F-1/A 1 df1a.htm AMENDMENT NO.2 TO FORM F-1 Amendment No.2 to Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on December 4, 2007

Registration No. 333-147601

 


SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


AMENDMENT NO. 2

TO

FORM F-1

REGISTRATION STATEMENT UNDER

THE SECURITIES ACT OF 1933

 


VanceInfo Technologies Inc.

LOGO

(Exact name of Registrant as specified in its charter)

 


Not Applicable

(Translation of Registrant’s name into English)

 


 

Cayman Islands   7371   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

3/F, Building 8, Zhongguancun Software Park

Haidian District, Beijing 100094

People’s Republic of China

+86 (10) 8282-5266

 


CT Corporation System

111 Eighth Avenue

New York, New York 10011

(212) 664-1666

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

 


Copies to:

 

David T. Zhang, Esq.

Latham & Watkins LLP

41st Floor, One Exchange Square

8 Connaught Place

Central, Hong Kong

+ 852 2912-2503

 

W. Clayton Johnson, Esq.

Cleary Gottlieb Steen & Hamilton LLP

Bank of China Tower

One Garden Road

Central, Hong Kong

+ 852 2521-4122

 


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

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

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

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

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

 


CALCULATION OF REGISTRATION FEE

 


Title of each class of

securities to be registered

   Amount to
be registered(1)(2)
   Proposed maximum
offering price per share
   Proposed maximum aggregate
offering price(1)
   Amount of
registration fee
 

Ordinary shares of par value US$0.001 per share(2)(3)

   8,797,500    US$ 9.50    US$ 83,576,250    US$ 2,566 (4)

(1)   Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933, as amended.
(2)   Includes ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and also includes ordinary shares that may be purchased by the underwriters pursuant to an over-allotment option. These ordinary shares are not being registered for the purpose of sales outside the United States.
(3)   American depositary shares issuable upon deposit of the ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No.333-147602). Each American depositary share represents one ordinary share.
(4)   Previously paid.

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

 



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

 

SUBJECT TO COMPLETION

PRELIMINARY PROSPECTUS DATED                     , 2007

LOGO

7,650,000 American Depositary Shares

VanceInfo Technologies Inc.

Representing 7,650,000 Ordinary Shares

 


This is the initial public offering of our American depositary shares, or ADSs. We are offering 6,300,000 ADSs, and the selling shareholders named in this prospectus are offering an additional 1,350,000 ADSs. Each ADS represents one ordinary share, par value US$0.001 per share. We will not receive any proceeds from the sale of ADSs by the selling shareholders. We have granted the underwriters an option to purchase up to 1,147,500 ADSs at the public offering price, less underwriting discount and commissions, within 30 days from the date of this prospectus to cover over-allotments.

Prior to this offering, there has been no public market for our ADSs or our ordinary shares. We currently expect the initial public offering price to be between US$7.50 and US$9.50 per ADS. Our ADSs have been approved for listing on the New York Stock Exchange under the symbol “VIT.”

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

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

 

     Per ADS    Total

Public Offering Price

   US$                 US$             

Underwriting Discount

   US$                 US$             

Proceeds to VanceInfo Technologies Inc. (before expenses)

   US$      US$  

Proceeds to the selling shareholders (before expenses)

   US$      US$  

The underwriters expect to deliver the ADSs to purchasers on or about                     , 2007.

 


 

Citi   Merrill Lynch & Co.
Jefferies & Company   Susquehanna Financial Group, LLLP

 


The date of this prospectus is                     , 2007


Table of Contents

LOGO


Table of Contents

Table of Contents

 

     Page

Prospectus Summary

   1

Risk Factors

   12

Forward-Looking Statements

   32

Use of Proceeds

   33

Dividend Policy

   34

Capitalization

   35

Dilution

   36

Enforceability of Civil Liabilities

   38

Corporate History and Structure

   39

Recent Developments

   42

Selected Consolidated Financial Data

   45

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

   48

Business

   79

Regulation

   104

Management

   107

Principal and Selling Shareholders

   115

Related Party Transactions

   119

Description of Share Capital

   123

Description of American Depositary Shares

   129

Shares Eligible for Future Sale

   138

Taxation

   140

Underwriting

   145

Legal Matters

   152

Experts

   153

Where You Can Find Additional Information

   154

Index to Consolidated Financial Statements

   F-1

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, the ADSs only in jurisdictions where such offers and sales are permitted. The information contained in this prospectus is current only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the ADSs.

