754,484
     
3,754,484
     
10,292,308
     
15,370,197
     
18,691,852
     
18,691,852
 

The following table sets forth our selected consolidated balance sheet data.
 
   
As of December 31,
 
   
2004
   
2005
   
2006
   
2007
   
2008
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
USD
 
   
(in thousands)
 
Cash
   
39,831
     
42,716
     
98,358
     
222,494
     
239,751
     
35,079
 
Trade accounts receivable
   
49,283
     
55,209
     
116,606
     
203,451
     
280,654
     
41,064
 
Total current assets
   
104,400
     
144,104
     
305,848
     
572,304
     
647,311
     
94,711
 
Goodwill
   
     
     
37,274
     
169,362
     
187,816
     
27,480
 
Total assets
   
118,277
     
159,137
     
389,141
     
821,747
     
943,887
     
138,104
 
Total current liabilities
   
73,836
     
101,547
     
141,218
     
315,727
     
367,352
     
53,749
 
Total liabilities
   
74,107
     
105,539
     
146,511
     
323,450
     
373,328
     
54,623
 
Stockholders’ equity
   
41,168
     
53,599
     
242,629
     
493,098
     
558,536
     
81,722
 
Total liabilities and stockholders’ equity
   
118,277
     
159,137
     
389,141
     
821,747
     
943,887
     
138,104
 

EXCHANGE RATE INFORMATION
 
The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated.  These rates are provided solely for investors’ reference and are not necessarily the exchange rates that are used in this annual report or will be used in the preparation of our other periodic reports or any other information to be provided by the company.
 
   
Noon Buying Rate
 
   
Period
End
   
Average(1)
   
High
   
Low
 
   
(Renminbi per USD1.00)
 
2004
   
8.2765
     
8.2768
     
8.2774
     
8.2764
 
2005
   
8.0702
     
8.1936
     
8.2765
     
8.0702
 
2006
   
7.8041
     
7.9723
     
8.0702
     
7.8041
 
2007
   
7.2949
     
7.6058
     
7.8127
     
7.2946
 
2008
   
6.8225
     
6.9477
     
7.2946
     
6.7800
 
November
   
6.8254
     
6.8281
     
6.8373
     
6.8220
 
December
   
6.8225
     
6.8539
     
6.8842
     
6.8225
 
2009
                               
January
   
6.8283
     
6.8223
     
6.8283
     
6.8089
 
February
   
6.8258
     
6.8228
     
6.8328
     
6.8188
 
March
   
6.8223
     
6.8223
     
6.8291
     
6.8130
 
April
   
6.8112
     
6.8177
     
6.8230
     
6.8112
 
May
    6.8143       6.8107       6.8188       6.8059  
 
5

 

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

This annual report contains translations of certain Renminbi amounts into U.S. dollar amounts at specified rates.  Translations from Renminbi to U.S. dollars at certain specified date refers to the noon buying rate on that particular date in The City of New York for cable transfers of Renminbi as certified for customs purpose by the Federal Reserve Bank of New York.  Unless otherwise stated, the translations of Renminbi into U.S. dollars have been made based on the noon buying rate on December 31, 2008, which was RMB6.8346 to USD1.00.  We make no representation that the Renminbi or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all.  See “Item 3. Key Information — Risk factors — Risks related to doing business in China — Any fluctuations in exchange rates could result in foreign currency exchange losses” and “— Restrictions on currency exchange may limit our ability to receive and use our revenues or financing effectively” for discussions on the effects of fluctuating exchange rates and currency control on the value of our ordinary shares.  On June 29, 2009, the noon buying rate was RMB6.8316 to USD1.00.

The People’s Bank of China, or the PBOC, issued a public notice on July 21, 2005 increasing the exchange rate of the Renminbi against the U.S. dollar by approximately 2.0% to RMB8.11 per USD1.00.  Further to this notice, the PRC government has reformed its exchange rate regime by adopting a managed floating exchange rate regime based on market supply and demand with reference to a portfolio of currencies.  Under this new regime, the Renminbi is no longer pegged to the U.S. dollar.  This change in policy has resulted in an approximate 16% appreciation of the Renminbi against the U.S. dollar between July 21, 2005 and June 29, 2009.  The PRC government may decide to adopt an even more flexible currency policy in the future, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar.
 
B.    Capitalization and indebtedness.
 
Not applicable.
 
C.    Reasons for the offer and use of proceeds.
 
Not applicable.
 
D.    Risk factors.
 
RISKS RELATING TO OUR BUSINESS
 
We have a limited operating history as a combined company, which makes evaluating our business and prospects difficult.
 
Our current business was formed upon the consummation of a three-party acquisition on November 24, 2006 among Yucheng, Sihitech BVI, parent of Beijing Sihitech, a company established in June 1999 that focused on providing system integration and other IT solutions and services, and e-Channels BVI, parent of e-Channels, a company established in February 2001 that focused on providing multi-channel software solutions and IT consulting services.  Our combined company has a limited operating history, which makes it difficult to evaluate our historical financial results and business prospects.  In addition, we acquired five companies in 2007.  See “Item 4. Information on the Company - A. History and development of the Company.”  Our future success depends on a successful integration of all these companies and the capturing of opportunities presented by these acquisitions.  If we experience difficulties in the integration process or are not able to take advantage of the perceived synergies between us and these companies, we may not be able to expand our operations and revenues as expected.
 
6

 
In addition, our management team has worked together for a relatively short period of time and it may be difficult to evaluate their effectiveness, on an individual or collective basis, as well as their ability to respond to future challenges to our business, including their ability to:
 
·
respond to increasing competitions in the industry;

·
adapt to changing technologies;

·
retain and expand our client base;

·
expand our solution and service offerings;

·
manage our business expansions, including integration of past and future acquisitions;

·
manage risks associated with intellectual property;

·
maintain effective control of our costs and expenses; and

·
attract, retain and motivate qualified personnel.
 
If we are unsuccessful in addressing these challenges, our results of operations and business prospects may be materially and adversely affected.
 
We may not be able to sustain our rate of revenue growth.
 
Our revenue has grown significantly in recent years.  Our revenue increased 50.4% from RMB289.7 million in 2006 to RMB435.5 million in 2007, and 55.4% from the 2007 revenue amount to RMB676.8 million in 2008.  In addition to our organic growth, our revenue growth, in particular the growth from 2006 to 2007, was significantly enhanced by our merger with e-Channels BVI on November 24, 2006 and our acquisitions of five companies in 2007.  In addition to revenues generated by these acquired companies, we were also able to achieve synergies among our existing business and the acquired businesses.   Without the impact of these acquisitions, our growth rate during this period would have been much lower.  In 2008, we did not make any acquisition and we may not be able to make acquisitions with a similar scale, or at all, in future periods, or make assurances that our future acquisitions, if any, will be able to provide the same level of synergy as our past acquisitions.  In addition, our past growth reflected our success in achieving market acceptance of our IT solutions and software and establishing market leadership in certain segments of China’s financial IT services industry.  As we become a larger and more mature company, we may not be able to sustain our recent rate of revenue growth in future periods. Additionally, the changing economic environment as a result of the current world recession may have an effect on our overall growth.
 
We have been relying on, and are expected to continue to rely on, a limited number of clients, in particular the various separate offices of China Construction Bank, for a significant proportion of our revenues.  Any loss of these clients could significantly impact our future revenues, and materially and adversely affect our operational results and our financial condition.
 
China Construction Bank is one of the largest banks in China and our largest user of our services, accounting in the aggregate for 54.0%, 59.2% and 47.8% of our revenues in 2006, 2007 and 2008, respectively.  We provide solutions and services to different provincial branch offices of China Construction Bank and to its head office.  Although the engagements with the branches and the head office are under separate and independent contracts, certain individual accounts still historically account for a significant amount of revenue.  For example, our largest account within China Construction Bank was with its head office, which accounted for 30.0%, 29.1% and 36.9% of our revenues in 2006, 2007 and 2008, respectively.  Notwithstanding the separate legal treatment of the engagements, a substantial failure to provide the contracted solutions and services under one of our agreements may result in a disruption to our overall relationship with China Construction Bank.  Also, if China Construction Bank’s general IT spending pattern and budget changes or decreases, it could adversely affect our ability to offer services and
 
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win contracts from different entities within the bank.  We have no long-term contracts with China Construction Bank or any of our major clients.  There are no assurances that we will be able to continue to retain these clients, and that we will maintain or increase our current level of business with them in the future.  If we lose any of these significant clients, or if any of them significantly reduces their use of our solutions and services, we may not be able to find replacement revenue sources, thus materially and adversely impacting our operating results and financial condition.  In addition, our current clients are primarily large national commercial banks that possess significant negotiating and pricing power, and if they exert pricing pressure on us, we cannot guarantee that we will be able to resist this pressure or find other replacement clients.  If we have to lower prices to maintain our business with these clients, our profitability may be materially and adversely affected.
 
Fluctuations in our clients’ annual IT budgets and spending cycles and other factors can cause our revenues and results of operations to vary significantly from quarter to quarter and from year to year.
 
Our revenues and results of operations will vary significantly from quarter to quarter and from year to year due to numerous factors, many of which are outside of our control.  As substantially all of our revenues are derived from providing services on IT projects outsourced from our banking clients in China, the amount of our revenues for any period is affected by the timing of our clients’ IT projects, which in turn depends on their internal budgeting and planning process, over which we have no control.  Historically, our banking clients have been awarding more projects in the third and fourth quarters as compared to the first and second quarters, as a result, we generally record stronger revenues in the third and fourth quarters of each year.  In addition, our revenues are generally the lowest in the first quarter of each year due to the Chinese New Year holiday.  Furthermore, the project mix of any given period also significantly affects our gross margin and results of operations.  For example, if we record a higher percentage of low margin hardware pass-through revenue as compared to higher margin software development revenue in a given quarter, our gross margin will be negatively affected.  We may not be able to control the timing and types of projects we undertake and the revenue we can record in a given quarter.
 
Due to the annual budget cycles of most of our clients, we also may be unable to accurately estimate the demand for our Software & Solutions, which could adversely affect our business planning.  Moreover, our results will vary depending on our clients’ business needs from year to year.
 
Other factors that may cause fluctuation of our quarterly and annual results include:
 
·
our ability to successfully develop, introduce and sell new or enhanced solutions in a timely manner;

·
the announcement or introduction of new or enhanced solutions by us or our competitors;

·
any delays in the completion of our projects; and

·
the results of our acquisitions of, or investments in, other businesses or assets.
 
Due to these and other factors, including factors discussed elsewhere in this “Risk factors” section, our results of operations may fluctuate significantly from quarter to quarter and from year to year, and our results of operations for any period may not be indicative of our performance in any future period.
 
In addition, we base our planned operating expenses, including research and development expenses, general and administrative expenses, and hiring of additional personnel in part on our expectations of future revenue.  If our revenues for a particular quarter are lower than we expect, we may be unable to proportionately reduce our operating expenses for that quarter, which would harm our results of operations for that quarter.  If our results of operations in future quarters fall below the expectations of securities analysts or investors, the market price of our shares will likely decline significantly.
 
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Our business depends on the banking industry in China, and changes within that industry could reduce demand for our solutions and services.  The recent growth of China’s banking industry and IT spending by China’s banks may not continue, which would have a material adverse effect on our results of operations and business prospects.
 
Substantially all of our revenues have been derived, and are expected to continue to be derived from, solutions and services which we provide to banks in China.  Our revenue growth in recent years has been driven in part by the growth in China’s banking industry, which is a result of China’s rapid economic development and recent industry-wide reforms.  These combined changes have greatly increased IT spending by China’s banks.  This growth may not continue at the same rate or at all.  Unfavorable economic conditions, such as a slow-down in the global economic development led by the recent economic downturn, potential instability in the global banking system and changing monetary policies in China, have and could continue to adversely impact China’s economy and the growth of banks operating in China, which may in turn impact their IT expenditures.  Any decreases in, or reallocation of, capital expenditures by our current and potential clients could have a material and adverse effect on our business, financial conditions and results of operations.  In addition, to encourage potential growth in the Chinese economy, the PBOC has adopted, and may continue to adopt, various macroeconomic measures that may encourage banks to lend more and to riskier clients than in the recent past.  This could cause an increase in the non-performing loan rate, which would materially impact bank profitability.  Finally, the PBOC may also impose monetary policies or interest rates that may reduce the profitability of China’s banks.  Any reduction in profitability of China’s banks may reduce their spending on IT, which may materially and adversely affect our business, financial condition and results of operations.
 
We may lose our clients and our financial results may suffer if our clients change the decision-making body for their IT procurement or investment, merge with or are acquired by other banks, develop their own in-house capabilities or fail to expand.
 
Many factors, including those listed below, could affect our clients’ decisions relating to their IT outsourcing and our business relationship with our clients:
 
·
Our clients may change the way they make IT spending decisions.  We derive a substantial majority of our revenues from providing IT solutions, software and services to China’s banks on a project-by-project basis, and client relationships play an important role in our ability to win projects from our clients.  We strive to build long-term relationships with our clients to increase our competitive advantage over other IT vendors.  We have recently observed a shift in the decision-making process for IT spending in China’s banks.  More decisions are being made at banks’ head offices, instead of provincial level branches, primarily due to centralization of customer data at the bank head offices.  Such a shift, or any other change of the decision maker in our clients, may result in the loss of business opportunities to competitors who have closer relationships than us with the new decision-making body within the bank.

·
Consolidation of our clients.  There is a continuing trend for financial institutions in China to consolidate.  Our clients may be acquired by other financial institutions and adopt the acquirer’s IT systems.  Also, as these institutions grow in size through consolidation, they may exert pricing pressure on vendors.  In addition, as restrictions against foreign ownership in the financial and insurance industries ease, more foreign investors may acquire stakes in or form strategic alliances with financial institutions in China, and may direct or influence management to use IT vendors recommended or favored by the investor, leading to the loss or reduction of our business with these existing clients.

·
Our clients may decide to develop their IT solutions in-house.  Our clients may find it more cost-effective to invest in and develop their own in-house IT capacity rather than relying on third-party vendors, thereby reducing their purchases of our solutions and services.  For example, a banking client for which we designed the initial online banking platform decided to later conduct further online banking development in-house, and as a result, we were not able to renew our contract with such client.
 
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·
Our clients fail to expand.  The banking industry in China is becoming increasingly competitive.  Our clients may not successfully compete with their domestic and foreign competitors in the future.  If any of our key clients suffer reduced market share or their results of operations and financial condition are otherwise adversely affected, they may reduce their IT spending and change expansion plans for their IT systems, which in turn may materially and adversely affect our growth and results of operations.

 The occurrence of any of these events may materially and adversely affect our business, financial condition and results of operations.
 
We are facing increasing competition in the market for IT services in China’s banking industry, and if we fail to compete successfully, we may lose clients and our revenues and profits may decline.
 
There is intense competition in the market for IT services in China’s banking industry, and the industry is characterized by frequent technological changes, evolving industry standards and changing client demands.  We face competition from both China’s domestic IT service providers, such as AsiaInfo Holdings, Inc. and Longtop Financial Technologies Limited, as well as global IT vendors, such as IBM Global Services and SAP AG.  See “Item 4. Information on the Company — B. Business overview — Competition”.  Some of our competitors have longer operating histories, larger clientele, more diverse service offerings, more extensive personnel and financial resources than we do.  While new IT service providers may also enter the industry, we also compete with the IT departments of our existing and potential clients, which may be capable of creating in-house solutions, thereby reducing the need for outside service providers.  We expect competition to increase and we cannot guarantee that we will successfully compete against our competitors.  Our current or future competitors may develop or offer solutions or services that are comparable or superior to ours at a lower price.  In addition, only some of our solutions and services are protected by intellectual property rights, and therefore, our competitors may copy some of our technologies without incurring the associated research and development expenses, and sell their competing products with lower cost, which could result in the loss of sales of our solutions and services.  If we fail to successfully compete against our current and future competitors, our business, financial condition and results of operations may be materially and adversely affected.
 
We undertake many of our projects on a fixed-price basis.  If we underestimate our costs, or fail to control our costs in the implementation of the projects, our gross margins and profitability may be materially and adversely affected.
 
We typically undertake our client projects on a fixed-price basis where we charge a fixed price to the client based on our evaluation of the estimated resources required to implement the project.  If we overestimate costs required for the project, our bid may become uncompetitive and we may lose business as a result.  Conversely, if we underestimate the project costs, complexity or scope of work to be done for the projects that we win, due to miscommunication with our clients or underestimation of technical difficulties, or if we incur additional costs due to unforeseen conditions, such as appreciation of personnel cost or the existence of software bugs, we will not be able to change the contract value or pass such additional costs to our clients.  As a result, we may have reduced gross margin from such projects or even suffer a loss, which would negatively affect our overall gross margin and profitability.
 
We may be forced to reduce the prices of our solutions and services due to increased competition, which could lead to reduced revenues and profitability.
 
We may be forced to reduce the prices of our solutions and services in response to price-cutting strategies of our competitors, in particular in the areas of labor intensive contracts with low requirements for proprietary solutions or know-how.  Many smaller financial IT service companies depend on offering low prices to win these contracts.  We may not be able to respond to such competition by controlling our costs, shifting to other service areas with higher margins or providing additional solutions and services or enhancements to enable us to charge premium prices, and we may lose clients in these particular segments of our business if we do not reduce our prices.  Any such reduction in prices may materially and adversely affect our business, financial condition and results of operations.
 
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Changes in technology could materially and adversely affect our business by increasing our costs, reducing our profit margins and causing a decline in our competitiveness.
 
The markets for our Software & Solutions change rapidly due to technological innovation, product introductions, declining prices and evolving industry standards, among other factors.  New solutions and technology often render existing solutions and services obsolete, excessively costly or otherwise unmarketable.  As a result, our success depends on our ability to keep up with the latest technological progress and anticipate technological advances and to develop or acquire and integrate new technologies into our Software & Solutions portfolio.  We cannot make assurances that we will be able to keep our solutions and services competitive in the evolving market.  In addition, rapid advances in technology also require us to commit substantial resources to researching, developing or acquiring new technologies and deploying them into our operations, as well as to continuously train personnel in new technologies and in how to integrate existing hardware and software systems with these new technologies.  Such research, development and training place significant burden to our financial resources.  If we are not able to devote adequate resources to keep our technologies competitive, our ability to effectively compete in the market may suffer as a result, which may materially and adversely affect our business, financial condition and results of operations.
 
Our failure to retain existing clients or changes in their continued use of our solutions and services will adversely affect our results of operations.
 
We strive to establish strong, long-term client relationships, so that our clients will come back to us project after project.  For many projects that we undertake with our clients, there are often subsequent phases as the client’s business develops and their IT needs evolve, and we are typically engaged for the follow-on work.  Revenue from such follow-on projects is a source of our repeating revenues.  Historically, such repeating revenues accounted for a significant portion of our total revenues.  Whether our clients will come back to us for such follow-on projects depends on a number of factors, including the quality of our work, the ease of use, reliability and price, as well as the cost of switching to another service provider.  Our existing clients may decide not to engage us for follow-on projects due to quality, our competitors’ aggressive pricing or the obsolescence of our solutions or other concerns.  In addition, our clients may decide to delay system expansions, upgrades and improvements due to a change in their own growth, spending patterns or IT budget.  Any material reduction in our repeat revenues may materially and adversely affect our business, financial condition and results of operations.
 