 


Until [·], 2007 (25 days after the date of this prospectus), all dealers that buy, sell or trade the ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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Prospectus Summary

The following summarizes information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. For a more complete understanding of this offering, we encourage you to read this entire prospectus. The following summary should be read in conjunction with the more detailed information and financial statements (including the related notes) appearing elsewhere in this prospectus. For a discussion of certain factors you should consider before deciding to invest in our ADSs, see “Risk Factors.”

Our Company

We are an information technology, or IT, service provider and one of the leading offshore software development companies in China. We ranked among the top three Chinese offshore software development service providers for the North American and European markets as measured by 2006 revenues, according to International Data Corporation, or IDC, a leading independent market research firm. Our comprehensive range of IT services includes research and development services, or R&D services, enterprise solutions, application development and maintenance, or ADM, quality assurance and testing, as well as globalization and localization. We provide these services primarily to corporations headquartered in the United States, Europe, Japan and China, targeting high-growth industries such as technology, telecommunications, financial services, manufacturing, retail and distribution.

We offer our services through our globally integrated network of onsite and offsite delivery locations, primarily in China, to enable our clients to focus on their core competencies and improve operating efficiencies. With over 3,000 professionals as of October 31, 2007, we operate a number of offshore development centers in China, or CDCs, each with dedicated project teams and facilities designed to provide tailored solutions to individual clients. We believe that these dedicated CDCs provide our clients with differentiated services and enhance their confidence in our capabilities. We also deliver our services at clients’ facilities or via our offices in major cities across China.

Our major clients include Citibank, HP, IBM, Microsoft, Motorola and TIBCO. The number of our clients increased significantly from 66 for 2004 to 187 for the nine months ended September 30, 2007. We deploy our sales and marketing teams in several of our key target markets and in close proximity to our clients, which enables us to better understand our clients’ needs, effectively cross-sell our services and develop new client relationships.

In recent years, we have experienced significant organic growth, complemented by selective strategic acquisitions. Since 2005, we have made a number of acquisitions to strengthen our service lines and industry expertise, diversify our client base, and expand our sales network and delivery platform. Our net revenues grew from US$8.2 million in 2004 to US$29.1 million in 2006, representing a compound annual growth rate, or CAGR, of 88.6%. Our net income grew from US$1.1 million to US$4.4 million over the same period, representing a CAGR of 97.5%. For the six months ended June 30, 2007, we generated net revenues of US$25.4 million and net income of US$3.6 million, representing a 128.5% increase and a 110.6% increase from our net revenues of US$11.1 million and net income of US$1.7 million for the six months ended June 30, 2006, respectively.

Industry Background

Businesses globally are outsourcing a growing portion of their IT processes to improve operating efficiencies, focus on core competencies and maximize shareholder returns. More significantly, many of these businesses are increasingly outsourcing IT processes to offshore locations, such as China and India, to access a high-quality and cost-effective workforce. Due to increases in labor costs and attrition rates in India, China has become an

 

 

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increasingly attractive alternative offshore outsourcing destination. IDC has predicted that the global offshore IT services market will grow to US$38.0 billion by 2011, representing a CAGR of 17.1% from 2006. IDC has estimated that the China-based offshore software development industry will grow from US$1.4 billion in 2006 to US$6.9 billion in 2011, representing a CAGR of 37.9%. The growth of the China-based offshore IT services industry is expected to far outpace the growth of the global IT services and global offshore IT services industries. We believe that established China-based IT services companies like us are well positioned to benefit from these trends.

Our Strengths

We believe that the following strengths differentiate us from our competitors and enable us to capitalize on the projected growth in the IT services industry in China:

 

   

proven ability to grow rapidly and sustain profitability;

 

   

extensive suite of sophisticated IT services and flexible delivery model;

 

   

long-standing relationships with blue-chip clients;

 

   

strategic positioning in high-growth industries and geographic markets;

 

   

experienced management team and high-quality professionals; and

 

   

disciplined acquisition strategy and proven integration capability.