Furthermore, we rely in part on our ability to cross-sell new solutions and services to our existing clients to our share of wallet with each client.  For our new clients, we typically provide one initial service component, such as a custom application development or the integration of a new application with legacy IT systems.  Then we seek to use such initial client engagement as a foothold to understand the clients’ IT needs and quickly build client relationships that will provide us with opportunities to demonstrate our capabilities and value so that they may engage us for additional projects.  If we fail to satisfy our clients in one product line, it may negatively impact our sales of other solutions and services to that client, which may materially and adversely affect our future revenue growth.
 
We are expanding into other business areas, such as our POS merchant acquisition services business, for which we have limited experience.  If we fail to manage and grow our new businesses, our financial condition and results of operations may be materially and adversely affected.
 
We established a wholly-owned subsidiary, Beijing Yuxingyicheng Information Technology Company Ltd., or Yuxinyicheng Information, to focus on the Point of Sale merchant acquiring services business, or POS, for credit and debit cards in a nationwide collaboration with China Merchants’ Bank, currently the largest credit card issuer in China.   Our banking partners have expanded to include regional cooperations with China Construction Bank, the Bank of Communications, China Citic Bank, the Bank of China and China Everbright Bank.  For each POS terminal that we deploy, we share with the collaborating bank a certain percentage of the processing fee for transactions occurred on the POS terminal.  In return, we bear
 
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the cost of POS terminals, related consumables, sales and marketing costs and other maintenance costs.  At this point, we still suffered a loss for our POS business in 2008.  We cannot guarantee that we will be successful in our management of this business.  Many factors, some of them are beyond our control, could materially and adversely affect our ability to turn this business into a profitable business, including:
 
·
our limited experience in managing the POS merchant acquiring business;

·
our ability to manage our relationships with our collaborators;

·
the low barriers to entry and increasing competition;

·
the existence of larger more established competitors, in particular China UnionPay, the predominant player in the field;

·
adoption of credit and debit cards and prepaid store cards as a way of payment by merchants and consumers in China; and

·
our ability to deploy additional POS terminals.
 
In addition, we may expand into other business areas in the future where we do not have significant experience and will be facing additional risks and uncertainties.  If we fail to mange and grow our POS business or other new businesses that we undertake, our overall business, financial condition and results of operations may be materially and adversely affected.

We are expanding into other sectors of the diversified financial services, and seek to establish a presence in IT services for insurance and securities companies, with which we have limited experience.  

We believe that we will be able to become an IT service provider for a broad range of diversified financial service companies as the market characteristics and underlying IT capabilities are similar to the banking industry.  In 2008, we established Elegon, a joint venture with 3i Infotech of India, to  localize their software to the Chinese market, including insurance products.

In the past our clients have been predominately banks in China.  As we expand into the insurance market, we may not be able to successfully localize the software or understand the requirements of insurance companies. Although the market for IT solutions for insurance companies is nascent and highly fragmented, there are already competitors in the space.  We may not be able to compete in a cost effective manner or gain successful reference sites that will enhance our reputation in this field.  Our IT solutions may also be outdated, before they are even brought to market, or we may not be able to develop appropriate solutions.  In addition, we do not have significant experience with insurance solutions and will be facing additional risks and uncertainties.  If we fail to manage and grow our service capabilities, in this or other business we undertake, our business, financial condition and results of operations may be materially and adversely affected.
 
We recently introduced an Application Service Provider, or ASP, services for SMBs, and we may not be able to successfully implement this new revenue model.

We typically provide our IT solutions and software on a project-by-project basis, through which we charge our clients based on the entire cost and an expected profit on a project.  Recently, we launched a new revenue model whereby we set up a complete and centralized IT architecture and software platform that can host multiple clients.  In January 2008, we entered into a collaboration agreement with China Financial Certification Authority, or CFCA, to provide an online banking ASP platform to serve SMBs.  CFCA will host and maintain the online banking platform, and we will provide the necessary hardware and online banking solutions. In exchange for ASP services, clients pay an annual hosting and maintenance fee and variable fees based on the number of users, transactions and other services, as stipulated in the contracts.  Revenues generated through the ASP platform are shared by Yucheng and the
 
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CFCA. Unlike our project-based revenue model, the initial charge to the client is small, and we expect to recover our costs and make a profit by generating recurring revenues tied to the use of the ASP platform.  However, we cannot guarantee that we will be able to generate a profit from this service.  Whether we can succeed in this business depends on how many SMBs are willing to use this service instead of creating their own online banking platform in-house or via customized outsourced project, and also to the extent their end customers use the online banking platform.  As we have borne significant costs to establish the platform, if we fail to generate enough interest among SMBs for the use of this service, or if their end customers do not use the online banking platform we provide, we may not be able to recover our costs and our business, financial condition and results of operations may be materially and adversely affected.
 
We are expanding our client base to include an increasing number of SMBs, which subjects us to additional risks, such as uncertainties of future businesses and credit risks.
 
As part of our effort to diversify our business and reduce our dependence on a limited number of banking clients, we have expanded our client base to include SMBs.  However, we have limited experience doing business with these banks and we cannot ensure that our sales strategies will be successful in obtaining repeat business, such as later phase improvement or expansion of the initial projects we undertake, from these clients as we are typically able to do with our larger clients, such as Top Four bank and Joint-Stock bank clients.  In addition, as compared to Top Four banks and Joint-Stock banks, we have less understanding of SMBs’ budgeting process and their project awarding practices, which makes it more difficult for us to predict future projects in order to allocate and plan our resources.  Furthermore, SMBs may not be as reliable as Top Four banks and Joint-Stock banks in making timely payments, which would subject us to additional credit risks.  If we cannot successfully manage these risks, our business, financial condition and results of operations may be materially and adversely affected.
 
We may not be able to prevent others from unauthorized use of our intellectual property, which could harm our competitive position and adversely affect our business and prospects.
 
We rely on a combination of patent, copyright and trademark laws, licensing agreements, confidentiality agreements, internal confidentiality policies and other contractual provisions, as well as technical measures to protect our intellectual property rights.  We cannot make assurance that PRC laws and our measures will be adequate to protect our intellectual property.  PRC laws are still developing in this area and the enforcement of such rights at the judicial level is highly uncertain and may not be as effective as in the United States or other countries.  We may not be able to deter competitors from copying our technology, reverse-engineering our solutions, or otherwise infringing on our intellectual property rights.  To protect our trade secrets and other proprietary information, our employees, consultants, advisors and collaborators are required to enter into confidentiality agreements.  There can be no assurance that these agreements will provide meaningful protection in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.  We hold registered rights covering certain aspects of our technology, in particular software solutions, but it is uncertain how much protection such registrations provide us.  We have 1 patent, 1 outstanding patent application and more than 31copyrights in China; however the protection is limited and may not sufficiently protect our intellectual property rights.  In addition, because we currently do not have patents, we are unable to rely on patent law to protect our intellectual property.  If we fail to protect our intellectual property and technology, or if our competitors independently develop technologies that are substantially equivalent or superior to our technology, our competitiveness may be adversely affected, which may materially and adversely affect our business and prospects.
 
Furthermore, if we believe third parties have infringed our intellectual property and other proprietary rights, we may have to resort to litigation to enforce our intellectual property and proprietary rights.  Intellectual property litigation is expensive and time-consuming.  Litigation may also cause significant diversion of company resources and management attention, cause disruptions in our daily operations, prove to be unsuccessful, and result in our intellectual property rights being held invalid or unenforceable, all of which could materially and adversely affect our business, financial conditions and results of operations.
 
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If we infringe on third-parties’ intellectual property rights, we could be required to cease offering the infringing solutions, redesign those solutions or enter into license agreements and pay royalties, any of which could have an material adverse impact on our business, financial condition and results of operations.
 
There can be no assurances that a third party will not assert that our solutions and services violate their intellectual property rights.  Intellectual property laws are not fully developed in China, and there may be significant uncertainties in the scope and enforceability of intellectual property rights a company holds.  As the number of solutions offered by Yucheng and our competitors increase and the functionality of these solutions further overlaps, intellectual property related litigation in our industry may increase.  Our competitors may claim that our solutions and services infringe their intellectual property rights and initiate litigation against us.
 
Any such claims, whether with or without merit, could be expensive and time consuming to defend, cause significant diversion of our management’s time and our resources, disrupt our daily operations and damage our reputation.  If we are found by a competent court to have infringed third parties’ intellectual property rights, we may be required to:
 
·
pay damages to the owner of the technology that we are found to infringe, which could be substantial;

·
cease making, selling or using solutions that incorporate the infringed intellectual property;

·
redesign our solutions around the infringed intellectual property, which may not be feasible; and

·
enter into licensing agreements and pay royalties in order to obtain the right to use necessary technologies.
 
Any such litigation and the judgment of any of these remedies may materially and adversely affect our business, financial condition and results of operations.
 
We may be subject to intellectual property infringement claims from our clients, which may force us to incur substantial legal expenses and, if the claim is upheld against us, may materially and adversely affect our business, financial condition and results of operations.
 
The majority of our contracts involving custom-designed software solutions provide that our clients own the intellectual property rights to software solutions developed under these contracts, and we are not permitted to use such intellectual property.  We only retain our proprietary rights to the methodologies, algorithms or patents that we use in the development of the custom-designed software solutions.  In addition, most of these contracts are silent as to whether we can make improvements on such custom-designed solutions and commercialize such improvements.
 
As a result of these contract provisions, we may be subject to intellectual property infringement claims by our clients.  It may be difficult to distinguish which part of the software that we developed for our clients represents our proprietary rights, and it is also not clear whether we have rights to make improvements on the software or part of the software that we developed for our clients.  If our clients initiate intellectual property claims against us, we may have to incur substantial legal expenses, which may also divert significant management attention and company resources, damage our client relationships and disrupt our normal business operations.  In addition, we may not be successful in defending against such litigation.  If we are found to have violated our clients’ intellectual property rights, we could be forced to pay licensing fees or be enjoined from using the related intellectual property and forced to develop and utilize alternatives.  Such a finding could also result in substantial monetary liabilities, harm our reputation, cause a decline in our sales and negatively affect our client relationships, all of which may materially and adversely affect our business, financial condition and results of operations.  One successful claim may also bring a cascade of other similar claims, which may further exacerbate the material adverse effect of such litigation on our business, financial condition and results of operations.
 
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Our intellectual property indemnification practices may materially and adversely impact our business.
 
We have agreed to defend many of our clients at our own cost for any third-party intellectual property claims filed against them arising from the solutions and services we furnished them, and indemnify them for any damages of intellectual property infringement.  This practice may subject us to significant litigation costs and indemnification claims by our clients.  We cannot assure that third-parties will not pursue such claims, which may materially and adversely affect our business, financial condition and results of operations.
 
We rely on selected third-party technologies and third-party suppliers for hardware equipment and software applications for our Platform & Maintenance Services.  If we are not able to obtain the needed items, our business could be materially and adversely affected.
 
We depend on the availability of the necessary hardware equipment and software applications from third-parties for our Platform & Maintenance Services. We have established business relationships with selected suppliers. We cannot assure that these vendors/distributors will continue to offer needed hardware or software solutions, continue their relationships with us or provide us their products at reasonable prices. In such an event, we may not be able to secure alternative suppliers or procure hardware equipment and software applications at a reasonable cost. In addition, even if we are able to obtain replacement third-party products in a timely manner, our solutions may not properly interface or interoperate with their hardware or software solutions, which may result in delays and client dissatisfaction, or even result in contractual breaches with our clients. We may be unable to develop an alternative solution on a timely basis or at a reasonable cost to circumvent the lack of products from third parties. Our failure or inability to acquire alternative third-party products or develop alternative solutions on a timely basis or at a reasonable cost may subject us to contract liability and our relationship with our clients may be negatively affected, which may materially and adversely affect our business, financial condition and results of operations.
 
We may be unsuccessful in identifying and acquiring suitable acquisition candidates or fail to complete acquisitions, which could adversely affect our growth.
 
We have grown in the past partly through selective acquisitions.  Through these acquisitions we expanded our revenue sources, added new solutions or services, acquired new clients and obtained qualified personnel, all of which complemented our organic growth.  We plan to continue to pursue selective acquisitions of high-quality financial IT services companies to further our future growth.  However, we may not be able to identify suitable future acquisition candidates or complete such acquisitions on terms commercially acceptable to us, which may impair our ability to effectively or efficiently implement our growth strategies.  In addition, identifying acquisition targets, due diligence and negotiations all require significant management attention and diversion of our resources.  If we fail to successfully complete acquisitions after spending significant management time and company resources, our business, financial condition and results of operations could be materially and adversely affected.
 
We face risks in connection with the acquisition of businesses.  If we fail to manage these risks, our financial condition and results of operations may be adversely affected.
 
We face risks in connection with the acquisition of businesses.  These risks include:
 
·
difficulties integrating acquired businesses and retaining necessary personnel to run such businesses;

·
entry into unfamiliar markets;

·
unforeseen or hidden liabilities;
 
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·
need for financial resources beyond our planned levels;

·
inability to generate sufficient revenues and profits to offset acquisition costs;

·
failures in realizing anticipated synergies; and

·
potential loss of or harm to relationships with employees and clients resulting from our integration of the acquired businesses.
 
Any of these risks may derail the success of our acquisitions.  As a result, we may not realize the benefit we anticipated while incurring significant costs, and our business, financial condition and results of operations may be materially and adversely affected.
 
If we are not able to retain our senior management team and critical staff members, and recruit quality personnel as we expand, our business and prospects will be adversely affected.
 
We depend on our ability to retain and recruit qualified personnel, including senior management and other key staff members.  The available talent pool in China is limited and competition is intense.  We depend on our senior management team for their industry knowledge and experience as well as their relationships with existing clients.  If we lose the service of any member of our senior management team, we may not be able to find a suitable replacement in a timely manner or at all.  Even if we are able to find a replacement, it will take time for the new person to be integrated into our business.  Furthermore, the ability to successfully complete client engagements depends on a trained, knowledgeable and stable staff, such as skilled engineers and project managers.  As we continue to grow, we need additional qualified staff to carry out our additional business projects, as well as other aspects of our business, such as marketing and sales, accounting and research and development.  If we are not able to retain our senior management team, recruit quality personnel as we expand, or provide appropriate training, career opportunities and otherwise motivate and retain our qualified employees, our business, financial condition and results of operations may be materially and adversely affected.  In addition, although we have non-competition provisions in our employment agreements with our management and key personnel, we cannot be certain that these provisions will not be breached and that they will be enforceable in a PRC court.  If our management and key personnel join our competitors or form competing businesses, our competitive position and business prospects may be materially and adversely affected.
 
Increases in wages for IT professionals will increase our costs and our gross margins and profit margins may be adversely affected.
 
Historically, wages for comparably skilled technical personnel in China’s IT services industry have been lower than in developed regions, such as in the U.S. or Europe.  However, in recent years, due to rapid economic development, intense competition for qualified IT professional and general inflation, wages in China’s IT services industry have increased and may continue to increase at even faster rates.  In addition, we may be required to implemented wages increase by the relevant labor bureaus’ guidelines, such as our average 12% wage increase in early April 2008.    Our Personnel cost accounted for 46.3%, 57.4% and 55.3% of our cost of revenues in 2006, 2007 and 2008, respectively.  Although we were able to increase productivity to counter the increase in our IT personnel costs, we cannot assure you that we will be able to achieve these or comparable cost savings in the future.  If we experience significant increases in wages for IT professionals, our cost of revenues will increase significantly, which could materially and adversely affect our gross margin and results of operations.
 
We provide warranties on third-party hardware and software that we procure for our clients.  We may incur substantial costs, if our clients file a significant number of warranty claims against us for such third-party hardware and software, and if those claims either exceed the scope of the warranties that the manufacturers or their agents have contracted to provide to us, or if such manufacturers or their agents do not honor their contract warranties.
 
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Through our Platform & Maintenance Services, we assist clients with the procurement and installation of third-party hardware and software which best meets their system requirements.  For the individual components, we typically provide warranties similar in scope to the warrants covered by the manufacturers.  However, we are generally responsible for the maintenance and service of the entire system, and will act on behalf of our clients to obtain manufacturer warranted services.  Most of our contracts do not have disclaimers or limitations on liability for special, consequential and incidental damages, nor do we limit the amount recoverable for damages.  If our clients file a significant number of warranty claims against us for such third-party hardware or software, we cannot be certain that the original manufacturers’ warranties will be fulfilled and that the costs incurred will be sufficiently cover.  The warranties obtained from such manufacturers may not cover the entire warranty claims, or the manufacturers may refuse to honor their contract warranties.  As a result, we may be liable for damages, which could materially and adversely affect our financial condition and results of operations.
 
Many of our contracts with clients permit termination by our clients as their IT requirements change, or if our performance is not consistent with the quality and other standards specified in those contracts.  Any termination of contracts may materially and adversely affect our business, results of operations and financial condition.
 
Many of our client contracts can be terminated by our clients as their IT requirements change, and without penalty. There are a number of factors relating to our clients that are outside of our control which might lead them to terminate a contract or project with us, including a change in financial condition, mergers and acquisitions or significant corporate restructurings. The ability of our clients to terminate contracts creates an uncertain revenue stream. Furthermore, many of our contracts provide that our client may terminate the contract if we fail to meet a specified timetable or fail to achieve certain quality or other standard. If our contracts are terminated due to this reason, in addition to the lost revenue and incurrence of penalties, our industry reputation may suffer. Any significant contract termination, especially if unanticipated, could have a negative impact on our business, financial condition and results of operations.
 
We may be subject to significant contract liabilities, if we fail to complete client projects on time, or if we fail to provide required level of services under our maintenance contracts.
 
Many of our client contracts require us to complete the projects in a certain timeframe and some also impose interim milestones. We cannot make assurances that we will always be able to complete our client projects on time or meet all the interim milestones. A number of reasons may result in delay of our client projects, such as unforeseen bugs, technical difficulties or lack of sufficient software engineers. Some of these factors are beyond our control. If we fail to meet the deadlines or milestones specified in the timetable, we may be subject to contractual penalties, such as significant late fees, and the client may have the right to terminate the contract and require us to compensate them for any loss they incurred due to our delay. If this happens, our reputation, client relationships as well as our business, financial condition and results of operations may be materially and adversely affected.
 
In addition, some of our client contracts require us to keep the client’s system in operation and are subject to contractual liabilities if the client’s system breaks down for more than a specified period of time.  If we fail to properly maintain the client system, or fail to fix system disruptions in a timely manner, we may breach such contracts and be subject to contractual liabilities, which could also materially and adversely affect our client relationships as well as our business, financial condition and results of operations.
 
Our solutions use internally developed technology and third-party products, any of which may contain errors and bugs, which may require us to spend additional time and incur additional expenses to correct.  These errors and bugs may also cause breaches in our service agreements and require us to pay damages to our clients.
 
Our solutions may contain undetected errors, defects or bugs that may or may not be correctable.  Our solutions also involve integration with products and systems developed by third-parties.  Complex third-party software programs may contain undetected errors or bugs when they are first introduced or as new

 
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versions are released. Because we cannot test our existing or future solutions or third-party products upon which our solutions are dependent for all possible scenarios, our solutions may contain errors which are not discovered until after they have been installed and we may not be able to correct these problems on a timely manner. We may be required to devote resources and incur significant expenses to detect and correct such errors and bugs, and we cannot guarantee that all of these errors or bugs can be corrected. These errors and bugs may also result in delays in project completion, loss of our solutions market share, injury to our reputation and damage our relationship with our clients. Furthermore, these errors or bugs may significantly impair their intended use and subject us to liabilities, which may require us to pay damages, which may adversely affect our client relationships as well as our business, financial condition and results of operations.
 
We may experience system failures, which could hurt our business reputation, and subject us to contract liability to our clients for the interruption in service. Our computer networks may be vulnerable to security risks that could materially and adversely affect our results of operations and subject us to liability.
 
Our operations depend on our ability to protect our systems from interruptions caused by damage from fire, earthquake, power loss, telecommunications failure, unauthorized access, computer hackers, computer viruses, software malfunction or other events beyond our control. We currently back-up data only relating to certain systems, such as financial, human resource and emails, and do not have sufficient backup facilities to provide full system services, if the primary facility is not functioning. We currently do not have an offsite disaster recovery system. In the event of major disasters, both primary and backup locations could be adversely impacted. We could also experience system interruptions due to the failure of our systems to function as intended, such as the failure of the systems relied upon to deliver online banking services or the failure of the interaction of our systems with other systems and networks of our clients or other third parties. Loss of all or part of the systems for a period of time could have a material adverse effect on our business reputation, financial condition and results of operations.
 
Our computer networks may be vulnerable to unauthorized access, computer hackers, computer viruses and other security problems caused by unauthorized access to, or improper use of, systems by third parties or employees. A hacker who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in operations. Although we intend to continue to implement security measures, computer attacks or disruptions may jeopardize the security of information stored in and transmitted through computer systems of our clients. Actual or perceived concerns that our systems may be vulnerable to such attacks or disruptions may deter banks and consumers from using our solutions or services. As a result, we may be required to expend significant resources to protect against the threat of these security breaches or to alleviate problems caused by these breaches.
 
Data networks are also vulnerable to attacks, unauthorized access and disruptions. For example, in a number of public networks, hackers have bypassed firewalls and misappropriated confidential information. It is possible that, despite existing safeguards, an employee could divert our clients’ funds, exposing us to a risk of loss or litigation and possible liability. Losses or liabilities that are incurred as a result of any of the foregoing may materially and adversely affect our business, financial condition and results of operations.
 
Our business benefits from certain government incentives. Expiration, reduction or discontinuation of, or changes to, these incentives will increase our operating expenses and tax burden and reduce our net income.
 
The PRC government has provided various incentives to domestic companies in the software industry in China in order to encourage development of this industry. Many of our PRC subsidiaries have historically received technology subsidies, business tax exemptions, value-added tax, or VAT, refunds and preferential income tax treatments. For example, many of our PRC subsidiaries enjoyed reduced enterprise income tax at the applicable rate of 15% on taxable profits in China, as compared to the statutory rate (33% prior to 2008 and 25% thereafter) and/or tax holidays due to their status as a foreign-invested enterprises, software enterprises or high-tech enterprises located in certain locations. Our tax savings from these
 
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preferential income tax treatments amounted to RMB11.9 million, RMB18.1 million and RMB31.2 million in 2006, 2007 and 2008, respectively. See “Item 5. Operating and Financial Review and Prospects — A. Operating results — Income taxes.” In addition, due to our status as software company in the high-tech industry, we received technology subsidies, VAT refunds, business tax refunds and other benefits in the amount of RMB3.2 million, RMB7.3 million and RMB6.2 million respectively, in 2006, 2007 and 2008. See “Item 5. Operating and Financial Review and Prospects — A. Operating results — Operating expenses — General and administrative expenses.” The PRC government may reduce or eliminate these incentives at any time in the future. Additionally, in order to continue to qualify for some of these incentives, we are required to meet stringent requirements on research and development activities and on our gross revenues.
 
On March 16, 2007, the PRC National People’s Congress passed the PRC Enterprise Income Tax Law, or the New EIT Law, and in December 2007 the PRC State Council issued implementation rules under the New EIT Law, both of which became effective on January 1, 2008. Under the New EIT Law and its implementation rules, a unified enterprise income tax rate of 25% and unified tax deduction standards will be applied equally to both domestic-invested enterprises and foreign-invested enterprises, but it repealed most of the existing preferential tax treatments, including the preferential tax rates and the tax holidays. The New EIT Law provides a five-year transition period that allows enterprises that enjoyed certain preferential tax treatment under the old enterprise income tax regime to gradually transition to the 25% statutory rate in a prescribed fashion. According to a notice issued by the PRC State Council, for enterprises that enjoyed preferential income tax rate of 15% pursuant to certain prior tax rules or regulations specified in the notice, the applicable enterprise income tax rate will increase to 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011 and 25% for 2012 and thereafter. For tax holidays specified in the notice, enterprises already enjoying such holidays prior to January 1, 2008 can generally continue to enjoy such tax holidays until their expiration, upon which time the 25% tax rate will apply. All other preferential tax treatments have generally terminated on December 31, 2007. Due to the application of the New EIT Law and its implementation rules, certain of our subsidiaries may no longer be able to enjoy any preferential income tax treatment, and certain others may need to pay higher transitional income tax rates starting January 1, 2008. As a result, we expect our effective income tax rate to gradually increase from our 2008 level, which may materially and adversely affect our financial condition and results of operations.
 
We may incur losses due to business interruptions resulting from the occurrence of natural catastrophes, acts of terrorism or fires, and we have limited insurance coverage.
 
Insurance companies in China offer limited business insurance products and we currently do not have insurance against business interruptions. Should any natural catastrophes, such as earthquakes, floods, typhoons, fire or any acts of terrorism occur in China that affect our operations, we might suffer not only significant property damages, but also the loss of revenue due to interruptions to our business operations, which could have a material adverse effect on our business, financial condition or results of operations. In addition, we do not have any key personnel insurance to cover any losses we may suffer due to any loss of our senior management and other key personnel. In any such event, we may incur additional costs, which could materially and adversely affect our financial condition and our results of operations.
 
Any health epidemics and other outbreaks could severely disrupt our business operations.
 
Our business could be materially and adversely affected by the outbreak of a health epidemic or pandemic. Any prolonged occurrence of a health crisis, such as severe acute respiratory syndrome, influenza or other adverse public health developments in China could require the temporary closure of our offices or prevent our staff from traveling to our clients’ offices to provide on-site services. Such closures could severely disrupt our business operations and materially and adversely affect our business, financial condition and results of operations.

RISKS RELATED TO DOING BUSINESS IN CHINA
 
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Adverse changes in China’s political and economic policies, including its policy of reforming its economic system, could have a material adverse effect on the growth of private businesses in China, such as ours.
 
All of our operations are conducted in China and all of our sales are made in China. Accordingly, our business, financial condition and results of operations are significantly affected by economic, political and legal developments in China. Since the late 1970s, China has been reforming its economic system and changing from a planned economy based on governmental dictates and priorities to one that uses market forces to influence deployment of economic resources, labor and capital and to determine business endeavors. It is impossible to predict whether or not the government will continue to encourage economic liberalization and further release its control over the economy and encourage private enterprise. We also cannot predict the timing or extent of future economic reforms that may be proposed. Any re-imposition of planned economy regulation or similar kinds of restrictions could reduce the freedom of private businesses to operate in a profitable manner, restrict inflows of capital or stifle investor willingness to participate in China’s economy. Any adverse change in the economic conditions or government policies in China could have a material adverse effect on overall economic growth, which in turn could lead to a reduction in demand for our solutions and services and consequently have a material adverse effect on our business. Moreover, to the extent we need additional capital; any restrictions on foreign ownership, foreign investment and repatriation of profits will hamper our ability to find capital outside of China.
 
The Chinese economy has experienced rapid growth and the accompanying inflation for the past few years. In 2009, the Chinese economy is expected to experience a slow-down in growth, due in part to the current global economic recession, which could lead to deflationary pressures and slower long-term growth prospects. These economic uncertainties and wide swings between inflation and deflation may result in the decreased profitability of China’s banks, and hence could adversely affect our business.

The rapid growth of China’s economy has resulted in higher levels of inflation in 2007 and 2008. China’s consumer price index (CPI) increased by 4.8% and 5.8% in the full year of 2007 and 2008, respectively. As part of the measures to control inflation, the People’s Bank of China, or PBOC, China’s central bank, has increased statutory deposit reserve ratio ten times in 2007 and five times in the first two quarters in 2008. However, as a result of the global economic slowdown in the second half of 2008, China’s economy has also been negatively impacted. To spur consumer spending, the PBOC decreased the deposit reserve ratio four times since early September 2008, and has cut benchmark interest rates three times in 2008. Due to China’s underdeveloped financial system, these volatilities and reactionary practices may have negative long-term consequences on bank’s profitability.

Given the poor economic visibility, rapid policy changes and global economic pressures on China, banks may be more conservative when it comes to upgrading or expanding their IT capabilities. This could potentially lead banks to defer IT purchase or demand price concessions, resulting in downward pricing pressure on IT vendors. If our pricing policies come under pressure, it is possible that we will not be able to correspondingly lower our expenses and our gross margin and net margin could be materially and adversely affected. In addition, any reduction in IT spending by banks or decline in IT pricing may affect our sales, which could materially and adversely affect our business, financial condition and results of operations.

PRC laws and other conditions may limit our ability to make dividend payments to our shareholders.
 
We are a holding company in the British Virgin Islands, or the BVI. We rely on our PRC subsidiaries to provide us with cash flow and to meet our other obligations, including paying dividends to our shareholders. Relevant PRC laws and regulations permit payment of dividends by a PRC subsidiary only from accumulated distributable profits, if any, determined in accordance with PRC accounting standards and regulations, and only after setting aside at least 10% of its current year profits (up to an aggregate amount equal to half of its registered capital). See “Item 8. Financial Information — A. Consolidated statements and other financial information — Dividend policy.” The PRC tax authorities may initiate changes in determining income of our PRC subsidiaries that would further limit their ability to pay dividends and make other distributions to us. It is therefore possible that our PRC subsidiaries will not have any distributable profit to pay us, even if they are profitable under US GAAP.
 
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In addition, although PRC law currently allows enterprises owned by foreign investors to remit their profits, dividends and bonuses earned in China to other countries, and the remittance does not require prior approval by the State Administration of Foreign Exchange, or SAFE, we cannot assure you such policy will not change. SAFE regulations require extensive documentation and reporting, some of which is burdensome and slows payments. If there is a return to payment restrictions and reporting, it may also adversely affect the ability of our PRC subsidiaries to distribute their profits to us. Furthermore, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may also restrict their ability to pay dividends or make other payments to us. Any limitation on our subsidiaries’ ability to distribute dividends to us may adversely affect our ability to pay dividends to our shareholders.
 
Any fluctuations in exchange rates could result in foreign currency exchange losses.
 
Our operating subsidiaries are all located in China and our functional currency is Renminbi, and we are subject to fluctuations of the exchange rate between the Renminbi and the U.S. dollar. PBOC sets and publishes daily a base exchange rate between the Renminbi and the U.S. dollar. Beginning on July 21, 2005, PBOC has set this rate with reference primarily to the supply and demand of Renminbi against a basket of currencies in the market during the prior day, taking into account other factors such as the general conditions existing in the international foreign exchange markets, as compared to an exchange rate pegged to the U.S. dollar before such date. As a result, from July 21, 2005 to April 9, 2008, the Renminbi appreciated approximately 16% against the U.S. dollar. There is increasing international pressure for the PRC government to further loosen its control of the foreign exchange rate to allow a faster appreciation of the Renminbi.
 
Because our earnings and cash from operations are denominated in Renminbi, fluctuations in exchange rates between the U.S. dollar and the Renminbi will affect our balance sheet and earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the Renminbi relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Furthermore, fluctuations in the exchange rate could affect the relative value of any dividend we issue, which will be exchanged into U.S. dollars, as well as the value of any U.S. dollar denominated investments we make in the future and any earnings on such investments. The value in Renminbi in terms of our financing activities denominated in U.S. dollars will also be adversely affected if Renminbi continues to appreciate against the U.S. dollar.
 
Restrictions on currency exchange may limit our ability to receive and use our revenues or financing effectively.
 
Foreign exchange transactions under capital accounts continue to be subject to significant foreign exchange controls and require the approval of PRC governmental authorities, including SAFE. If our PRC subsidiaries borrow foreign currency loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance our PRC subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities including the Ministry of Commerce or its local branches. These limitations could affect the ability of our PRC subsidiaries to obtain foreign exchange through debt or equity financing.
 
Recent PRC regulations relating to offshore investment activities by PRC residents may increase the administrative burden we face and create regulatory uncertainties that could restrict our overseas and cross-border investment activity, and a failure by our shareholders, who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.
 
SAFE promulgated regulations that require registration with local SAFE offices in connection with direct or indirect offshore investment and cross-border investment through the special purpose vehicles by
 
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PRC residents, including PRC individual residents and PRC corporate entities. These regulations apply to our shareholders who are PRC residents and also apply to our prior and future offshore acquisitions. In particular, the SAFE regulations require PRC residents to file with competent SAFE offices information about offshore companies in which they have directly or indirectly invested or through which the cross-border investment is conducted and to make follow-up filings in connection with certain material transactions involving such offshore companies, such as increases or decreases in investment amount, transfers or exchanges of shares, mergers or divisions, long-term equity or debt investments, external guarantees or other material events that do not involve return investment.
 
The SAFE regulations retroactively require registration by March 31, 2006 of direct or indirect investments in offshore companies or cross-border investments previously made by PRC residents in offshore companies. If a PRC resident with a direct or indirect stake in an offshore parent company or any cross-border investment fails to make the required SAFE registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Further, failure to comply with various SAFE registration requirements described above could result in liability under PRC law for foreign exchange evasion.
 
To date, our major shareholders who are PRC residents, or whose shares are beneficially owned by PRC residents, have completed the required foreign exchange registration with the local foreign exchange bureau according to these SAFE regulations. They are still required to file with competent SAFE offices when there are material transactions involving us. We are committed to complying and to ensuring that our shareholders who are subject to these regulations to continue comply with the relevant rules. However, due to the newness of the regulations and uncertainty concerning the reconciliation of the new regulations with other approval requirements, it remains unclear how the regulations, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities, and we cannot make assurances that all of our shareholders who are PRC residents will comply with our requests to make or obtain any applicable registrations or approvals required by the regulations or other related legislation. The failure or inability of our PRC resident shareholders to receive any required approvals or make any required registrations may subject us to fines and legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiaries from making distributions or paying dividends or affect our ownership structure, as a result of which our business operations and our ability to distribute dividends to you could be materially and adversely affected.
 
We may be treated as a resident enterprise for PRC tax purposes under the New EIT Law and we may therefore be subject to PRC income tax for any dividends we receive from our subsidiaries, which may materially and adversely affect the amount of dividends we must pay to our shareholders.
 
Under the New EIT Law and its implementation rules, enterprises established under the law of non-PRC jurisdictions, but whose “de facto management body” is located in China, are treated as resident enterprises for PRC tax purposes. Although the implementation rules stipulate that the “de facto management body” refers to the organization which substantially manages and controls the operation, staff, finance, properties and other aspects of the enterprises, it is currently unclear in which specific situations a non-PRC enterprise’s “de facto management body” is located in China. All of our management is currently based in China. If we are treated as a resident enterprise for PRC tax purposes, we will be subject to PRC tax on our worldwide income at the 25% uniform tax rate, which will include any dividend income we receive from our subsidiaries. In addition, the New EIT Law provides that the qualified dividend income between resident enterprises is exempted income, and the implementation rules stipulates that the “the qualified dividend income between resident enterprises” refers to the direct investment between resident enterprises, it is not clear what is considered a qualified resident enterprise under the New EIT Law. If we are required under the New EIT Law to pay income tax for any dividends we receive from our subsidiaries, it will materially and adversely affect the amount of dividends we may pay to our shareholders.
 
Dividends payable by us to our non-PRC shareholders, and gains on the sales of our ordinary shares, may be subject to withholding taxes under PRC tax laws, which may materially reduce the value of the investment.
 
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The New EIT Law and its implementation rules provide that an income tax rate of 10% will normally be applicable to dividends payable to non-PRC investors which are derived from sources within China. This provision may apply to our non-PRC shareholders, if we are deemed as a resident enterprise for tax purposes. According to a notice issued by the PRC State Council, this 10% income tax starts to apply to dividends declared from profits generated after January 1, 2008. In addition, under the New EIT Law and its implementation rules, if we are deemed as a resident enterprise, any gains realized on the transfer of shares by such investors are also subject to 10% tax, if such gains are regarded as income derived from sources within China. We are a BVI holding company and substantially all of our income may come from dividends we receive from our subsidiaries, primarily those located in China. If we declare dividends from such income to our shareholders, it is unclear whether such dividends, or the gain our non-PRC shareholders may realize from the transfer of our ordinary shares, would be treated as PRC-sourced income and be subject to PRC tax. If we are required under the New EIT Law to withhold PRC income tax on our dividends payable to our non-PRC shareholders, or if non-PRC shareholders are required to pay PRC income tax on the transfer of their ordinary shares, the value of the investment may be materially and adversely affected.
 
Uncertainties with respect to the PRC legal system could limit the protection available to investors and the company.
 
The PRC legal system is a civil law system based on written statutes. Unlike in the common law system, prior court decisions may be cited for reference, but have limited precedential value. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. We conduct all of our business through our consolidated entities established in China. These entities are generally subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to wholly foreign-owned enterprises. However, since many laws, rules and regulations are relatively new, and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involves uncertainties, which may limit legal protection available to us. For example, we may have to resort to administrative and court proceedings to enforce the legal protection that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to predict the outcome of Chinese administrative and court proceedings as well as assess the level of legal protection we enjoy in China versus in more developed legal systems. These uncertainties may impede our ability to enforce the contracts we have entered into with our business partners, clients and suppliers. In general, these uncertainties, including the inability to enforce our contracts, could materially and adversely affect our business and operations. Furthermore, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Accordingly, we cannot predict the effect of future developments in the PRC’s legal system, particularly with regard to China’s IT industry and banking industry, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us and other foreign investors. In addition, any litigation in China may be protracted and result in substantial costs and diversion of our resources and management attention.
 
There may be difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States judgments against us, our subsidiaries, our officers and directors and experts named in this annual report.
 
We are incorporated in the British Virgin Islands and our operating subsidiaries are formed under PRC law. Substantially all of our assets are located in China. In addition, our directors and executive officers reside within China, and substantially all of the assets of these persons are located within China. It may not be possible to effect service of process within the United States or elsewhere outside China upon our directors, executive officers or experts named in this annual report, including effecting service of process with respect to matters arising under United States federal securities laws or applicable state securities laws. China does not have treaties providing for the reciprocal recognition and enforcement of judgments
 
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of courts with the United States and many other countries. As a result, recognition and enforcement in China of judgments of a court in the United States and many other jurisdictions in relation to any matter, including securities laws, may be difficult or impossible. Furthermore, an original action may be brought in China against our assets and our subsidiaries, our directors and executive officers and experts named in this annual report only if the actions are required to be arbitrated by PRC law and only if the facts alleged in the complaint give rise to a cause of action under PRC law. In connection with any such original action, a PRC court may award civil liability, including monetary damages.
 
RISKS RELATING TO OUR SHARES
 
Future sales of shares, or the perceived sale of additional shares, may lead to a decline in the market price of our shares.
 
We issued 5,328,320 ordinary shares as part of the initial purchase price for the acquisitions of Sihitech BVI and e-Channels BVI. All of these shares are currently held by our management and employees. As of March 31, 2009, all of such shares are tradable subject to restrictions under Rule 144 and insider trading rules.
 
As a significant portion of our shares are held by a small number of shareholders, historically trading volume of our shares has been relatively low. We cannot predict the effect, if any, market sales of securities held by our significant shareholders or any other shareholders or the availability of these securities for future sale will have on the market price of our ordinary shares.
 
In addition, certain of our shareholders and their transferees and assignees have certain registration rights with respect to 750,000 shares. See “Item 7. Major Shareholders and Related Party Transaction — Registration rights agreement.” Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the public market could cause the price of our ordinary shares to decline.
 