Our Strategy

Our goal is to become the leader in the rapidly growing IT services industry in China. Specific elements of our growth strategy include:

 

   

further strengthen and expand service line expertise;

 

   

continue to penetrate and grow strategic client accounts;

 

   

expand geographic and industry reach;

 

   

continue to improve and optimize delivery capabilities; and

 

   

pursue strategic acquisitions and alliances.

Our Challenges

The primary challenges we face include:

 

   

our dependence on a limited number of clients;

 

   

our concentration in a limited number of industries;

 

   

intense competition from other IT outsourcing companies;

 

   

management of our growth and effective integration of acquired businesses; and

 

   

increases in wages for professionals and the recruitment and retention of trained employees.

We also face other risks and uncertainties that may materially affect our business, financial condition, results of operations and prospects. You should consider the risks discussed in “Risk Factors” and elsewhere in this prospectus before investing in the ADSs.

 

 

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Corporate History and Structure

We commenced operations in 1995 through Beijing Wensi Chuangyi Software Technology Co., Ltd., or Wensi Chuangyi, a limited liability company established in China. Our holding company, Thinkplus Investments Limited, subsequently renamed VanceInfo Technologies Inc. LOGO, or VanceInfo, was incorporated under the laws of the British Virgin Islands in April 2004. In July 2004, we formed Worksoft Creative Software Technology Ltd., which was subsequently renamed VanceInfo Creative Software Technology Ltd., or VanceInfo Beijing. VanceInfo Beijing is a wholly foreign owned enterprise established under PRC law and a wholly owned subsidiary of VanceInfo. On August 31, 2004, VanceInfo Beijing acquired the IT services business and related assets of Wensi Chuangyi. In October 2005, VanceInfo was redomiciled to the Cayman Islands.

The following diagram illustrates our current corporate structure and the place of formation and affiliation of each of our subsidiaries and affiliates as of the date of this prospectus, excluding one subsidiary being liquidated.

LOGO

 

LOGO

   Beneficial interest

LOGO

   Contractual arrangements, including an exclusive technology development and consultation agreement and a power of attorney. Shanghai Megainfo Tech Co, Ltd. is 100% owned by Mr. Ming Zhao, a Chinese citizen. For a description of these arrangements, see “Corporate Structure and History” and “Related Party Transactions.”

Since 2005, we have acquired a number of businesses in China and Japan. For a detailed description of our acquisitions, see “Corporate History and Structure.”

Corporate Information

Our principal executive offices are located at 3/F, Building 8, Zhongguancun Software Park, Haidian District, Beijing 100094, People’s Republic of China. Our telephone number at this address is +86 (10) 8282-5266. Our registered office in the Cayman Islands is located at the offices of Codan Trust Company (Cayman) Limited,

 

 

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Cricket Square, Hutchins Drive, P.O. Box 2681, George Town, Grand Cayman, KY1-1111, Cayman Islands. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.

Investors should contact us for any inquiries through the address and telephone number of our principal executive offices. Our principal website is www.vanceinfo.com. The information contained on our website is not a part of this prospectus.

 

 

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Conventions That Apply to this Prospectus

Unless we indicate otherwise, all information in this prospectus reflects the following:

 

   

no exercise by the underwriters of their over-allotment option to purchase up to 1,147,500 additional ADSs representing 1,147,500 ordinary shares;

 

   

conversion of all outstanding Series A, Series B-1, B-2 and B-3 preferred shares into ordinary shares, exercise of all outstanding warrants to purchase our Series B-3 preferred shares and conversion of all of these Series B-3 preferred shares into ordinary shares, in each case immediately upon the closing of this offering; and

 

   

all shares and per share data have been adjusted to reflect a 100-for-1 split that became effective on March 10, 2005 and a further 10-for-1 split that became effective on November 3, 2005.

The holder of the outstanding warrants to purchase our Series B-3 preferred shares has elected to exercise these warrants by the net exercise method. See “Related Party Transactions—Other Share Issuance—Warrants.” The number of ordinary shares issuable upon the conversion of the Series B-3 preferred shares for which the warrants are exercisable is derived based on an assumed initial public offering price of US$8.50, the midpoint of the range shown on the front cover of this prospectus. In the event that the final offering price is different from the assumed price, we will include the actual number of ordinary shares issued in our final prospectus relating to this offering.

Except where the context otherwise requires and for purposes of this prospectus only:

 

   

“attrition rate”, with respect to an IT service company or its business unit during a specified period, refers to the ratio of the number of professionals that have left that company during the period, excluding employees employed for less than six months, to the number of full-time professionals that were on that company’s payroll at the ending date of the same period;

 

   

“China” or “PRC” refers to the People’s Republic of China, excluding, for purposes of this prospectus only, Taiwan, Hong Kong and Macau;

 

   

“Citibank” refers to Citibank N.A., Singapore Branch and Citicorp Software and Technologies Services (Shanghai) Limited;

 

   

“HP” refers to Shanghai HP Co., Ltd., a subsidiary of Hewlett-Packard Company;

 

   

“Huawei” refers to Huawei Technologies Co., Ltd. and certain of its affiliates;

 

   

“IBM” refers to International Business Machine China Company Limited, IBM Global Services (China) Company Limited and IBM Solution and Services (Shenzhen) Co., Ltd.;

 

   

“Microsoft” refers to Microsoft Corporation and Microsoft (China) Co., Ltd.;

 

   

“Motorola” refers to Motorola (China) Technologies Limited and Motorola (China) Electronics Ltd.;

 

   

“professionals”, with respect to an IT service company, refer to employees executing IT services for its clients;

 

   

“TIBCO” refers to TIBCO Software Inc.;

 

   

“US$,” “U.S. dollar” or “$” refers to the legal currency of the United States; and

 

   

“we,” “us,” “our company,” “our” and “VanceInfo” refer to VanceInfo Technologies Inc. LOGO, a Cayman Islands company, its predecessor, the IT services business of Beijing Wensi Chuangyi Software Technology Co., Ltd., its subsidiaries and its variable interest entity, Shanghai Megainfo Tech Co., Ltd.

 

 

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Our financial statements are expressed in the U.S. dollar, which is our reporting and functional currency. However, a majority of the revenues and expenses of our consolidated operating subsidiaries and variable interest entity are denominated in Renminbi, or RMB, the legal currency of China. This prospectus contains amounts denominated in Hong Kong dollars, or HK$, the legal currency of the Hong Kong Special Administrative Region, and Japanese Yen, or JPY, the legal currency of Japan, and contains translations of certain Renminbi, Hong Kong dollar and Japanese Yen amounts into U.S. dollars at specified rates. With respect to amounts not recorded in our consolidated financial statements included elsewhere in this prospectus, all translations from Renminbi to U.S. dollars were made at the noon buying rate in the City of New York for cable transfers in Renminbi per U.S. dollar, and all translations from Hong Kong dollars to U.S. dollars were made at the noon buying rate in the City of New York for cable transfers in Hong Kong dollars per U.S. dollar, and all translations from Japanese Yen to U.S. dollars were made at the noon buying rate in the City of New York for cable transfers in Japanese Yen per U.S. dollar, each as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from Renminbi to U.S. dollars have been made at a rate of RMB7.6120 to US$1.00, all translations from Hong Kong dollars to U.S. dollars have been made at a rate of HK$7.8184 to US$1.00, and all translations from Japanese Yen to U.S. dollars have been made at a rate of JPY123.39 to US$1.00, each the noon buying rate in effect as of June 29, 2007. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted to U.S. dollars or Renminbi, or any Hong Kong dollar or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Hong Kong dollars, or any Japanese Yen or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Japanese Yen, as the case may be, at any particular rate, or at all. On December 3, 2007, the noon buying rates were RMB7.4010 to US$1.00, HK$7.7879 to US$1.00 and JPY110.44 to US$1.00.

 

 

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The Offering

 

Total ADSs offered

7,650,000 ADSs

 

        By us

6,300,000 ADSs

 

        By the selling shareholders

1,350,000 ADSs

 

ADSs outstanding immediately after this offering

7,650,000 ADSs

 

Ordinary shares outstanding immediately after this offering

36,051,407 ordinary shares(1)

 

The ADSs

Each ADS represents one ordinary share.