Furthermore, we may need to do additional financing in the future in the form of our ordinary shares or securities convertible into, or exchangeable for, our ordinary shares, which will further dilute the shareholding of shareholders and may result in decline of our share price.
 
If certain financial or financing objectives are achieved, selling shareholders in the three-party acquisition will be entitled to receive shares of our stock which would result in dilution and might have an adverse effect on the market price of our ordinary shares.
 
Selling shareholders in the three-party acquisition have the right to earn up to 952,832 shares per year from 2007 to 2010 based on net profit targets. See “Item 4. Information on the Company — A. History and development of the Company — Corporate history”. We are required to issue 952,832 shares to these selling shareholders in the three-party acquisition based on our fiscal results, which were met in 2007 and 2008. There is no obligation to register these shares after issuance. However, after being held for the appropriate periods, these shares will be eligible for resale under Rule 144 of the Securities Act. If the additional shares are earned, they will significantly increase the number of our shares outstanding, and result in dilution to our existing shareholders. The issuance of these additional shares may cause a decrease in the trading price of our shares in the public market.
 
A large portion or our shares are owned by two of our directors and executive officers. These shareholders will have a significant influence over our corporate transactions and other matters that require shareholder approval.
 
Our executive officers and directors, including Messrs. Weidong Hong, Chairman and Chief Executive Officer and director and Shuo Zeng, Chief Operating Officer and director, in aggregate control the vote of about 21.7% of our issued and outstanding ordinary shares, assuming they do not sell any of their shares and our total number of issued and outstanding shares does not change. These two major shareholders maintain a significant influence over the outcome of corporate transactions or other matters submitted to our shareholders for approval, including the election of directors and the approval of other business transactions.
 
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The interest of these shareholders may not be the same as the interest of our other shareholders. This concentration of ownership could have the effect of delaying or preventing a change in our control or discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material adverse effect on the market price of our shares or prevent shareholders from realizing a premium over the market price for their shares. In addition, if our major shareholders chose to dispose of a material portion of the ordinary shares they hold, the prevailing market price of our shares may decline.
 
Certain provisions in our organizational documents may discourage our acquisition by a third party, which could limit your opportunity to sell your shares at a premium.
 
Our Memorandum and Articles of Association include provisions that could limit the ability of others to acquire control of us. Under those provisions, our board has the power to issue preferred shares with such rights attaching to them as they decide and that this power could be used in a manner that would delay, defer or prevent a change of control of our company. These provisions could have the effect of depriving shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to acquire control of us in a tender offer or similar transactions.
 
The market price for our shares may be volatile.
 
Our share price has been highly volatile and is expected to remain highly volatile in the future. Many factors affect the market price for our shares, including the following:
 
·
actual or anticipated fluctuations in our quarterly results of operations;

·
changes in financial estimates by securities research analysts;

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

·
the addition or departure of key personnel;

·
the addition or loss of key clients;

·
fluctuations of exchange rates between the Renminbi and the U.S. dollar;

·
intellectual property litigation;

·
the release from or expiration of lock-up or other transfer restrictions on our outstanding ordinary shares or sales of additional shares; and

·
general economic or political conditions in China and the United States.
 
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our shares.
 
Although publicly traded, the trading market in our ordinary shares has been substantially less liquid than the average trading market for a stock quoted on NASDAQ and this low trading volume may adversely affect the price of our ordinary shares.
 
Although our ordinary shares are traded on NASDAQ under the symbol “YTEC”, the trading market in our ordinary shares has been substantially less liquid than the average trading market for companies quoted on NASDAQ. Reported average daily trading volume in our ordinary shares for the three-month period ended March 31, 2009 was approximately 77,000 shares. Limited trading volume will subject our shares to greater price volatility and may make it difficult to sell our shares at an attractive price.
 
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As a foreign private issuer with ordinary shares listed on NASDAQ, we may follow certain home country corporate governance practices instead of certain NASDAQ requirements.
 
As a foreign private issuer whose ordinary shares are listed on the NASDAQ Global Market, we are permitted to follow certain home country corporate governance practices instead of certain NASDAQ requirements. A foreign private issuer that elects to follow its home country practice must submit to NASDAQ a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws. In addition, a foreign private issuer must disclose in its annual reports filed with the SEC each NASDAQ requirement with which it does not comply followed by a description of its applicable home country practice. As a company incorporated in the British Virgin Islands and listed on the NASDAQ Global Market, we expect to follow our home country practice with respect to, among other things, the composition of our board, director nomination procedures, the compensation of officers, annual meetings, the distribution of annual reports to shareholders and quorum requirements at shareholders’ meetings. In addition, we expect to follow BVI law instead of NASDAQ requirements that mandate that we obtain shareholder approval for certain dilutive events, such as the establishment or amendment of certain equity-based compensation plans, an issuance that will result in a change of control, certain transactions other than a public offering involving issuances of 20% or greater interests in the Company and certain acquisitions of the stock or assets of another company.
 
In addition, we are obligated to file an annual report on Form 20-F with audited financial statements and a report on Form 6-K at such times as we release information to the public either voluntarily or pursuant to the BVI laws. Therefore, our frequency of filing financial and other information may be less than that of a domestic United States registered company under the rules and regulations of the SEC. Investors may not receive information on a timely basis, therefore increasing their risk of investment.
 
We are a BVI company and, because judicial precedent regarding the rights of shareholders is more limited under BVI law, shareholders may have less protection for their shareholder rights than they would under U.S. law.
 
Our corporate affairs are governed by our Memorandum and Articles of Association, the BVI Business Companies Act, 2004 and the common law of the BVI. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under BVI law are to a large extent governed by the common law of the BVI. The common law of the BVI is derived in part from comparatively limited judicial precedent in the BVI as well as from English common law, the decisions of whose courts are of persuasive authority, but are not binding on a court in the BVI. The rights of our shareholders and the fiduciary responsibilities of our directors under BVI law are not necessarily as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the BVI has a less developed body of securities laws as compared to the United States, and some states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law. In addition, BVI companies may not have standing to initiate a shareholder derivative action in a federal court of the United States. As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of our board or controlling shareholders than they would as public shareholders of a company incorporated in a U.S. jurisdiction.
 
ITEM 4.
INFORMATION ON THE COMPANY
 
A.   History and development of the Company.

CORPORATE INFORMATION
 
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Our legal name is Yucheng Technologies Limited, which was incorporated in the BVI on November 17, 2005. Our principal executive offices are located at Beijing Global Trade Center, Tower D , Floor 9, 36 North Third Ring Road East, Dongcheng District, Beijing 100013, P.R. China, and our telephone number is +86 10 5913 7998. Our registered office in the BVI is at P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola. We maintain an Internet website at www.yuchengtech.com. Our agent for service of process in the United States is National Corporate Research at 10 E. 40th Street, 10th Floor, New York, New York 10016.
 
CORPORATE HISTORY
 
Yucheng Technologies was founded on November 24, 2006 via a three-party acquisition among China Unistone, Sihitech BVI and e-Channels BVI. Pursuant to the acquisition agreement and its amendment, in addition to the initial purchase considerations, the selling shareholders of Sihitech BVI and e-Channels BVI are entitled to additional cash and equity purchase consideration upon satisfaction of certain conditions. With respect to additional cash consideration, they are entitled to:
 
(1)
USD4,960,000, if we receive an aggregate of USD34,250,000 in gross proceeds from an additional financing, including, but not limited to, (a) exercise of our warrants, (b) our successful completion of a secondary offering, or (c) the private investment into us by a strategic investor;
 
(2)
USD1,000,000, if the average closing price of our stock in any 60 consecutive trading days of the year, or the Average Share Price, is above USD10.00 in 2006;

(3)
USD2,000,000, if the Average Share Price is above USD12.00 in any 60 consecutive trading days of 2007; and

(4)
USD3,000,000, if the Average Share Price is above USD14.4 in any 60 consecutive trading days of 2008;
 
provided, however, that in the event that all of the above events occur, the maximum aggregate amount to be paid by us to the selling shareholders will be no more than USD10,000,000. As of March 31, 2009, the hurdle criteria for conditions (1), (3) and (4) have been met. We paid USD4,960,000 to the selling shareholders in 2007, with respect to condition (1). With respect to condition (3), we have paid USD1,200,000 to the selling shareholders and accrued USD800,000. With respect to condition (4) we have accrued USD3,000,000.
 
With respect to additional equity consideration, the selling shareholders are entitled to receive 952,832 shares each year for four years starting from 2008, if we achieve a net profit of the following amounts according to the financial statements audited in accordance with US GAAP, where net profit shall be determined for this purpose only, as net profit (determined on the basis of US GAAP) before the amortization expenses related to the acquisition of e-Channels:
 
Year Ending December 31,
 
Net Profit
2007
 
USD8.5 million
2008
 
USD11.9 million
2009
 
USD16.7 million
2010
 
USD23.3 million
 
As of March 31, 2009, the net profit target for the years ended December 31, 2007 and December 31, 2008 were met. Accordingly, we are required to issue 952,832 shares to the selling shareholders for each year. We have issued 952,832 shares (related to the 2007 performance hurdle) to the selling shareholders in 2008. 952,832 shares for the 2008 performance hurdle have been accrued as of December 31, 2008 and shares are expected to be issued in the second quarter of 2009, pending the filing of the 2008 Annual Report.
 
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In 2007, we made four acquisitions which became wholly-owned subsidiaries: Sunrisk, Recency, Fuyi and Fujie. All acquisition related payments for Sunrisk and Recency have been paid. For Fuyi and Fujie of the total possible RMB20.7 million consideration, RMB17.1 million has been paid and RMB3.5 million has been accrued, with the variance due to operating results. Subsequently, we sold a 49% interest in Sunrisk. The minority shareholders are Gu’an Qihang, a private Chinese company, and 3 individual investors.

In May 2007, we acquired a 75% interest of Easycon, a provider of IT solutions and service to SMBs in China. In January 2008, we acquired the remaining 25% interest and Easycon is now a wholly-owned subsidiary. All payments have been made in relation to the 2007 consideration. An aggregate consideration of RMB7.2 million was negotiated with the minority shareholders of Easycon. RMB6 million was paid on February 2, 2008, RMB1.2 million was paid on April 1, 2008.

On August 2008 we established a joint venture Elegon Infotech, a joint venture with 3i Infotech of India. In 2008, we made cash advances to Elegon approximately RMB1.8 million, and collected from Elegon approximately RMB1.8 million. The balance due from Elegon is RMB143.

B.   Business overview.
 
OVERVIEW OF OUR BUSINESS
 
We are a leading provider of information technology, or IT, software, solutions and services to China’s banking sector. Our Software & Solutions business enables our clients to establish and maintain IT platforms to better manage their operations and serve their customers’ needs. We develop and deliver an extensive suite of technology via our Software & Solutions business, which we believe are best in class in the Chinese market, and are tailored toward specific functional needs of our clients. Software & Solutions provides critical functionality required in China’s banking industry, including Channel Solutions, Management Solutions and Business Solutions. For a more detailed description, see “Item 4. INFORMATION ON THE COMPANY – B. Business overview. – Our solutions and services – Software & Solutions.”
 
We generally provide our Software & Solutions to our clients on a project-by-project basis, whereby our clients agree to enter into one or several fixed-price, all-inclusive contracts, as opposed to purchasing separate individual service components from us on a time-and-materials or per-segment basis.
 
In addition to Software & Solutions, we also provide Platform & Maintenance Services to our clients, which involves selecting, procuring and reselling third-party hardware equipment and software applications to our clients. This also involves monitoring and assisting in the installation of such equipment and software at clients’ sites, as well as assisting in the integration of the installed equipment with clients’ existing IT systems. We typically only provide Platform & Maintenance Services as part of a larger client engagement that includes Software & Solutions, or if we anticipate that the Platform & Maintenance Services component will lead to future Software & Solutions revenue from the same client.
 
Beginning in early 2007, we launched our POS merchant acquiring business, which includes deploying Point-of-Sale terminals, or POS terminals, to merchants and processing credit and debit card payments through these POS terminals in collaboration with banks. Our POS business enables banks to increase their number of installed terminals in a more rapid and efficient manner, and creates a new, recurring revenue stream for us under the revenue sharing arrangements in which we enter into with our collaborating banks.
 
Since becoming a public company in November 2006, we have grown both organically and through acquisition of other IT solutions and service providers in China’s banking industry. In total, we have acquired five companies:
 
·
a 100% interest of Sunrisk, a provider of risk management solutions and services to China’s banks; subsequently in April 2008, we sold a 49% interest in Sunrisk to third-parties.
 
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·
a 100% interest of Easycon, a provider of IT solutions and service to SMBs in China;

·
a 100% interest of Recency, a provider of business intelligence solutions and consulting services to China’s banks; and

·
a 100% interest of both Fujie and Fuyi, two related companies focused on ERP management consulting and project implementation.
These acquisitions have enabled us to offer a broader range of solutions and services, provided us with access to a broader client base, and helped us to strengthen our management team and employee base.

In January 2007, we established Yuxinyicheng Information, through which we conduct our POS Merchant Acquiring Services. Yucheng maintained an 80% controlling interest in the subsidiary and an individual investor controlled a 20% minority interest. As of January 2009, we acquired the minority interest and Yuxinyicheng Information is currently a wholly-owned subsidiary.

In August 2008, we invested in Elegon Infotech, Ltd., a joint venture with 3i Infotech of India. We hold a 49% interest in the company.
 
We conduct our business through various subsidiaries in the PRC. Together with our head offices in Beijing, we have subsidiaries or branch offices in 19 other cities. As of December 31, 2008, we had 1,941 employees.
 
As a result of both organic growth and acquisitions, our revenue grew from RMB289.7 million in 2006 to RMB676.8 million (USD99.0 million) in 2008, representing a compound annual growth rate, or CAGR, of 52.9%, and our net income grew from RMB40.7 million in 2006 to RMB81.0 million (USD11.9 million) in 2008, representing a CAGR of 41.1%.
 
OUR INDUSTRY
 
According to IDC, the market for banking industry IT solution spending in China is expected to grow from RMB6.1 billion (USD0.9 billion) in 2008 to RMB12.3 billion (USD1.8 billion) in 2012, representing a CAGR of 19.6%. This rapid growth in IT solution spending is driven primarily by the development in China’s economy and the ongoing regulatory reform catalyzed by China’s accession into the WTO, and the resulting increase in competition in China’s banking industry. To meet increasingly complex customer demands and to stay competitive in the market place, China’s banks are increasingly relying on IT systems for the management of their operations, such as processing transactions, analyzing operational data and managing risks, thereby creating growth opportunities for IT service providers such as us.

The following table sets forth China’s banking industry IT solution spending by solution type from 2005 to 2012.
 
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Source: IDC, September 2008
 
China’s banking and financial institutions and their IT needs
 
China’s banking industry continues to be the primary provider of capital to China’s economy and bank deposits remain the primary choice for domestic savings. According to IDC, there are currently less than 9,000 banking institutions operating in China today. This number is expected to continue to decline as the Chinese Banking Regulatory Commission (CBRC), continues to emphasis industry consolidation to increase the efficiency of banks and the integrity of the Chinese banking system. Most of banking institutions in China are either wholly state-owned or state-controlled, directly or through state-owned enterprises. In recent years, there have been a growing number of privately-owned as well as foreign-owned banks, although they are still relatively small in number to date. In addition, to promote competition the CBRC lessened regional restrictions, thereby allowing more banks, especially joint-stock and SMBs, to expand nationally.
 
China’s banking industry can be classified into four groups, including:
 
·
Tier 1 - State-controlled commercial banks. Commonly known as the “Big Four,” this group is comprised of the Industrial and Commercial Bank of China, Bank of China, China Construction Bank and the Agricultural Bank of China. These four banks are the largest among China’s domestic banks in terms of assets, deposit base, loan portfolio and nationwide branch network. According to the 2007 IDC Report, the Big Four together account for over 50% of bank assets in China. In recent years, three members of the Big Four, i.e., the Industrial and Commercial Bank of China, Bank of China and China Construction Bank, have completed an initial public offering and listing of their shares on the Hong Kong Stock Exchange. Although the Big Four have substantial in-house IT capabilities, we believe that, given their status as overseas listed companies on foreign exchanges and their needs to achieve global best practices; they will continually need to use third-party IT solution and service providers.

·
Tier 2 – National commercial banks. More commonly referred to as “Joint-Stock” banks, this group comprises of 13 other national commercial banks, which are owned by a combination of government entities, state-owned enterprises and other investors. Many members of this group, such as Bank of Communications, China Merchants Bank, China Minsheng Banking Corporation, Huaxia Bank, Shanghai Pudong Development Bank and Shenzhen Development Bank, are listed domestically and/or in Hong Kong. Joint-Stock banks generally have the financial resources necessary to maintain sufficient in-house IT capabilities to meet their needs. However, we believe that they are in substantial need of third-party expertise to enable them to sustain the growth rates that they have achieved in recent years.
 
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·
Tier 3 – Small and Medium-sized Banks (SMBs). According to IDC, in 2007 this group comprised 124 city commercial banks and over 8,520 cooperatives (including rural commercial banks and rural cooperative banks). We believe that most of the SMBs lack both the financial resources and in-house IT expertise needed to either scale up operations or to meet increasingly stringent regulatory requirements. As such, we believe they are most likely to allocate a majority of their IT spending to third-party providers such as us. Although foreign banks possess the financial resources, they are not familiar with local market practices and the regulatory requirements and often require the assistance of China’s domestic IT service providers.

·
Central bank and policy banks. The People’s Bank of China, or PBOC, is PRC’s central bank, which formulates China’s monetary policies and implements, such policies through a number of means, such as setting deposit reserves, interest rates and foreign exchange rates. In addition, there are three policy banks in China: the Agricultural Development Bank of China, China Development Bank and the Export-Import Bank of China. These policy banks were established in the mid-1990s as a result of banking reforms to assume the government driven policy lending functions from the Big Four. China Development Bank is in the process of transforming from a policy bank to a national commercial bank.
 
In addition to banks, there are numerous non-banking financial institutions in China, including insurance companies, securities brokerages, investment companies, asset management companies, finance companies and investment banks. This industry segment is still in the early stages of development in China. As this industry segment matures, we expect it to undergo significant consolidation. The IT systems and applications used in these non-banking financial institutions have similarities to those used in banking institutions. We believe as these financial institutions become larger, they will need more complex and sophisticated IT solutions to manage their business and service their customers. Non-banking financial institutions present potential business opportunities for IT service providers, such as Yucheng. As we are a leader in Channel Solutions for banks and our systems, such as call centers and e-transactions software, are readily adaptable to new applications.
 
Furthermore, we believe that in order to continue to access new channels for growth, banks may use their strong government support and access to capital to expand into new financial services adjacent to the banking sector, such as insurance, asset management, securities brokerage and investment banking, if such diversification becomes allowed under PRC laws and regulations. We believe such expansion and the need to integrate these new businesses with their existing banking businesses will require banks to place an even greater emphasis on IT capabilities in order to increase efficiency. As their IT needs become increasingly complex, their use of third-party IT services will continue to increase, in particular from those providers with experience in both the banking industry and the non-banking financial services industry.
 
Driving forces of IT spending at China’s banking institutions
 
China’s growing economy and the ongoing regulatory reforms are two major driving forces of change for China’s banking industry. China has experienced rapid economic growth over the past three decades, largely as a result of the PRC government’s extensive economic reforms. China’s gross domestic product, or GDP, as measured by the National Bureau of Statistics of China, has a grown in nominal terms at a CAGR of 17.1% from 2004 to 2008, the latest year available. China’s economic growth, combined with increasing fixed capital formation, high household savings rates, and a closed capital account, have driven the growth of China’s banks in the past decade. Such a rapidly developing economy places heavy demands on the efficiency and integrity of the country’s banking system. In recent years, China’s banking system has undergone significant changes and evolved to become an increasingly market-driven system.
 
In addition, China’s entry into the WTO in December 2001 and its accession commitments have served as a catalyst for regulatory reforms in China’s banking sector. In addition to PBOC, the most important government entity overseeing China’s banks is the Chinese Banking Regulatory Commission (CBRC). The CBRC was formed in April 2003 to assume the principal bank regulatory functions from PBOC as a response to the WTO entry requirements and the need to improve banking regulations. Since its establishment, the CBRC has pushed for improved disclosure, management accountability, more prudent
 
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regulatory standards and more efficient operations. It has played a key role in carving out bad debt, recapitalizing leading banks, regulating bank operations and driving reform throughout the banking system. The CBRC’s actions have led to significant improvements in corporate governance, risk management, internal controls and financial and operational transparency of China’s banks. While China’s banking industry is still evolving from a level well below the Organization for Economic Co-operation and Development’s (OECD) standards, supervision and regulation of China’s banks has improved dramatically in recent years, and is expected to continue to improve.
 
As required by the WTO accession agreement, China has gradually phased out limitations on foreign financial institutions. Foreign banks are now able to accept Renminbi denominated deposits, which previously was a significant advantage for domestic banks. In addition, the limitations on geographic network expansion are being reduced, which is promoting greater competition amongst domestic banks and greater access for foreign banks. We believe that the liberalization of the banking and financial services industry in China will force domestic banks and other financial institutions to improve their operations, increase the breadth of their product offerings and enhance their quality of services so that they can more effectively compete with increasingly prevalent international competitors.
 
As such, we expect China’s banking institutions to more aggressively seek technology and outsourced solutions to resolve inefficiencies and lower costs, so that they can compete more effectively in the marketplace. According to IDC, as of the end of 2007, China’s domestic banks total assets were estimated to be RMB52.6 trillion (USD7.7 trillion), which represents a year over year increase of 19.7%. The tremendous growth in assets is increasing the need for efficient technology. We believe that, as part of a broad-based effort to accelerate compliance with requirements of the WTO and Basel II (the international standards for better risk management for banks), China’s domestic banks will increasingly benchmark themselves to their foreign counterparts, and seek to achieve operational efficiencies through long-term increases in IT spending.
 
These developments in China’s banking industry indicate strong demand for IT capabilities, a significant portion of which we expect will be outsourced to third-party IT solution and service providers. In addition, due to their limited business scale and resources as compared to large Big Four and Joint-Stock banks, we believe that SMBs will rely even more heavily on third-party service providers to meet their increasingly complex IT needs. We believe that all of these developments present significant growth opportunities for IT service providers in China.
 
Requirements to be a successful third-party IT service provider for China’s banking institutions
 
As the market for our services continues to evolve, the needs of our clients continue to become increasingly sophisticated. Based on our experience, we believe the following criteria are increasingly relevant to our existing and new clients when selecting a third-party IT provider:
 
·
extensive experience in providing the specific services required;

·
ability to proactively identify and address additional issues that may be encountered with a given client’s IT operations for a project initially undertaken for different objectives;

·
ability to complete the overall project and interim project milestones on timely basis;

·
ability to deliver solutions and services on budget for each project;

·
best-in-class solutions which can be implemented quickly and cost effectively and which leverage prior solution development experience;

·
flexible project staffing and resource allocation that best meets the project’s scope, scale and length; and

·
client access to the deepest and most valuable technical and industry-specific expertise, such as highly experienced senior staff members.
 
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We believe that as our clients’ needs become increasingly complex, so will the requirements for success in our industry. Our ability to remain competitive will depend, in part, on ongoing investments in our technological capabilities and our human resources, which we believe differentiate us from our competitors. We also expect our industry to continue to undergo rapid consolidation. China’s domestic banks increasingly seek vendors with comprehensive service offerings and the scale necessary to provide solutions and services seamlessly to numerous client locations across China. In order to succeed, we may need to continue to seek attractive acquisition candidates to compliment our existing core strengths.
 
OUR SOLUTIONS AND SERVICES
 
We provide a broad range of solutions and services to meet China’s banking institutions IT needs. Based on the nature of our solutions and services, we categorize them as Software & Solutions, Platform & Maintenance Services or POS. This is a new categorization system that we are implementing beginning in our 2008 annual report and it will be the basis for our future reporting. Software & Solutions includes the development and sale of our software solutions, IT consulting and implementation and customized software development. Platform & Maintenance Services relates to the procurement, re-sale, installation, integration and maintenance of third-party hardware and software. Starting in this Annual Report, we officially classify our POS merchant acquiring business as its own category.
 
Software & Solutions
 
We primarily provide Software & Solutions to our banking clients via customized software, standard software, customized solution development, and consulting services; however, we believe that conceptually it is more relevant to discuss the end result of our business. Therefore, we classify our Software & Solutions into the following sub-categories:
 
·
Channel Solutions. Channel Solutions are designed to facilitate banks’ interactions with their customers, to improve communication and transaction efficiency and to enhance the overall customer banking experience. Channel Solutions include: customized online banking solutions, our E-Banking ASP and call center solutions, which allow our clients serve their customers in a more timely and cost effective manner. Our solutions automate our clients’ operations and allow them to better track performance of different interaction methods. According to a June 2008 report issued by IDC, a third-party research organization, we ranked second among all of the banking IT solution providers in China for Channel Solutions as measured by 2007 revenues. In 2006, 2007 and 2008, our revenues from Channel Solutions were RMB19.4 million, RMB49.4 million and RMB97.7 million, respectively, representing a CAGR of 124.4%, and accounted for 6.7%, 11.3% and 14.4% of our total revenues, respectively.

·
Management Solutions. Management Solutions help banks to collect and analyze data, so that they can monitor and manage risks and performance in a timely manner, as well as business intelligence. These solutions support intelligent data analysis to enhance management reporting and sound decision making. We provide a suite of consulting and implementation services in risk and performance management, such as asset and liability management, funds transfer pricing and profitability analysis. In 2006, 2007 and 2008, our revenues from Management Solutions were RMB50.4 million, RMB97.5 million and RMB93.9 million, respectively, representing a CAGR of 36.5% and accounted for 17.4%, 22.4% and 13.9% of our total revenues, respectively.

·
Business Solutions. Our Business Solutions include a wide range of transaction-related solutions, such as core-banking, foreign exchange and loan management. We provide our core banking solutions, which manage all operations relevant to deposit and loan accounts, principally to SMBs, as they usually lack the internal IT capabilities needed to develop and maintain their own systems. In 2006, 2007 and 2008, our revenues from Business Solutions were RMB10.7 million, RMB45.5 million and RMB72.3million, respectively, representing a CAGR of 160.0%, and accounted for 3.7%, 10.5% and 10.7% of our total revenues, respectively.
 
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We develop customized, function-specific applications according to our clients’ needs and integrate these applications into our clients’ existing IT systems. Increasingly, we are leveraging our customized development work, so that we can use the same core technology in customized projects for other clients and extract economies of scale from our own business. We believe that providing “repeatable” solutions will become increasingly important as we target new segments of the market, such as SMBs, which have limited budgets for large-scale, highly customized IT work.
 
Platform & Maintenance Services

We primarily provide Platform & Maintenance Services in conjunction with our Software & Solutions business. Platform & Maintenance Services, although not a primary focus or growth area for us, is necessary as it assure that our clients IT investments function correctly and smoothly in relation to their IT infrastructure. We classify our Platform & Maintenance Services into the following sub-categories:

·
Platform Services. Platform Services is comprised in large part of our former System Integration business. As a total solutions provider, our Platform Services assists our clients with the selection of appropriate third-party hardware or software, manufacturer negotiations (proposals, bids and pricing terms) and, as required, installation support and testing of the third-party hardware and software. We can also integrate the new equipment and software with our clients’ existing IT architecture. In 2006, 2007 and 2008, our revenues from platform services were RMB190.2 million, RMB204.9 million and RMB339.7 million, respectively, representing a CAGR of 33.6%, and accounted for 65.7%, 47.0% and 50.2% of our total revenues, respectively.

·
Maintenance & Ancillary Services. Comprised mainly of our former IT Services business, this category focuses on the maintenance and support services that we provide after a project is completed. In addition, we perform limited agency services where we procure third-party IT equipment for other system integrators and charge a commission. We record these revenues as Maintenance & Ancillary Services. In 2006, 2007 and 2008, our maintenance and ancillary services revenue amounted to RMB18.9 million, RMB34.6 million and RMB58.7 million, respectively, representing a CAGR of 75.8%, and accounted for 6.5%, 7.9% and 8.7% of our total revenues, respectively.
 
POS Merchant Acquiring Services
 
Beginning in early 2007, we initiated our POS business, to leverage the growing use of credit and debit cards in China. Our POS business allows us to capitalize on new business opportunities presented by shifting consumer payment trends in China, while creating diverse and reoccurring revenue streams. POS also allows our bank clients to focus on their core competencies, while outsourcing non-core functions to third-party providers, such as Yucheng.
 
Our business model for POS involves executing a multi-year contract with banks to deploy POS terminals with new merchants. The contracts are typically renewed on an annual basis, unless terminated by either the bank or the merchant. Under these agreements, subscribing merchants typically do not pay a direct fee for our services. Instead, Yucheng is entitled to a portion of the acquiring bank’s revenues from each transaction fee generated on a POS terminal that we deployed. The POS terminals we deploy are able to accept both domestic and foreign, credit cards and debit cards.

We as a third-party services provider we typically:

·
bear the up-front sales and marketing costs

·
supply and install the POS terminals

·
install software to connect the POS terminals with the bank’s payment processing network
 
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·
provide the training and ongoing maintenance

·
supply consumables

·
other merchant support services

We initiated our POS business through Yuxinyicheng Information, in collaboration with China Merchants Bank, in early 2007 to deploy POS terminals nationwide, which according to its data, is currently the largest credit card issuer in China. In February 2008 we won an award from China Merchants Bank as its top provider of POS merchant acquiring services for 2007. In 2008, we expanded our bank network to include the Guangdong branch of China Construction Bank, the Beijing branch of Bank of Communications, the Beijing branch of Bank of China, the Beijing branch of China Citic Bank and the Nanning branch of China Everbright Bank. As of December 31, 2008, we had deployed over 21,300 POS terminals.
 
Nature of our client engagements
 
Our objective is to maximize our share of IT spending with new and existing clients by developing an initial service relationship and then cross-selling additional services. Large, multi-year projects are usually separated into different phases; each phase is covered by a separate contract. For our Software & Solutions and our Platform Services, we typically enter into one contract with our clients for each project or phase that we undertake. Our Software & Solutions contracts typically last between two and twelve months (averaging six to seven months) and our contracts for Platform & Maintenance Services are generally shorter.

Each project typically involves multiple service components to fulfill the project or particular project phase’s requirements. We typically price our Software & Solutions relating to a project or a project phase based on an all-inclusive, fixed-price basis, rather than on an à la carte basis for individual components or segments. To the extent we are successful in managing projects, fixed-price contracts have historically allowed us to employ various process methodologies designed to improve the overall project profitability, while maintaining the highest quality and milestone-oriented service. Our Platform Service projects are generally priced based on the cost of the third-party hardware or software, plus an applicable margin to cover our service costs. Our clients are generally required to pay us in installments, with a portion of payment made upon executing the contract, upon achieving certain interim milestones, and upon completing the client inspection.
 
We are starting to implement a re-occurring revenue model, when the functionality of our solutions is per-user or per-transaction based. Under this model, we set up the entire IT architecture and software platform, such as an entire online banking IT platform, and charge our clients for the use of the IT platform and on a per-user or per-transaction basis.

In January 2008, we entered into a collaboration agreement with China Financial Certification Authority (CFCA) to develop our E-Banking ASP platform targeted toward SMBs. The CFCA is China’s regulatory agency for secured online transactions. It will host and maintain the online banking platform to ensure the highest level of transaction security and service availability. We will provide the necessary hardware and solution technology to operate the platform. In exchange for using the E-Banking ASP services, clients are expected to pay a fixed annual fee for hosting and maintenance, as well as variable fees depending on the number of users, the transaction type and the transaction volume. These revenues will then be shared between Yucheng and the CFCA. As part of the agreement, we will also customize elements of the E-Banking ASP platform per our client’s request, in return for additional fees. Compared to our traditional project-based revenue model, the client’s initial charge using a recurring revenue model is relatively small; however, we are confident that in the long run it will generate increased revenues tied to the platform usage.
 
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We believe this revenue model appeals to the SMBs, which may not have the financial resources and internal IT capabilities to maintain their own online banking platform. We also believe that revenues generated from the recurring models will also improve the predictability and sustainability of our revenues.
 
OUR COMPETITIVE STRENGTHS
 
We believe the following competitive strengths enable us to compete more effectively as an IT service provider to China’s banking institutions.
 
Broad client base and extensive domestic Chinese bank experience.
 
Our client base includes all of China’s most prominent Top Four banks as well as many of the Joint-Stock and SMBs. We have successful reference sites at the Top Four banks, and count 15 of China’s 17 largest banks as our clients. As the Top Four and Joint-Stock banks tend to set IT norms in China’s banking industry, our close client relationships in these segments enable us to gather the deep expertise required to maintain our leadership position. Through the acquisition of Easycon and also organic growth, we have also expanded our client base to include numerous SMB clients. We believe that our broad client base and extensive industry expertise serve as a testament to our solution quality and as an endorsement to new customers.
 
Deep relationships with existing clients and effective new client development strategy.
 
In the course of serving our existing clients, we typically develop a detailed and proprietary understanding of our clients’ internal IT operations, as well as their existing and future IT needs. As our clients typically prefer to maintain continuity in their third-party IT outsourcing relationships, we believe we are well-positioned to serve our clients’ needs on future projects, especially where we have had significant prior input into the client’s IT systems. By undertaking of one project with a new client, we are often able to gain insights into the client’s additional IT needs and cross-sell or up-sell solutions and services to the client, which in turn further strengthens our relationship and increases our competitiveness.
 
Extensive suite of solution and service offerings.
 
To date, we have developed a broad range of solutions, which we deliver via our suite of proprietary applications. Our solutions are often packaged with our other services, such as consulting, custom application development, legacy system integration, third-party packaged software application implementation, application testing, and system integration services, to create a comprehensive service. Our broad range of capabilities allows us to tailor our solutions to each of our clients’ particular business needs, providing our clients with a “one-stop shopping” experience. Our approach has enabled us to become increasingly important to our clients’ overall IT strategies, allowing us to more effectively cross-sell and up-sell additional solutions and services to help better meet their long-term needs.
 
Highly leveragable product suite.
 
The substantial experience, both industry-specific and technology-related, that we have gained in providing a broad range of solutions to numerous clients historically has allowed us to develop deep insight into how best to serve both new and existing clients. This has also enabled us to engineer applications during the course of a specific client engagement that allow us to more easily facilitate upgrades and additional solutions at a subsequent client engagement. We believe that this capability provides us with a significant competitive advantage as we target new clients, such as SMBs.
 
Strong management team and highly experienced IT employees.
 
We believe that our management team and employees are our most important assets and provide us with a substantial competitive advantage during our day-to-day business operations. Our executive management team, on average, possesses 15 or more years of directly relevant industry experience. These individuals have been instrumental in growing our businesses organically, as well as in identifying,
 
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acquiring and integrating acquisition targets to date. We believe that they have demonstrated a superior understanding of and ability to effect consolidation in our rapidly changing industry. With significant industry experience and strong track record, we believe that our management team, our founders in particular, has established a favorable reputation within our industry and in the broader marketplace, which can help us win additional clients as well as business partners and future acquisition targets. In addition, we believe that our employee base, which has come together both organically and via acquisition, is a highly experienced and capable group, allowing us to target, assess and deliver client engagements more effectively and efficiently.
 
Broad geographic presence.
 
In addition to our headquarters in Beijing, we maintain subsidiaries and branch offices in 19 other cities across China. As many of our clients, in particular the Top Four and Joint-Stock banks, have a nationwide or multi-province presence, our broad geographic presence allows us to be close to our clients in multiple locations, which further helps us to maintain close relationships with them. In addition, as we further expand our SMB client base, our broad geographic coverage makes it easier for us to connect with them and provide our solutions and services in a client-facing fashion, which we believe is critical for effective cross-selling and up-selling of additional services and solutions.
 
Strong brand in the marketplace.
 
We have an established reputation as a leading provider of IT services to China’s premier banking institutions with our clients and among China’s banking IT service provider community. We have enjoyed close business relationships with many Top Four and Joint-Stock banks, including China Construction Bank, which has been our customer on an annual basis since 1999. Our services to these premier banking institutions has earned us credibility and prestige in the industry. For example in 2008, we were named “Outstanding Chinese Financial Technology Products 2008” by New Financial World magazine, a Chinese IT industry magazine. In 2007, Yucheng was recognized as “One of the ten best IT solution providers for China’s financial industry” by Computer Partner World, a leading IT focused magazine in China. We believe that our established reputation and credibility provide us advantages in our competition for new businesses opportunities.
 
OUR STRATEGIES
 
Our objective is to become the leading provider of IT services to China’s diversified financial services sector.  While we believe that we have already established an attractive market position, we intend to further grow our business and enhance our overall market standing by implementing the following strategies:
 
Continue to drive organic growth through cross-selling and up-selling of new services to our existing Top Four and Joint-Stock bank clients.
 
We have established close relationships with most of the Top four and Joint-Stock banks in China, and have successfully undertaken multiple projects for these banks.  We intend to further leverage such relationships and cross-sell more solutions and services to these banks.  For example, we have provided numerous services, such as online banking, call center, risk management, business intelligence, foreign exchange, performance management solutions, to China Construction Bank, which has been our largest client by revenue in each of the past three years.  In comparison, we have provided much more limited IT solutions and services to many other Top Four and Joint-Stock banks.  We intend to leverage our experience with China Construction Bank to actively promote our other IT solutions and services in other banks.
 
Continue to expand into new client segments, such as SMBs.
 
We intend to broaden our client base to include more SMBs.  As compared to large Top Four and Joint-Stock banks, SMBs do not have the business scale, financial resources or internal IT capabilities to

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develop highly sophisticated IT systems and solutions. As such, they generally demand less customization of IT solutions, providing us opportunities to sell our solutions in a more standardized manner with minimal incremental cost per sale. In addition, due to their smaller size and increasing needs, oftentimes we are in a superior position to negotiate contract terms with SMBs as compared to large banks. For example, we are often able to extract licensing fees from SMBs for our software applications. By the end of 2008, SMBs accounted for 17.1 % of our revenues, compared to 16.3% of revenues in 2007, and we expect to continue expand our SMB market share.
 
Shift from a project-based revenue model to a transaction-based revenue model in certain segments.
 
Our traditional business model involves negotiating a fixed-price contract with our clients based on the complexity and duration of each project we undertake. Such projects generate one-time revenues and generally must be renegotiated should the client decide to expand the project or make improvements, either in the current year or in subsequent years. We have initiated our transaction-based revenue model by delivering certain of our offerings, such as online banking solutions, to our clients through a combination of a fixed fee plus subsequent variable fees. We believe that such a delivery method is more economical and of particular interest to SMBs, which are more likely to forgo a custom online banking project due to the upfront costs.

We forayed into this model in January 2008 via a collaboration agreement with Chinese Financial Certification Authority (CFCA), the Chinese governmental body regulating e-commerce security. In return for our E-Banking ASP, SMBs are expected to pay CFCA and us a combination of annual maintenance fee, plus subsequent per-transaction or per-user fees. As of January 2009, we have eight clients on our E-Banking ASP. We plan to expand this model to cover other services, as feasible.
 