 

 

The depositary will hold the ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement. You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange. We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

 

 

To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

 

Depositary

JPMorgan Chase Bank N.A.

 

Over-allotment option

We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to 1,147,500 additional ADSs from us at the initial public offering price, less underwriting discounts and commissions, solely for the purpose of covering over-allotments.

 

Use of proceeds

Our net proceeds from this offering are expected to be approximately US$45.8 million, assuming an initial public offering price per ADS of US$8.50, which is the midpoint of the range listed on the cover page of this prospectus. The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees by providing them with equity incentives, and obtain additional capital. We plan to use the net proceeds we receive from this offering for general corporate purposes, including capital expenditures, such as in connection with establishing new offices to expand our delivery platform, and funding possible future strategic acquisitions. See “Use of Proceeds” for additional information.

 

 

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

 

Listing

Our ADSs have been approved for listing on the New York Stock Exchange. Our ADSs and ordinary shares will not be listed on any other stock exchange or traded on any over-the-counter trading system.

 

Proposed New York Stock Exchange symbol

“VIT.”

 

Risk factors

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

 

Lock-up

We, our directors and executive officers, all of our existing shareholders and certain of our existing optionholders have agreed with the underwriters not to sell, transfer or dispose of, directly or indirectly, any of our ADSs or ordinary shares or securities convertible into or exercisable or exchangeable for our ADSs or ordinary shares for a period of 180 days following the date of this prospectus.

 

 

In addition, certain of our executive officers have agreed with the underwriters that the lock-up restrictions shall apply to the ordinary shares or ADSs held by them or their affiliates immediately after the closing of this offering for an additional 360-day period commencing on the date of the expiration of the 180-day lock-up period. Commencing on the date of the expiration of the initial 180-day lock-up period and at the end of each 180-day period thereafter until the expiration of the 360-day extended lock-up period, one-third of the ordinary shares or ADSs held by such executive officers or their affiliates as of the date of this prospectus will be released from the lock-up restrictions. See “Underwriting.”

 

Reserved ADSs

At our request, the underwriters have reserved for sale, at the initial public offering price, up to 5% of the ADSs offered by this prospectus to our directors, officers, employees, business associates and related persons through a directed share program.

 


 

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

 

   

excludes 5,217,893 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus at a weighted average exercise price of US$3.09 per share;

 

   

excludes ordinary shares reserved for future issuances under our share incentive plans; and

 

   

excludes up to 20,058 ordinary shares and ordinary shares with a value of up to US$3.4 million that may be issuable as contingent consideration in connection with our acquisitions.

 

 

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Our Summary Consolidated Financial and Operating Data

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

We were incorporated in April 2004 and acquired our predecessor, the IT services business of Wensi Chuangyi, in August 2004. The acquisition was accounted for using the purchase accounting method with a new accounting basis. The summary consolidated statement of operations data of our predecessor from January 1, 2004 to August 31, 2004 are presented below.

The following summary consolidated statement of operations data for the years ended December 31, 2005 and 2006 and the consolidated balance sheet data as of December 31, 2005 and 2006 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our summary consolidated statement of operations data for the six months ended June 30, 2006 and 2007 and the consolidated balance sheet data as of June 30, 2007 have been derived from our unaudited financial statements included elsewhere in this prospectus. Our summary consolidated statement of operations data from January 1 to August 31, 2004 have been derived from our unaudited consolidated management accounts which are not included in this prospectus. Our summary consolidated statement of operations data from September 1 to December 31, 2004 and our consolidated balance sheet data as of December 31, 2004 have been derived from our unaudited consolidated financial statements which are not included in this prospectus. We have prepared the unaudited consolidated financial information on the same basis as our audited consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The historical results are not necessarily indicative of results to be expected in any future period.

For a description of our selected unaudited consolidated financial results for the three months ended September 30, 2007, see “Recent Developments.”