Expand our solutions and service offerings to address new growth opportunities.
 
As part of our ongoing effort to broaden our service offerings and increase our share of third-party IT and service spending by banks, we have launched our POS business targeting China’s growing consumer credit and debit card payment processing market. In early 2007, we entered into collaboration with China Merchants Bank, currently the largest credit card issuer in China, to deploy POS terminals with new merchants nationwide that will enable them to accept payments by credit and debit cards. In 2008, we expanded our partnerships to include five more banks. With each bank we have a revenue sharing agreement, whereby we share a portion of the processing banks fee for transactions conducted on our terminals. We believe that our POS business has tremendous growth potential because POS terminal saturation in China is still very low, compared to more developed countries, and more consumers in China are recognizing the benefit of electronic payments instead of cash. In addition, to creating a new and recurring revenue stream for us, we believe this new business can also add significant value to our existing and new client relationships, as we alleviate the burden of a non-core competency.

In 2008, we began to enter the insurance segment by localizing 3i Infotech’s solutions for the Chinese markets. We believe that this will offer us a new revenue stream and allow us to diversify our revenue sources. We look forward to expanding our footprint in the diversified financial services space. Although this is a more nascent industry, we believe that there is tremendous growth potential.

We have expanded our CRM capabilities with the acquisition of a Siebel CRM implementation team in December 2008. The team has extensive experience customizing Siebel CRM systems for customers across many industries, including banking. As Chinese banks become more complex, having the right solutions to improve management team capabilities will be critical.
 
Pursue selective acquisitions, joint ventures and strategic alliances.
 
Historically, we have supplemented our organic growth strategy through selective acquisitions and strategic alliances to increase our solutions and service offerings and overall market share. In 2007, we acquired five companies. In 2008, we had a total of six cooperation agreements with banks for POS merchant acquiring business; we entered into an agreement with CFCA for hosting our E-Banking ASP
 
 
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platform; in August, we completed our Elegon JV with 3i Infotech of India to localize their globally renowned solutions for the Chinese market. These acquisitions, strategic alliances and cooperations have expanded our revenue sources, increased our solution and service offerings, diversified our client base, enhanced our research and development capabilities, augmented our management resources and employee base, and enhanced our long-term competitive position.
 
Expand our client base and service offerings to include the adjacent financial services industries.
 
Non-banking financial services market has been growing very rapidly in China. In the long term, it is likely that our banking clients will expand their portfolio of capabilities into those market. In 2008, to better serve our banking clients in the long-term, we established the Elegon JV, with 3i Infotech of India to take advantage of the long-term potential opportunities in the growing diversified financial services. We believe that with our existing banking IT expertise and relationships, when we enter into adjacent verticals, we will be able to enhance our long-term growth potential.
 
PROJECT DEVELOPMENT AND MANAGEMENT
 
The following chart illustrates our typical project development and management process.
 
 
Project management
 
We manage our projects principally through the following steps:
 
·
Project setup. We conduct feasibility and margin analysis before the set-up of each project, which requires approval of the sales, pre-sales implementation and technology management teams.

 
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·
Project planning. Following project setup approval, the project manager designs the overall project plan, including estimates for workload and costs, so that necessary resources can be allocated.

·
Project monitoring. Our project manager then tracks the project’s progress and results are presented both internally and to the client, through various project progress reports. Any changes to the scope of the project need to be approved from our sales, pre-sales implementation and technology management teams.

·
Risk management. We estimate potential risks upon project setup, and establish relevant strategies and measures to respond to any such risks to minimize their impact.

·
Quality assurance. We conduct frequent tests and examinations to ensure the quality of our solutions and services.

·
Client satisfaction survey. We regularly distribute a client satisfaction questionnaire to our clients during project implementation and adopt appropriate measures to address any issues raised.

·
Project closing. Our sales, pre-sales implementation and technology management teams need to approve the completion of each project, and we assess the overall the project achievements and financial return.
 
Project development
 
Our project development activities include the following:
 
·
Needs analysis. The first step of our project development is to understand our client’s business needs for the project. We carry out frequent communications with our client and conduct extensive analyses of their needs based on their business and current IT system.
 
·
System design. Based on our understanding of our client’s business needs, we design the overall system architecture, including databases, customer interfaces and modules to best address such needs.
 
·
Coding and module testing. Once we have a system design or part of the system design to meet our client’s requirements, we start coding individual functional modules. Each of our functional modules is tested and debugged individually to ensure quality and functionality.
 
We work closely with our clients during the above steps, and these steps may be repeated or conducted in parallel to ensure that we have a system that best meets our client’s business requirements.
 
·
System testing. After we finish coding and testing the individual modules, we start connecting the modules and performing testing at the system level.
 
·
System test run and client examination. After the system passes system testing, we then install it at our client’s site and conduct a real data test run with our client. We work closely with our client to address and resolve any issues that may come up during the test run and client examination.
 
·
System delivery and maintenance. After passing client examination, the system is delivered to our client and the project development cycle is closed. Generally, we provide one year of maintenance and support for most of our solutions. We assign an employee as the principal contact person to receive client feedback, evaluate the severity of any problem arising from the use of the IT solution, resolve the problem and maintain an issue log.

 
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QUALITY ASSURANCE
 
We have built quality assurance measures into our project management process. We conduct frequent tests, both in the module level and system level, to ensure our solutions meet our high quality standards and required functionality. We frequently interact with our clients throughout the entire project development process, soliciting feedback and taking measures to improve our solutions and services.
 
We conduct various technical and management appraisals before, during and after project implementation. Technical appraisals include demand appraisal, design appraisal, code spot tests, internal check and acceptance, and client check and acceptance; management appraisals include project set-up appraisal, plan appraisal and settlement appraisal. These appraisals are designed to ensure the smooth progress of our projects and quality of our implementation.
 
We have established a set of quality control procedures and follow standard software development protocols in our development processes. Beijing Sihitech received an ISO 9001:2000 certification in March 2005 and e-Channels received an ISO 9001:2000 certification in July 2006. We are still in the process of obtaining level 3 certification of Capability Maturity Model Integration, or CMMI, for our software development operations. CMMI is a framework for business process improvement that is widely accepted in the software industry.
 
SALES AND MARKETING
 
We employ a direct sales model to market and sell our solutions and services. As of December 31, 2008, we had a 264-person total sales and marketing staff in 19 cities across China, of which 82 are focused on our core business and 182 are dedicated to our POS business. Our core business sales personnel are organized into four teams based on client type and geographic location. We have a Top Four and Joint-Stock bank sales team and an SMB sales team, which are both based in Beijing, and two regional sales teams, which cover the eastern China and southern China regions. Our Top Four and Joint-Stock bank sales team is primarily responsible for sales and marketing for our Top Four and Joint-Stock bank clients. Within our Top Four and Joint-Stock bank sales team, we have dedicated sales groups that focus on key clients, such as China Construction Bank, Agricultural Bank of China and CITIC Bank. Our regional offices assist in the sales and marketing process by maintaining active relationships with to the local branch offices of Top Four and Joint-Stock banks. Our SMB sales team in Beijing and our two regional sales offices are primarily responsible for sales and marketing activities in their respective regions.
 
Our sales strategy also differs depending on the type of clients. For Top Four and Joint-Stock banks, we establish and maintain long-term partnerships, providing these leading banks with a comprehensive set of IT consulting and implementation services and a focus on growing with the IT needs of each client. We also strive to provide our solutions and services to these clients in follow-on projects by cross-selling our other solutions and services. For SMBs, we aim to secure a foothold with our leading IT solutions, such as online banking or through the acquisition of companies specializing in that banking segment, such as Easycon. Due to their limited experience with third-party IT solution and service providers, in many cases, these clients are unaware initially of the broad range of solutions and services that may be obtained from a third-party provider, and are therefore unaware of the benefits in leveraging the experience and capabilities of a provider such as ourselves. The initial client engagement enables us to understand clients’ IT needs, quickly build relationships internally, and provide us opportunities to demonstrate to them our capabilities and value proposition so that we can cross-sell or up-sell our additional solutions and services to best meet their long-term business needs.
 
Many banks select their IT service providers through competitive bidding. Before submitting a bid, we usually conduct a detailed due diligence study of the bank, our competitors, the technical advantages we have regarding the project, duration of the project, our estimated cost and profitability and potential for a long-term relationship with the client. We selectively submit bids on projects where we believe we have a competitive advantage. In addition to price, we believe clients usually select the winning bidder based on a number of other factors, including reputation and track record of the IT service provider, its technical capabilities, historical relationship with the client and the functionality of the proposed solutions.

 
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Many of our client projects are separated into different phases, often spanning more than one year. For the latter phases of the projects that we initially undertake, banks usually do not engage in any additional open bidding. Instead, we typically conduct new negotiations to determine the scope and cost of the new phase.
 
As for our POS business, our sales are conducted largely through direct sales efforts to the merchants made on behalf of our partner banks. We also conduct various joint-promotion activities with collaborating banks to help increase our brand awareness in the marketplace, such as a restaurant promotion month and a promotional bonus point program. The sales personnel for our POS business are separately managed by our subsidiary, Yuxingyicheng Information. As of December 31, 2008 we have sales teams located in 20 cities across China.
 
Our total sales and marketing expenses were RMB14.0 million, RMB29.1 million and RMB49.4 (USD7.2 million) for 2006, 2007 and 2008 respectively, and were mainly comprised of compensation expenses. In addition to salaries, our sales staff receives a significant portion of their compensation from sales commissions.
 
OUR CLIENTS
 
Our current clients consist primarily of Top Four and Joint-Stock banks that look for customized IT solutions to meet specific business and operational requirements. Of the 17 Top Four and Joint-Stock banks, 15 are our clients and some have been so for more than five years. We have also been adding SMBs to expand our client base, and diversify our dependence on any one client.
 
China Construction Bank, one of the largest banks in China, and our client since 1999, has been our largest client through the headquarters and its branch offices in each of 2006, 2007and 2008, accounting for 54.0%, 59.2% and 47.8% of our total revenues, respectively, in those three years. Our contracts with China Construction Bank were signed separately with different departments within the bank group, branches at the provincial level and headquarters and we consider each of them effectively separate clients, since the decision makers and budgets are unrelated. If we treat different decision making bodies within China Construction Bank as separate clients, China Construction Bank head office was our largest client in each of the past three years, accounting for 30.0%, 29.1% and 36.9% of our total revenues in 2006, 2007 and 2008, respectively. Revenues from each of other branches of China Construction Bank accounted for less than seven percent of our total revenues in each of 2006, 2007 and 2008. No other client accounted for over ten percent of our revenues in each of 2006, 2007 and 2008.
 
We realize the risks involved with overdependence on one or a few clients, and have taken measures to expand our client base. Our number of Joint-Stock bank clients has increased, accounting for 8.9% in 2006, 7.2% in 2007 and 10.5% in 2008. As our Joint-Stock client base has grown, its contribution as a percentage of total revenues has also increased and accounted for 6.1% in 2006, 11.4% in 2007 and 15.9% in 2008. Over the past three years our SMB client base grew and included 11 in 2006, 80 in 2007 and 69 in 2008. Our percentage of revenues from SMBs as a percentage of total revenues was 3.3% in 2006, 16.3% in 2007 and 17.1% in 2008. We believe over time, Joint-Stock banks and SMBs will experience the greatest competitive pressures and are likely to significantly increase their IT investments. We have positioned ourselves to take advantage of this opportunity as it develops.
 
In addition to China’s domestic banks, we have also begun marketing our services to the Chinese operations of foreign banks, which have expanded significantly in recent years due to China’s WTO commitments. For example, we entered into contracts with the PRC subsidiary of Hana Bank of Korea in late 2007 to develop their bank card processing system and online banking platform, and with the PRC subsidiary of Bank of East Asia of Hong Kong in early 2008 to develop their online banking platform.
 
SUPPLIERS
 
 
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We work with third-party suppliers for hardware equipment and certain software components that we incorporate into our solutions. Our hardware suppliers include IBM, HP, DELL and Sun for servers, EMC for storage, Cisco, Huawei and F5 for network equipment. Our software suppliers include Oracle, IBM, Symantec, Microsoft, Genesys and EDIFY. We do not depend on any single supplier for either hardware or software. In 2008, four service providers accounted for more than 10% overall third-party hardware and software purchases. Details are provided in the table below:

Company
 
Percentage
 
Teamsun
    11.0 %
Digital China
    10.4 %
eSOON
    10.1 %
HP
    10.1 %
 
Our POS terminal suppliers include Ingenico, Landi, Hypercom, Sagem, Pax, Spectra and Xinguodo. We have not experienced any difficulty in the procurement of POS terminals. Generally, these suppliers provide a three-year service warranty on the POS terminals free of charge. After the expiration of this period, we assume all costs associated with the maintenance of these POS terminals.
 
RESEARCH AND DEVELOPMENT
 
The market for our solutions and services is characterized by rapid technological change. As China’s banks upgrade their technology to meet international standards, we must ensure that we keep pace with technological developments, client demands, emerging industry standards and an increasingly sophisticated environment by enhancing our current service offering on a timely basis and developing new solutions that capture underdeveloped market segments.
 
Our research and development at the company level focuses on developing new fundamental platforms and applications that can be used in a variety of our IT solutions. Currently, we conduct our company level research and development activities primarily in our Financial Information Technology Institute, or the Tsinghua Institute, which we formally established in April 2006 pursuant to a research collaboration arrangement with Tsinghua University. Under the collaboration arrangement, we provide research funding and personnel, and Tsinghua University provides research facilities, as well as their own personnel. Currently, the Tsinghua Institute has 15 members, ten of which are our employees. The Tsinghua Institute has already been successful in developing a number of new technologies that we have deployed to some of our clients. We jointly own the intellectual property from the collaboration with Tsinghua University, and each party can commercialize such intellectual property without the consent of the other party. We also established a company level research and development center in Guangzhou, focusing on information management technology and business intelligence.
 
We also carry on research and development activities at the business division level in our various subsidiaries. Our business divisions are more familiar with our clients’ specific IT needs and focus on developing applications that are more closely linked to immediate trends. As of December 31, 2008, we had 40 employees carrying on research and development activities.
 
Including the amount we capitalized, our internal software development costs amounted to RMB2.3 million, RMB10.7 million and RMB13.7 million (USD2.0 million) in 2006, 2007 and 2008, respectively. In addition, as we conduct a substantial amount of research and development activities in connection with our client projects, a significant amount of research and development related expenses are recorded as cost of revenues for the client project rather than research and development expenses.

INTELLECTUAL PROPERTY
 
We rely on a combination of patent, copyright and trademark laws, licensing agreements, confidentiality agreements, internal confidentiality policies and other contractual provisions, as well as technical measures to protect our intellectual property rights. We have one received patent for our dynamic
 
 
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password method and system based on mobile communication terminals and still have one pending patent application for our dynamic password method and system with encryption with the PRC State Intellectual Property Office. We routinely register our proprietary software to the National Copyright Administration of the PRC pursuant to the Regulations for the Protection of Computer Software (2002) to ensure protection under the PRC copyright laws. As of December 31, 2008, we had 31 software products registered with the National Copyright Administration of the PRC, including primarily system architecture and platforms and various software applications.

Our employees are required to enter into agreements assigning us the intellectual property developed within the scope of their employment. We have also established internal confidentiality procedures to safeguard our intellectual property. We enter into confidentiality agreements with all of our employees, collaborators, clients and suppliers, and prohibit our employees from designing into our solutions intellectual property that belongs to any third party. As intellectual property laws in China are still being developed and offer limited protection, we rely heavily on our confidentiality procedures, confidentiality agreements as well as technical measures to protect our proprietary technology and intellectual property.
 
Pursuant to the majority of our client contracts relating to our software, solutions and services, our clients own the intellectual property developed in connection with the projects, while we retain our proprietary rights to the methodologies, algorithms or patents that we used in the development of custom software solutions. However, it is often difficult to distinguish the part of the software that we developed for our clients, which represents our proprietary rights. As a result, there is a risk that our client may claim that we infringed their intellectual property rights. See “Item 3. Key information — Risk factors — Risks relating to our businesses — We may be subject to intellectual property infringement claims from our clients, which may force us to incur substantial legal expenses and, if determined adversely against us, may materially and adversely affect our business, financial condition and results of operations.” In addition, we typically agree to defend our clients on our own costs for any third-party intellectual property claims filed against them arising from the solutions and services we provided them, and indemnify them for any damages of intellectual property infringement, which may subject us to significant intellectual property indemnity claims. See “Item 3. Key information — Risk factors — Risks relating to our businesses – Our intellectual property indemnification practices may materially and adversely impact our business.”
 
We have registered one trademark, “Yucheng,” in the Trademark Office of the State Administration of Industry and Commerce of the PRC. We also own a number of domain names, including the domain name of our main website, www.yuchengtech.com.
 
COMPETITION
 
The market for IT services in China’s banking industry is intensely competitive and characterized by rapid technological change. Competition in our industry is based to a great extent on industry experience, solution quality, reference sites, breadth of services offered, reputation, price and relationship. Past track records with a particular banking client are also of particular importance. As a result, our success rate is usually higher with banks that we have provided solutions and services to in the past, and we are usually engaged by our existing clients to work on projects that are the expansion of or improvements on the original projects that we undertook.
 
Our major competitors can be categorized into two groups, global IT vendors and China’s domestic IT solutions and service providers. Our major competitors in the global IT vendor category include Accenture, IBM Global Services and TCS/FNS. These competitors are strong in high-level, enterprise-wide IT strategy consulting. Our major domestic competitors include Client Server International Inc., Digital China Holdings Limited, Huayuchang International Scientific & Educational Development Ltd., Hi Sun Technology Holdings Ltd. and Longtop Financial Technologies Limited. Each of these competitors has their focus and strength in different types of IT solutions and services, and we compete with different companies depending on the types of solutions we intend to provide to a given client.
 
We also compete with the internal IT departments of our existing and potential clients, which may be capable of creating in-house solutions, thereby reducing the need for outsourced service providers. For example, a banking client for which we designed an initial online banking platform decided later to conduct further development in-house.

 
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In addition to the competitors listed above, there are many other smaller providers of IT solutions and services to China’s banks. Most of these providers are small- to mid-sized companies focusing on narrowly specified niche markets within the broader IT solutions and services market.
 
In the POS merchant acquiring business, we primarily compete with China UnionPay, the predominant POS provider on whose network credit and debit card transactions are processed.
 
INSURANCE
 
We own a property in Xiamen which we use as office space, and lease all of our other offices, and we do not maintain any property insurance for such offices. In addition, consistent with industry practice in China, we do not maintain business disruption insurance or key person insurance. We do maintain Director and Officer Liability insurance, in accordance with standard practices for U.S. listed companies.
 
REGULATION
 
The following summarizes major PRC laws, rules and regulations applicable to our business.
 
Regulation of the software and systems integration industries
 
China’s State Council and a number of ministries and agencies have issued a series of rules and regulations aimed at stimulating and regulating the growth of the software and systems integration industries in China. The principal regulations governing the software and systems integration industries include:
 
·
The Interim Administration Measures for Qualification of Systems Integration of Computer Information (1999);
 
·
The Certification Standards and Administration Measures of Software Enterprises (2000);
 
·
The Appraisal Condition for Qualification Grade of Systems Integration of Computer Information (Revised Version) (2003);
 
·
Certain Policies for Encouraging Development of the Software Industry and Integrated Circuits Industry (2000);
 
·
The Software Products Administration Measures (2000);
 
·
The Interim Administration Measures for Qualification of Systems Integration of Computer Information Concerning State Secrets (2001);
 
·
The Administrative Measures on Verification of Key Software Enterprises within the State Plan (2005);
 
·
The Administrative Regulation for Commercial Cryptogram (1999); and
 
·
The Administrative Measures on Examination and Sales Licensing of Security Products for Computer Information Systems (1997).
 