 

 

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     Predecessor     VanceInfo  
     Period from
January 1 to
August 31, 2004
    Period from
September 1 to
December 31, 2004
   

For the Year Ended December 31,

   

For the Six Months

Ended June 30,

 
        

2004
(Combined)(1)

    2005     2006     2006     2007  
     (in $ thousands, except percentage, share, per share and per ADS data)  

Consolidated Statement of Operations Data

              

Net revenues

   4,851     3,312     8,163     15,481     29,051     11,118     25,398  

Cost of revenues(2)

   (2,566 )   (1,980 )   (4,546 )   (9,125 )   (17,961 )   (6,983 )   (15,671 )
                                          

Gross profit

   2,285     1,332     3,617     6,356     11,090     4,135     9,727  
                                          

General and administrative expenses(2)

   (941 )   (1,128 )   (2,069 )   (3,026 )   (6,140 )   (2,356 )   (5,393 )

Selling and marketing expenses(2)

   (70 )   (68 )   (138 )   (270 )   (681 )   (252 )   (780 )
                                          

Total operating expenses

   (1,011 )   (1,196 )   (2,207 )   (3,296 )   (6,821 )   (2,608 )   (6,173 )
                                          

Government subsidies

               102     54     50     21  
                                          

Income from operations

   1,274     136     1,410     3,162     4,323     1,577     3,575  

Net income

   1,080     42     1,122     3,235     4,376     1,688     3,555  

Deemed dividend on Series A convertible redeemable preferred shares — accretion of redemption premium

               (462 )   (611 )   (297 )   (320 )
                                          

Income attributable to holders of ordinary shares

   1,080     42     1,122     2,773     3,765     1,391     3,235  
                                          

Income per ordinary share:

              

Basic

       0.00         0.13     0.08     0.04     0.07  

Diluted

       0.00         0.13     0.07     0.04     0.06  

Income per ADS:

              

Basic

              

Diluted

              

Weighted average ordinary shares used in calculating net income per ordinary share:

              

Basic

       5,169,710         11,530,684     9,605,507     10,513,346     9,759,935  

Diluted

       5,169,710         11,530,684     10,205,449     10,829,887     11,047,626  

Pro forma income per ordinary share(3):

              

Basic

   -     0.00     -     0.19     0.20     0.08     0.13  

Diluted

   -     0.00     -     0.19     0.19     0.08     0.13  

Other Consolidated Financial Data

              

Gross margin(4)

   47.1 %   40.2 %   44.3 %   41.1 %   38.2 %   37.2 %   38.3 %

Operating margin(5)

   26.3     4.1     17.3     20.4     14.9     14.2     14.1  

Net margin(6)

   22.3     1.3     13.7     20.9     15.1     15.2     14.0  

 

 

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(1)   The 2004 full-year financial data presented in this section are the combination of the data for the period from January 1 to August 31, 2004 and the period from September 1 to December 31, 2004. This aggregation of the results for certain periods should not be construed as a measure of performance in conformity with U.S. GAAP because:

 

   

the earnings of our predecessor for the period from January 1 to August 31, 2004 have been determined using the historical cost method; and

 

   

the earnings of VanceInfo from September 1 to December 31, 2004 have been determined using the purchase accounting method in accordance with SFAS No. 141.

Nevertheless, although the presentation of the combined full year financial data for the year ended December 31, 2004 is not in accordance with U.S. GAAP, we believe that this combination is useful and can provide users with a more complete understanding of our results of operations from year to year.

 

(2)   Includes share-based compensation expenses as follows:

 

     Predecessor    VanceInfo  
     Period from
January 1 to
August 31, 2004
   Period from
September 1 to
December 31, 2004
   

For the Year Ended
December 31,

   

For the Six Months Ended

June 30,

 
         

2004

(Combined)

    2005     2006     2006     2007  
     (in $ thousands)  

Share-based compensation expenses included in:

               

Cost of revenues

                  (45 )   (22 )   (37 )

General and administrative expenses

      (297 )   (297 )   (67 )   (632 )   (308 )   (402 )

Selling and marketing expenses

                  (36 )   (17 )   (20 )

 

(3)   Pro forma basic and diluted net income per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding for the year plus the number of ordinary shares resulting from the assumed exercise of all outstanding warrants and the assumed conversion of the outstanding Series A, Series B-1, Series B-2 and Series B-3 convertible preferred shares upon the closing of this offering.

 

(4)   Gross margin represents gross profit as a percentage of net revenues.

 

(5)   Operating margin represents income from operations as a percentage of net revenues.

 

(6)   Net margin represents net income as a percentage of net revenues.

 

     As of December 31,    As of June 30,
2007
     2004    2005    2006   
     ( in $ thousands)

Consolidated Balance Sheet Data:

           

Cash and cash equivalents

   721    4,437    20,565    15,697

Accounts receivable

   3,377    5,774    11,815    17,963

Total assets

   5,853    15,700    42,044    55,282

Total liabilities

   2,382    2,171    5,583    10,841

Convertible redeemable preferred shares

      7,226    31,648    31,938

Shareholders’ equity

   3,359    6,165    4,640    11,860

Total liabilities, minority interest, convertible redeemable preferred shares and shareholders’ equity

   5,853    15,700    42,044    55,282

 

 

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Risk Factors

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

Risks Related to Our Company and Our Industry

We depend on a limited number of clients for a significant portion of our revenues and any loss of business from these clients could reduce our revenues and significantly harm our business.

We have derived, and believe that in the foreseeable future we will continue to derive, a significant portion of our revenues from a limited number of clients. Microsoft and IBM, our top two clients, each accounted for over 20% of our net revenues in 2005 and 2006. In the six months ended June 30, 2007, one of these clients accounted for over 20% and the other accounted for over 15% of our net revenues. In the aggregate, these two clients accounted for 57.8%, 53.1% and 40.5% of our net revenues in 2005, 2006 and the six months ended June 30, 2007, respectively. Our top five clients accounted for approximately 77.8%, 69.3% and 59.9% of our net revenues in 2005, 2006 and the six months ended June 30, 2007, respectively. Our ability to maintain close relationships with these clients is essential to the growth and profitability of our business. A number of factors other than our performance could cause the loss of or reduction in business or revenue from a client and these factors are not predictable. For example, a client may demand price reductions, change its outsourcing strategy, switch to another IT outsourcing service provider or return work in-house. We generally do not have long-term commitments from any of our clients to purchase our services. Although we usually enter into master service agreements, or MSAs, with clients, these MSAs are not commitments to purchase our services, and statements of work, or SOWs, from clients are required for specific orders to purchase our services. In addition, the MSAs and SOWs typically may be terminated by our clients on short notice. If we fail to enter into or renew MSAs with one or more of our major clients in any particular period, if major clients reduce their service volumes under SOWs, or if any existing MSAs or SOWs with major clients are terminated, some or all of the business of our major clients could be lost or reduced, which could have a material adverse effect on our business, results of operations and financial condition.

Our revenues are highly dependent on a limited number of industries and any decrease in demand for outsourced services in these industries could reduce our revenues and adversely affect our results of operations.

A substantial portion of our clients are concentrated in the technology and telecommunications industries. For the year ended December 31, 2006 and the six months ended June 30, 2007, a majority of our net revenues were derived from clients in the technology and telecommunications industries. Our business growth largely depends on continued demand for our services from clients in these industries and other industries that we may target in the future, as well as on trends in these industries to outsource R&D services, enterprise solutions, ADM, quality assurance and testing, globalization and localization and other IT services. A downturn in any of our targeted industries, particularly the technology and telecommunications industries, a slowdown or reversal of the trend to outsource IT services in any of these industries or the introduction of regulations which restrict or discourage companies from outsourcing could result in a decrease in the demand for our services and adversely affect our results of operations.

Other developments may also lead to a decline in the demand for our services in these industries. For example, consolidation in any of these industries or acquisitions, particularly involving our clients, may decrease the potential number of buyers of our services. Any significant reduction in or the elimination of the use of the services we provide within any of these industries would result in reduced revenues and harm our business. Our clients may experience rapid changes in their prospects, substantial price competition and pressure on their profitability. This, in turn, may result in increasing pressure on us from clients in these key industries to lower our prices, which could negatively affect our business, results of operations and financial condition.

 

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We face intense competition from onshore and offshore IT outsourcing companies and, if we are unable to compete effectively, we may lose clients and our revenues may decline. Our clients may also choose to use internal resources to provide the IT services they need, thereby causing us to lose revenues.