Under these regulations, except for software developed for self-use, software products developed in China are subject to a registration system administered by the PRC Ministry of Information Industry (MII) and its local branches or agencies. This registration system requires software developers to obtain registration certificates for their software products. A software product cannot be sold in China without such registration. The valid term of each registration is for five years, and it may be renewed upon expiry.

 
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Companies in China engaged in systems integration are required to obtain qualification certificates from MII. Companies planning to setup computer information systems are required to engage systems integration companies with appropriate qualification certificates. This qualification certificate is subject to biannual review and is renewable every four years.
 
The Qualification Certificate for Integration of Computer Information Systems Concerning State Secrets granted by the PRC State Secrecy Bureau is required for a company to engage in computer systems integration activities involving state secrets. The valid term of such certificate is for three years, and it may be renewed upon expiry, subject to the satisfaction of all the requirements. The State Secrecy Bureau will only issue this special qualification certificate to China’s domestic companies. Foreign invested companies, including Sino-foreign joint ventures and wholly foreign-owned enterprises, are not allowed to engage in any computer systems integration activities that involve state secrets.
 
Encryption software is an essential component of internet banking systems. The development, production and sale of commercial encryption products in China is regulated by the PRC National Encryption Administrative Bureau (Encryption Bureau) and its authorized local branches. A company engaging in the encryption-related business is subject to certain licensing requirements, such as obtaining a production license, sale and distribution license, and a license for research and development from the Encryption Bureau. In addition, both importing and exporting products and equipment containing encryption technology are subject to the prior approval of the Encryption Bureau.
 
Companies in China engaged in providing security products for computer information systems are required to obtain a sales license after official examination from the PRC Ministry of Public Security (MPS) or its authorized local branches. The valid term of each license is for two years which can be renewed upon expiry.
 
We generally register our software and have obtained, or are in the process of obtaining, from MII or other regulatory agencies all the certificates, permits or licenses necessary for conducting our business.
 
Regulation on foreign investment
 
According to The Guidelines on Foreign Investment issued by State Council on February 11, 2002, and The Catalogue on Foreign Invested Industries (2007 Revision) issued by National Development and Reform Commission and the Ministry of Commerce on October 31, 2007, IT solutions and services fall into the category of industries in which foreign investment is encouraged.
 
Regulations on foreign exchange
 
The principal regulations governing foreign exchange in China are the PRC Foreign Exchange Administration Regulations (1996), as amended in 1997. Under these regulations, current account income denominated in foreign currencies shall be sold to designated banks or deposited into foreign exchange bank accounts. The Renminbi is convertible for current account items including the distribution of dividends, interest payments and trade and service-related foreign exchange transactions. For conversion of the Renminbi for capital account items, such as making inbound and outbound direct investments, borrowing foreign loans, repatriating investments and investing in securities outside China, prior approval of or registration with State Administration for Foreign Exchange (SAFE) is required.
 
Pursuant to the Administration Rules on the Settlement, Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from SAFE or its local branches. Foreign investment enterprises are permitted to remit their profits or dividends in foreign currencies out of their foreign exchange accounts or exchange Renminbi for foreign currencies through banks authorized to conduct foreign exchange business. Capital investments by foreign-invested enterprises outside of China are also subject to limitations, which include approvals by SAFE, the Ministry of Commerce of the PRC and the PRC National Development and Reform Commission or their local counterparts.

 
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Pursuant to SAFE’s Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage in Financing and Return Investments via Overseas Special Purpose Vehicles, generally known in China as SAFE Circular 75, which became effective November 1, 2005, (i) a legal person entity incorporated in China, a PRC citizen, or an individual with habitual residence in China due to certain economic benefits, who is referred to as an onshore resident under SAFE Circular 75, shall register with the local branch of SAFE before it establishes or controls an overseas special purpose vehicle (SPV) for the purpose of overseas equity financing (including convertible debts financing); (ii) when a PRC resident contributes the assets or equity interests it holds in a domestic enterprise into an SPV, or engages in overseas financing after contributing assets or equity interests into an SPV, such PRC resident shall modify its SAFE registration in light of its interest in the SPV and any change thereof; and (iii) where an SPV undergoes material events relating to increases or decreases in investment amount, transfers or exchanges of shares, mergers or divisions, long-term equity or debt investments, or external guarantees, or other material events that do not involve return investments, such PRC resident shall, within 30 days from the occurrence of such material event, apply to the local branch of SAFE to amend or file the registration of foreign exchange of overseas investment. Onshore residents who have established or controlled SPVs and completed return investments before November 1, 2005, the effective date of SAFE Circular 75, were also required to register with the local SAFE branch before March 31, 2006.
 
To further clarify the implementation of SAFE Circular 75, SAFE issued The Notice of the State Administration of Foreign Exchange on Operating Procedures concerning Foreign Exchange Administration for Domestic Residents to Engage in Financing and in Return Investment via Overseas Special Purpose Companies on May 29, 2007 (Circular 106). Under Circular 106, if the investment in the overseas SPV fails to be registered with SAFE by the onshore residents, (1) the overseas SPV is not qualified to conduct overseas financing or return investment; and (2) the PRC subsidiaries of the SPV are prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to the overseas SPV. Moreover, failure to comply with the above SAFE registration requirements could result in liabilities under PRC laws for evasion of foreign exchange restrictions. All our PRC resident beneficial owners have registered with local SAFE branch as required under the SAFE regulations in respect to return investment.
 
Regulations on offshore parent holding companies’ direct investment in and loans to their PRC subsidiaries
 
An offshore company may make an equity investment in a PRC company, which will become the PRC subsidiary of the offshore holding company after the investment. Such equity investment is subject to a series of laws and regulations generally applicable to any foreign-invested enterprise in China, which include the Wholly Foreign-Owned Enterprise Law, the Sino-Foreign Equity Joint Venture Enterprise Law, the Sino-Foreign Contractual Joint Venture Enterprise Law, all as amended from time to time, and their respective implementation rules. Under these laws and regulations, the contribution and increase of the registered capital of a foreign-invested enterprise is subject to prior approval by the relevant authorities.
 
Shareholder loans made by offshore parent holding companies to their PRC subsidiaries are regarded as foreign debts in China for regulatory purposes, and are subject to a number of PRC laws and regulations, including the PRC Foreign Exchange Administration Regulations, the Interim Measures on Administration on Foreign Debts, the Tentative Provisions on the Statistics Monitoring of Foreign Debts and its implementation rules, and the Administration Rules on the Settlement, Sale and Payment of Foreign Exchange. Under these regulations, shareholder loans made by offshore parent holding companies to their PRC subsidiaries shall be registered with SAFE. Furthermore, the total amount of foreign debt that can be borrowed by such PRC subsidiaries, including any shareholder loans, shall not exceed the difference between the total investment amount and the registered capital amount of the PRC subsidiaries, both of which are subject to governmental approval.

 
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Regulations on dividend distribution
 
Under the relevant PRC laws and regulations, foreign-invested enterprises in China may distribute dividends only out of their accumulated profits determined in accordance with Chinese accounting standards and regulations. In addition, wholly foreign-owned enterprises in China are required to contribute at least 10% of their after-tax profits based on PRC accounting standards each year to their general reserves fund until the accumulative amount of the reserve fund reaches 50% of the registered capital of such wholly foreign-owned enterprise. Contributions to the fund may not be distributed as dividends.
 
 C. Organizational structure.
 
The following diagram illustrates our organizational structure as of December 31, 2008:

 
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The following summarizes relevant information concerning our subsidiaries:
 
 
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Beijing Yuxinyicheng Technology Limited, or Yuxinyicheng. Yuxinyicheng was established as a wholly foreign-owned enterprise in China on October 19, 2006. It is 68.25% owned by Sihitech BVI and 31.75% owned by e-Channels BVI. It is a holding company in China without its own business operations.
 
Beijing Sihitech Technology Co., Ltd., or Beijing Sihitech. Beijing Sihitech, along with its subsidiaries Shanghai Software, Beijing Software, Shanghai Sihitech, Guangzhou Sihitech and Xiamen Yucheng, engages in the provision of system integration, software development, information technology consulting, maintenance and support services. Beijing Sihitech and its subsidiaries mentioned above were the principal operating entities of Sihitech BVI prior to the three-party merger.
 
Beijing Easycon Electronics Limited, or Easycon. We acquired 75% interest of Easycon in June 2007 and the remaining 25% interest in January 2008. Easycon specialized in providing IT services to smaller and regional commercial banks in China. Its banking integrative service management system and credit management system both hold a significant market share and are very well received among SMBs.
 
Beijing e-Channels Century Technology Co., Ltd., or e-Channels. E-Channels engages in the provision of technology development, technology transfer, consulting and training services, in particular relating to online booking-related solutions. E-Channels was the principal operating entity of e-Channels BVI prior to the three-party merger.
 
Beijing Yuxinhengsheng Information Technology Limited, or Sunrisk. We initially acquired 100% interest of Sunrisk in March 2007. Sunrisk is a risk management total solutions provider for the Chinese banking industry, focusing on consulting, product implementation and system integration in the area of enterprise risk management for financial institutions. In April 2008, Yuxinyicheng introduced a strategic investor to acquire 49% of Sunrisk’s equity interest. As a result, Yuxinyicheng’s equity interest in Sunrisk was diluted to 51% from 100%.

Beijing Yuxinyicheng Information Technology Limited, or Yuxinyicheng Information (POS). We established Beijing Yuxinyicheng Information (POS) in January 2007, and its focus is on providing our POS merchant acquiring business in collaboration with banks. Initially we held 80% of the equity and in January 2009 we acquired the minority interest in our POS business; it is now a wholly-owned subsidiary.
 
Chengdu Recency Technologies Limited, or Recency. We acquired 100% interest of Recency in June 2007. Recency is a business intelligence solution and consulting service provider for the Chinese banking industry, focusing on software development, information technology consulting, maintenance and support.
 
Shanghai Fujie Business Consulting Limited, or Fujie and Shanghai Fuyi Business Consulting Limited, or Fuyi. We acquired 100% interest of Fujie and Fuyi in October 2007. Fujie and Fuyi are related companies focusing on Enterprise Resource Planning, or ERP, management consulting, software development, maintenance and support.

Guangzhou Yuxinyicheng Information Technology Limited, or Guangzhou Yuxinyicheng. We established Guangzhou Yuxinyicheng in November 2007, and it provides system integration, software development, information technology consulting and maintenance and support to our customers.

Chengdu Elegon Information Technologies Limited, Elegon. We established Elegon in August 2008 in conjunction with 3i Infotech Ltd and hold a 49% interest. The investment in Elegon is accounted for using the equity method. Elegon is a product company that is localizing 3i Infotech’s solutions for the Chinese market.
 
D. Property, plant and equipment.
 
Our principal executive offices are located at Beijing Global Trade Center, 36 North Third Ring Road East, Dongcheng District, Beijing where we lease approximately 3,953 square meters of office space. We have 19 other office locations in China, including Shanghai, Guangzhou, Xian, Xiamen, Zhengzhou,

 
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Chengdu, Shijiazhuang, Shenyang, Nanjing, Dalian, Harbin, Wuxi, Changzhou, Wuhan, Changsha, Dongguan, Nanning, Liuzhou and Shenzhen. We own a property in Xiamen with a gross floor area of 1,258 square meters, and we lease properties in all other cities with an aggregate gross floor area of 8,452 square meters. We use all these properties as office space for our employees. The aggregate rent for all our offices is RMB586,783 (USD85,855) per month.
 
ITEM 4A.
UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
 
The following discussion and analysis of our financial condition and results of operations in should be read in conjunction with the section titled “Selected Consolidated Financial Data” and our consolidated financial statements and related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements. In evaluating our business, you should carefully consider the information provided in “Item 3. Key Information — Risk factors”.
 
OVERVIEW
 
We are a leading provider of information technology, or IT, solutions and services to China’s domestic banking sector. Our solutions and services enable our clients to establish and maintain IT platforms and operational capabilities to better manage their operations and serve their customers’ needs.
 
Historically, we derived a majority of our revenues from providing system integration services (now included under Platform Services), which included selecting, procuring and reselling third-party hardware equipment and software applications to our clients, monitoring and assisting in the installation of such equipment and software at our clients’ sites and assisting in the integration of the installed equipment and software with our clients’ existing IT systems. Due to the lower gross margin and growth potential of Platform Services as compared to software-related solutions and services, in 2006 we began to shift our focus away from providing Platform Services. Platform Services revenue represented 50.2% of our total revenues in 2008, and we expect that its percentage of our total revenues will gradually decline over time.
 
Our current business focus is to develop and deliver an extensive suite of software-related solutions and services tailored toward specific functional needs of our clients. Our software-related solutions and services encompass all major categories of IT solutions used in China’s banking industry, namely Channel Solutions, Management Solutions and Business Solutions. Our revenues derived from providing software-related solutions and services have grown at a much faster pace than our revenues derived from Platform Services in recent years, in part due to our shifted business focus, and in part due to our acquisitions. For a detailed description, please see “Item 4. Information on the Company - A. History and development of the Company. - Corporate History.”

We predominately provide our software and software-related solutions to our clients on a project-by-project basis, and charge an all inclusive fee for each project. Previously, these contracts were recognized under the heading of IT Solutions and Services, in this 20-F and going forward they will be classified under Software & Solutions.

We charge Platform Services based on material and service cost plus certain margin. Previously, these contracts were recognized under the heading of Systems Integration, in this 20-F and going forward they will be classified under Platform & Maintenance Services and in the sub-category of Platform Services.
 
We also provide IT maintenance and support services to our clients as well as limited agency services, in which we source third-party IT equipment from other system integrators and charge clients on a commission basis. Previously, these contracts were recognized under the heading of IT Solutions and Services, in this 20-F and going forward they will be classified under Platform & Maintenance Services and in the sub-category of Maintenance & Ancillary Services.

 
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Beginning in early 2007, we launched our POS merchant acquiring business, which deploys and serves POS terminals in collaboration with our partner banks, enabling merchants to process debit card and credit card payments. We receive a percentage of the transaction processing fees that occur through our POS terminals. Revenue from our POS merchant acquiring business currently accounts for a relatively small portion of our revenues. In the past these revenues were included in our Channel Solutions revenues, under our IT Solutions and Services business. In this 20-F and going forward our POS revenues will be a distinct category.
 
Our clients are primarily banking institutions in China; for a complete description, see “Item 4. B. Business Overview — Our Clients.”
 
Our revenues grew from RMB289.7 million in 2006 to RMB435.5 million in 2007 and to RMB676.8 (USD99.0million) million in 2008, representing a CAGR of 52.9%. In 2008, we have changed the way we categorize revenues and have recalculated previous years’ figures in order to provide a clear comparison.

·
Our Software & Solutions revenue grew from RMB80.5 million in 2006 to RMB192.4 in 2007 and to RMB263.9 million (USD38.6million) in 2008, representing a CAGR of 81.1%.

·
Our Platform & Maintenance Services revenue grew from RMB209.2 million in 2006 to RMB239.5 million in 2007 and to RMB398.3 million (USD58.3 million) in 2008, representing a CAGR of 38.0%.

·
Our POS business was established in 2007 and revenues grew from RMB3.6 million in 2007 to RMB14.6million (USD2.1 million) in 2008.

·
As a result our gross margins were 25.7% in 2006, 36.2% in 2007 and 33.6% in 2008.
 
Our net income increased during the past three years representing RMB40.7 million in 2006, RMB66.7 million in 2007 and RMB81.0 million (USD11.9 million) in 2008, representing a CAGR of 41.1%.
 
Our growth has been and will continue to be driven in large part by the sales of our solutions and services to our banking clients. We expect our sales of solutions and services to Joint-Stock banks and SMBs to continue to increase at a faster pace than our sales to the largest, Top Four banks. In addition, we expect our POS merchant acquiring business to also provide a source of revenue growth in the future. Our past growth has been partly attributable to the acquisitions we made in 2007 as well as our acquisition of e-Channels in November 2006. We expect to continue to grow both organically and through acquisitions.
 
BASIS OF PRESENTATION
 
Yucheng was incorporated on November 17, 2005 as a subsidiary of China Unistone. After completion of a redomestication merger of China Unistone with and into Yucheng and a three-party acquisition among Yucheng, Sihitech BVI and e-Channels BVI on November 24, 2006, Yucheng became the holding company of our business. Sihitech BVI was our predecessor from an accounting perspective, and the purchase method of accounting was used in consolidating e-Channels BVI and China Unistone into Sihitech BVI. Therefore, our operating results for 2006 reflected those of Sihitech BVI and the operating results of e-Channels BVI from November 25, 2006 to the end of 2006; and our operating results for 2007 reflected those of both Sihitech BVI and e-Channels BVI as well as our 2007 acquisitions from their respective acquisition date to the end of 2007.
 
FACTORS AFFECTING OUR RESULTS OF OPERATIONS
 
Our results of operations in any period are affected by a number of factors, including factors affecting our industry and factors related to the management and operations of our businesses.
 
 
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Factors affecting our industry
 
Growth of the banking industry in China and the need for third-party IT services providers
 
Our growth has been attributable to the rapid development of China’s banking industry. China’s banking industry has undergone significant reforms and modernization in recent years in order to manage the challenges associated with a rapidly developing economy and to fulfill China’s requirements as a WTO member. As part of such efforts, since 2005, a number of Chinese banks have listed their shares on the international stock exchange, including ICBC, which is the largest IPO to date.

To continue to meet the demands of the changing market landscape in China, banks have greatly increased their IT spending in order to upgrade their systems and capabilities. As most of Chinese banks do not have strong in-house IT development capabilities, these banks largely rely on third-party IT service suppliers, such as us, to meet their IT needs. We expect that as competition in China’s banking industry intensifies, and as China’s banks strive to meet Basel II requirements, they will rely more heavily on third-party IT solution and service providers for their IT needs. Any factors that adversely affect the growth of China’s banking industry, such as a general slow-down in China’s economy, a global economic downturn, or the adoption of economic growth and inflation rate policies by the PRC central government, may reduce the profitability of China’s banks and result in a decrease in their IT spending, which could in turn adversely affect our business. Furthermore, our results of operations are also affected by the extent China’s banks continue to outsource their IT services. Any increase or decrease in the extent of outsourcing IT solutions and services by China’s banks will positively or negatively affect business opportunities available to us.
 
Changes in decision making over IT spending among our clients
 
We derive the substantial majority of our revenues by providing IT related solutions and services to China’s banks on a project-by-project basis. We have observed a recent shift in the way IT spending is decided in China’s banks, with more decisions being made at banks’ head offices instead of provincial level branches. Such centralization changes the competitive dynamics in our industry and generally favors large IT service providers with premium brands, broad product offerings and deep client relationships, in particular relationships with the bank’s head offices.
 
Competition in China’s banking IT service industry
 
Our results of operations have been, and will continually be primarily affected by, the competitive landscape in China’s banking IT service industry. Due to competitive pressures between banks, we have observed that SMBs in China are focusing more on an IT service provider’s reputation and service quality as compared to price when awarding IT projects, which enhances our competitive position. On the other hand, as more competitors enter the IT service market for big banks, these banks may be able to extract increasing pricing concessions. In addition, as China’s banking IT service industry develops, more global IT service providers are entering the market, which may further intensify competitive pressures.
 
Factors related to the management and operation of our businesses.
 
Revenue mix
 
We derive our revenues primarily from two sources, Software & Solutions and Platform & Maintenance Services. Platform & Maintenance Services has a much lower gross margin as compared to Software & Solutions. Our consolidated gross profit and gross margin are greatly affected by our revenue mix.

We began to shift our business focus to Software & Solutions in 2006. We currently typically only provide Platform & Maintenance Services as part of a larger client engagement that includes Software & Solutions, or if we anticipate that the Platform & Maintenance Services component will lead to future

 
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Software & Solutions revenue from the same client. As a result of these factors, our revenues from Platform & Maintenance Services as a percentage of total revenues was 58.9% in 2008 and the corresponding historical figures using the new revenue categorization method is 72.2% in 2006 and 55.0% in 2007. Our gross margins have therefore fluctuated in line with our revenue mix and were 33.6% in 2008 compared to 25.7% in 2006 and 36.2% in 2007. We intend to continue to focus on providing Software & Solutions, and expect the percentage of our revenues from Platform & Maintenance Services to gradually decrease. Furthermore, as we generate more revenue from our POS business, it will also have a stronger impact on our revenue mix and our gross margin.
 
Timing of Chinese banks’ outsourced IT projects
 
Substantially all of our revenues are derived from outsourced IT projects for China’s Banks. As a result, our revenues for any given period are affected by the timing of our clients’ IT projects, which in turn depends on their internal budgeting and planning process. This process may differ, depending on the type of client and project. For example, the head offices of our Top Four and Joint-Stock bank clients generally determine the major IT solutions and services projects according to an annual budget and plan, which is usually finalized in the first calendar quarter of each year. In contrast, regional branches of these big banks and our SMB clients may decide smaller projects on ad hoc basis and follow a less precise schedule. For more detailed information, please see “Item 3. Key Information – D. Risk factors. – Risks relating to our business – Fluctuations in our clients’ annual IT budgets and spending cycles and other factors can cause our revenues and results of operations to vary significantly from quarter to quarter and from year to year.”
 
Client composition
 
In 2006, our clients were primarily China’s Top Four banks. Beginning in 2007, we have gradually expanded our client base to include more Joint-Stock banks as well as SMBs. The percentage of our revenues derived from Joint-Stock banks accounted for 6.1% in 2006, 11.4% in 2007 and 15.9% in 2008. At the same time, SMBs represented the following percentages of our revenues 3.3% in 2006, 16.3% in 2007 and 17.1% in 2008.

Top Four banks, because of their size, generally have the strongest bargaining power in their negotiations with us, and generally require extensive customization of our solutions. On the other hand, they have not been as price sensitive in the past because of the complexity of their projects and their financial resources; however, this trend may be changing due to increasing competition in the banking IT service industry. Joint-Stock banks project requirement and budgets are in many respects similar to the Top Four banks. In contrast, SMBs generally have fewer customization requirements, enabling us to sell repeatable solutions with minimal customization. In addition, we are more in an equal footing in contract negotiations with SMBs, which have gradually realized the benefits of our leading products. Our changing client composition and changes in their behavior are expected to affect our future results of operations.
 
Success of our new business initiatives
 
We launched the POS business in early 2007 and as of the end of 2008 had deployed more than 21,000 terminals. For a complete description of this business, see “Item 4 – Information on the Company – B. Business overview – POS Merchant Acquiring Services.” As we bear the initial sales and marketing costs as well as the capital expenditure relating to the deployed POS terminals, while revenues from this business, which directly relate to the value transacted through each deployed POS terminal, take time to ramp up, this business is expected to negatively affected our results of operations until 2010. In addition, we have recently started to provide our online banking solutions and services in a per-transaction or per-user based revenue model rather than our traditional project-based revenue model, which, similar to our POS business, requires significant initial capital expenses while revenues will take time to ramp up. We expect that these new business initiatives will bring us revenue predictability and stability in the long-run. As these new business initiatives become more important in our overall business, our future results of operations will be significantly affected by their success or failure. Furthermore, as part of our expansion strategy, we intend to expand our IT solutions and services to non-banking financial institutions, and whether we can succeed in that expansion will also affect our future results of operations.
 
 
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Success in our acquisition and integration of acquired businesses
 
In addition to organic growth, we intend to grow by continuing to acquire or invest in complementary businesses to our existing business. Our acquisition of e-Channels in November 2006 and our acquisitions of five companies in 2007 broadened our solution and service offerings, increased our client base, strengthened our management talent and employee base and created a wider range of cross-selling and up-selling opportunities, which greatly contributed to our past growth, in particular our revenue growth from Software & Solutions and the improvement of our overall gross margin. Our future growth will continue to be affected by our ability to identify appropriate acquisition targets, acquire such targets at appropriate costs, integrate the acquired businesses with our existing businesses and realize synergies from such acquisitions. In addition, as China’s banks are becoming more sophisticated in their IT requirements, they are increasingly favoring large solution and service providers with solid financial background and broad product offerings. As a result, our industry will be consolidating, which we believe will present larger players in the industry, such as us, more opportunities to grow by acquisition.
 
CRITICAL ACCOUNTING POLICIES
 
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements which have been prepared in accordance with US GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of our assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
An accounting policy is considered critical, if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or if changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe that the following accounting policies involve a higher degree of judgment and complexity in their application and require us to make significant accounting estimates. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this annual report.
 
Revenue recognition
 
The Company generates revenues primarily from Software & Solutions, Platform & Maintenance Services and POS services. Revenue is recognized as follows:

(i)           Software & Solutions–they mainly consist of services including implementation, customization, training, consulting and post-contract customer support (“PCS”). Revenue from software and solutions services is generated primarily from customer orders in which customers purchase bundled solutions that include the Company’s software or software system and services, and third party hardware. Our bundled solutions generally require significant production, modifications, or customization of software or software system, contract accounting is therefore applied in accordance with Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type Contracts (“ARB No. 45”) and the relevant guidance in SOP No. 81-1, Accounting for Performance of Construction-Type and Certain Product-Type Contracts (“SOP 81-1”), and in Statement of Position (SOP) 97-2 Software Revenue Recognition (“SOP 97-2”). Based on our fact pattern, we apply the percentage-of-completion method of revenue recognition to account for the bundled solutions to the period from the start of the significant production, modification, or customization through to the last element delivered, which is the end of the PCS service period. Labor costs and direct project expenses are used to determine the stage of completion. Revisions in estimated contract profits are made in the period in which the circumstances requiring the revision become known. Provisions, if any, are made for anticipated losses on uncompleted contracts.

 
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In a typical bundled solutions contract that includes PCS, the Company generally offers the PCS to customers for one year. In limited circumstances, the Company would offer PCS for more than one year. In dealing with one-year PCS, the Company follows paragraph 59 of SOP 97-2 to recognize PCS revenue upon delivery of the software & solutions, as it considers that (i) the PCS fee is included with the initial solution service fee; (ii) the PCS included with the initial solution service is for one year or less; (iii) the estimated cost of providing PCS during the arrangement is insignificant and (iv) unspecified upgrades/enhancements offered during the PCS arrangements historically have been and are expected to continue to be minimal and infrequent. In dealing with bundled solutions contract that include multi-year PCS, the Company recognizes the revenue from the bundled solutions services using the percentage-of-completion method as mentioned above.
 
Costs and estimated earnings in excess of billings on uncompleted contracts consist of recognized recoverable costs and accrued profits on contracts for which billings had not been presented to customers as of the balance sheet date. Billings in excess of revenue recognized for which payments have been received are deferred until the applicable revenue recognition criteria have been met.

The determination of the amount of revenue requires us to make estimates about total cost to complete the project and the stage of completion. The assumptions, estimates, and uncertainties inherent in determining the stage of completion affect the timing and amounts of revenues and expenses reported. If we do not have a sufficient basis to measure the progress of completion or to estimate the total contract revenues and costs, revenue is recognized when the project is complete and, if applicable, the final acceptance is received from the customer. The over or under recognized contract profits will be recognized in the income statement when the actual costs were known or in the year in which the project is complete.
 
 
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(ii)           Platform & Maintenance Services Platform & Maintenance Services consist of system integration service, agency sales and maintenance services. System integration services mainly consist of value added services of planning, designing, installing, integrating and testing of hardware sold to customers. Revenue from system integration services is recognized in accordance with SAB Topic 13, Revenue Recognition, when the following conditions are all met: persuasive evidence of an arrangement exists, system integration services have been rendered and products have been delivered and accepted, the price is fixed or determinable and, collectibility is reasonably assured. Customer’s acknowledgement evidences their acceptance of the system integration work being completed at which time revenue is recognized. The contract revenue and related costs are deferred if the customer’s acknowledgement is not obtained.
 
Revenue from sales of IT equipment and software to the end users, which are limited to passing the IT equipment and software from vendors to end users, is treated as agency sales. The Company records the net difference between the amount it bills to end users and the fees charged by third party vendors as revenue. The Company considers the criteria set out in EITF 99-19 in determining whether it should recognize such revenues at gross or net of revenue. The Company believes that based on its arrangement with the system integrators, end users (banks) and the third party IT manufacturers, the net approach is appropriate as the Company is not the primary obligor to the end users, does not take general inventory risk, does not have latitude in establishing price and does not have discretion in supplier selection with respect to the IT equipment or software delivered to end users.

Maintenance service revenue is recognized ratably over the maintenance period.

(iii)     POS service – POS service is a business process outsourcing service, including merchant acquisition, deployment, installation and maintenance of POS terminals, merchant training and technical support. POS revenue is recognized in accordance with SAB Topic 13, Revenue Recognition, when the following conditions are all met: persuasive evidence of an arrangement exists, service is performed, the price is fixed or determinable and, collectibility is reasonably assured.

Allowance for Doubtful Accounts
 
Our allowance for doubtful accounts is based on management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, customer disputes and the collectability of specific customer accounts. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our operating results. The allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off.
 
Impairment of long-lived assets
 
The Company evaluates for impairment its long-lived assets to be held and used, including fixed assets, intangible assets and other non-current assets, when events or changes in circumstances indicate, in management’s judgment, that the carrying value of such assets may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimate undiscounted future cash flows expected to be generated by the asset.  If the carrying value of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount that the carrying value exceeds the estimated fair value.

Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of carrying amount or estimated fair value less the cost to sell, and are no longer depreciated. 
 
 
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Judgments and assumptions are inherent in management’s estimate of undiscounted future cash flows used to determine recoverability of an asset and the estimate of an asset’s fair value used to calculate the amount of impairment to recognize. The use of alternate judgments and/or assumptions could result in the recognition of different levels of impairment charges in the consolidated financial statements.

Capitalisation of internal software development costs

Internal development of software products is accounted for in accordance with SFAS No.86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed”. SFAS No.86 requires that the cost of developing software be expensed prior to establishing technological feasibility and those costs be capitalized once technological feasibility has been established. Capitalization ceases upon general release of the software. The determination of whether internal software development costs are subject to capitalization is, by its nature, highly subjective and involves significant judgments. This decision could significantly affect earnings during the development period. Also, judgement is required in determination of no significant subsequent testing cost will be incurred after the capitalization of software development costs. Further, once capitalized, the software costs are generally amortized on a straight-line basis over the estimated economic life of the product. The determination of the expected useful life of a product is highly judgmental. Finally, capitalized software costs must be assessed for realizability at the end of each reporting period.

Pre-contract costs
 
Due to the business environment in which the Company operates, it is common practice that the Company commences the software development or IT consulting project for its banking clients without commercial contracts being signed. If the contracts are not obtained during the reporting period where implementation costs have been incurred, the Company defers revenue recognition for the related contracts until contracts are obtained. In accordance with SOP 81-1, as modified by SOP 98-5, costs that are incurred for a specific anticipated contract and that will result in no future benefits unless the contract is obtained, including cost of equipment, direct labor costs, and other ancillary costs, are deferred until receipt of the signed contract, and are then included in contract costs or inventory. Such deferred costs, subject to their not being related to costs of start-up activities, are evaluated periodically for probability of recoverability. If deemed unrecoverable, deferred costs are expensed to operating expenses.

Costs of start-up activities, including organization costs, are expensed as incurred.

Costs incurred in connection with anticipated contracts are deferred outside the contract cost or inventory classification if their recovery from future contract revenue or from other dispositions is considered probable.
 
Goodwill
 
Goodwill represents the excess of the purchase price and related costs over the fair value assigned to net tangible and identifiable intangible assets of business acquired and accounted for under the purchase method.

In accordance with SFAS No. 142 Goodwill and Other Tangible Assets, the impairment evaluation of goodwill is conducted annually, or more frequently, if events or changes in circumstances indicate that an asset might be impaired. The evaluation is performed by using a two-step process. In the first step, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is generally determined on the basis of discounted future cash flows. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, then a second step must be completed in order to determine the amount of the goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value to all of its assets and liabilities other than goodwill (including any unrecognized intangible assets) in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of the second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference.

 
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The assumptions used in the estimate of fair value are generally consistent with the past performance of each reporting unit and are consistent with the projections and assumptions that are used in current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions. Although we believe the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. We did not recognized any impairment charges in fiscal 2008, 2007 or 2006.

Income taxes
 
Our effective tax rate includes the impact of certain undistributed foreign earnings for which no U.S. taxes have been provided because such earnings are planned to be indefinitely reinvested outside the United States. Remittances of foreign earnings to the U.S. are planned based on projected cash flow, working capital and investment needs of our foreign and domestic operations. Based on these assumptions, we estimate the amount that will be distributed to the U.S. and provide U.S. federal taxes on these amounts. Material changes in our estimates could impact our effective tax rate.

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In order for us to realize our deferred tax assets, we must be able to generate sufficient taxable income in those jurisdictions where the deferred tax assets are located. We consider future growth, forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate and prudent and feasible tax planning strategies in determining the need for a valuation allowance. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such a determination. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance.
 
RECENTLY ISSUED ACCOUNTING STANDARDS
 
Recently Adopted Accounting Pronouncements
 
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157 (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and enhances fair value measurement disclosure. In October 2008, the FASB issued FASB Staff Position (“FSP”) 157-3 “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”). FSP SFAS 157-3 clarifies the application of SFAS 157 in a market that is not active, and provides guidance on the key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. Effective January 1, 2008, the Company adopted the measurement and disclosure requirements related to financial assets and financial liabilities. The adoption of SFAS 157 for financial assets and financial liabilities did not have a material impact on the Company’s results of operations or the fair values of its financial assets and liabilities.
 
FSP SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP SFAS 157-2”) delayed the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the fiscal year beginning after November 15, 2008. The Company is currently assessing the impact that the application of SFAS 157 to nonfinancial assets and liabilities will have on its results of operations and financial position.

In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of SFAS No. 115, which permits companies to measure

 
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many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option). Adoption of FASB 159 is optional and it may be adopted beginning in the first quarter of 2007. The adoption of FASB No. 159 did not have significant impact on its consolidated financial statements.

RECENT ACCOUNTING PRONOUCEMENTS NOT YET ADOPTED

During May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (“FAS 162”). FAS 162 identifies the sources of accounting principles and the framework for selecting principles to be used in the preparation and presentation of financial statements in accordance with generally accepted accounting principles. This statement will be effective 60 days after the Securities and Exchange Commission approves the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of ‘Present Fairly in Conformity With Generally Accepted Accounting Principles’. The Company does not anticipate that the adoption of FAS 162 will have an effect on its consolidated financial statements.

During March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures About Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“FAS 161”). This new standard requires enhanced disclosures for derivative instruments, including those used in hedging activities. It is effective for fiscal years and interim periods beginning after November 15, 2008, and will be applicable to the Company in the first quarter of fiscal 2009. The Company is currently evaluating the impact, if any, the adoption of FAS 161 will have on its consolidated financial statements.

During December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements (“FAS 160”). FAS 160 requires all entities to report noncontrolling (minority) interests in entities in the same way as equity in the consolidated financial statements. The Company is required to adopt FAS 160 for the first fiscal year beginning after December 15, 2008. The Company is currently evaluating the impact, if any, the adoption of FAS 160 will have on its consolidated financial statements.

During December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations (“FAS 141R”). FAS 141R provides revised guidance for recognizing and measuring assets acquired and liabilities assumed in a business combination. It establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed and also requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Changes in acquired tax contingencies, including those existing at the date of adoption, will be recognized in earnings if outside the maximum measurement period (generally one year). FAS 141R will be applied prospectively to business combinations with acquisition dates on or after January 1, 2009. Following the date of adoption of FAS 141R, the resolution of such items at values that differ from recorded amounts will be adjusted through earnings, rather than goodwill. The Company is still considering that impact of SFAS 141R, if any, will depend on the nature and size or business combinations the Company consummates after the effective date to its financial statements.

In May 2008, the FASB issued FASB FSP APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)". FSP APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer's non-convertible debt borrowing rate. Such separate accounting also requires accretion of the resulting discount on the liability component of the debt to result in interest expense equal to an issuer's nonconvertible debt borrowing rate. In addition, the FSP provides for certain changes related to the measurement and accounting related to derecognition, modification or exchange. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis. The impact of this standard cannot be determined until the transactions occur.

 
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In June 2008, the FASB issued FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities." FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing income per share under the two-class method pursuant to SFAS No. 128, "Earnings per Share." This guidance establishes that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Furthermore, all prior period earnings per share data presented shall be adjusted retrospectively to conform to the provisions of FSP EITF 03-6-1. The impact of this standard cannot be determined until the transactions occur.

In April 2008, the FASB issued FASB Staff Position, or FSP, No. FAS 142-3, “Determination of the Useful Life of Intangible Assets.” The final FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets,” or SFAS No. 142. The FSP is intended to improve the consistency between the useful life of an intangible asset determined under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141 (revised 2007), “Business Combinations,” and other principles under GAAP. FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. We are currently assessing the impact that this FSP will have on our results of operations and financial position.

A. Operating Results.

The following table sets forth a summary of our consolidated statement of income for the periods indicated. The operation results of any period are not necessarily indicative of the results that may be expected for any future period.
 
   
For the Year Ended December 31,
 
   
2006
   
2007
   
2008
 
   
RMB
   
%
   
RMB
   
%
   
RMB
   
USD
   
%
 
   
(in thousands, except percentages)
 
Revenues
    289,650       100.0       435,519       100.0       676,819       99,028       100.0  
Cost of revenues
    (215,332 )     (74.3 )     (277,826 )     (63.8 )     (449,277 )     (65,735 )     (66.4 )
Gross profit
    74,318       25.7       157,693       36.2       227,542       33,293       33.6  
Operating expenses
                                                       
Research and development expenses
    (902 )     (0.3 )     (8,370 )     (1.9 )     (10,148 )     (1,485 )     (1.5 )
Selling and marketing expenses
    (13,990 )     (4.8 )     (29,053 )     (6.7 )     (49,383 )     (7,225 )     (7.3 )
General and administrative expenses
    (14,170 )     (4.9 )     (50,668 )     (11.6 )     (95,425 )     (13,962 )     (14.1 )
Total operating expenses
    (29,062 )     (10.0 )     (88,091 )     (20.2 )     (154,956 )     (22,672 )     (22.9 )
Income from operations
    45,256       15.6       69,602       16.0       72,586       10,621       10.7  
Other income (expenses)
    (1,254 )     (0.4 )     4,453       1.0       (3,840 )     (562 )     (0.6 )
Income before minority interests and income taxes
    44,002       15.2       74,055       17.0       68,746       10,059       10.2  
Income tax (expenses) benefit
    (3,271 )     (1.1 )     (5,528 )     (1.3 )     9,538       1,395       1.4  
Income before minority interests
    40,731       14.1       68,527       15.7       78,284       11,454       11.6  
Minority interests
                (1,813 )     (0.4 )