The market for IT services is highly competitive and we expect competition to increase due to a number of factors. We believe that the principal competitive factors in our markets are industry experience, quality of the services offered, reputation, marketing and selling skills, as well as price. We face significant competition from various competitors, including:

 

   

other Chinese IT services companies, such as Achievo Corporation, or Achievo, Chinasoft International Ltd., or Chinasoft International, Dalian Hi-Think Computer Technologies Co. Ltd, or DHC, HiSoft Technology International Limited, or Hisoft, Neusoft Group Ltd., or Neusoft, and SinoCom Software Group Limited, or SinoCom;

 

   

Indian IT services companies, such as Cognizant Technology Solutions Corp., or Cognizant, HCL Technologies Ltd., or HCL, Infosys Technologies Ltd., or Infosys, Satyam Computer Services Limited, or Satyam, Symphony Services, or Symphony, Tata Consultancy Services Ltd., or TCS, and Wipro Technologies, or Wipro;

 

   

in-house IT departments of large corporations; and

 

   

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

In addition, the trend towards offshore outsourcing, international expansion by foreign and domestic competitors and continuing technological changes will result in new and different competitors entering our markets. These competitors may include entrants from the communications, software and data networking industries or entrants in geographic locations with lower costs than those in which we operate. Some of these existing and future competitors have greater financial, human and other resources, longer operating histories, greater technological expertise, more recognizable brand names and more established relationships in the industries that we currently serve or may serve in the future. In addition, some of our competitors may enter into strategic or commercial relationships among themselves or with larger, more established companies in order to increase their ability to address client needs, or enter into similar arrangements with potential clients. Clients tend to engage multiple IT services outsourcing providers instead of using an exclusive service provider, which could reduce our revenues to the extent that clients obtain services from other providers. Clients may prefer service providers that have facilities located globally or that are based in countries more cost-competitive than China. Therefore, we cannot assure you that we will be able to retain our clients while competing against such competitors. Increased competition, our inability to compete successfully against competitors, pricing pressures or loss of market share could harm our business, financial condition and results of operations.

We do not have long-term commitments from our clients, and our clients may terminate contracts before completion or choose not to renew contracts, which could adversely affect our business and reduce our revenues.

Our clients are not obligated for any long-term commitments to us. Many of our MSAs are either renewable for one-year periods or have no fixed terms, and our SOWs are typically project-based and valid only for several months. In addition, our clients can terminate many of our MSAs and SOWs with or without cause, and in most cases without any cancellation charge. Some of our MSAs specify that if a change of control of our company occurs during the term of the contract, the client has the right to terminate the contract. With respect to our material client contracts, this offering will not trigger any change-of-control provision or we have obtained waivers from the relevant clients. However, if any future event triggers any change-of-control provision in our client contracts, these contracts may be terminated, which would result in our loss of revenues. Most of the MSAs we have entered into with our clients require us to purchase and maintain specified insurance coverage during the terms of the MSAs,

 

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including commercial general insurance or public liability insurance, umbrella insurance, product liability insurance, and workmen’s compensation insurance. As the insurance industry in China is still in an early stage of development, a number of these types of insurance are not available on reasonable terms in China. Historically, we have not purchased any of the required insurance. Although to date no client has brought any claims against us for such failure, our clients have the right to terminate these MSAs.

Failure to perform or observe any contractual obligations could result in cancellation or non-renewal of a contract, which could cause us to experience a higher than expected number of unassigned employees and an increase in our cost of revenue as a percentage of revenue, until we are able to reduce or reallocate our headcount. The ability of our clients to terminate MSAs makes our future revenues uncertain. We may not be able to replace any client that elects to terminate or not renew its contract with us, which would adversely affect our business and revenues.

Furthermore, in some of our MSAs, our clients are also entitled to request us to transfer, to them or their designees, the assets of our CDCs that serve them and all of the operating relationships, including leases for the premises of the CDCs, employment relationships with the employees dedicated to the CDCs and contracts with subcontractors, at a pre-agreed transfer price which is generally a multiple of our monthly service fees from the relevant client for CDC services prior to the transfer. This transfer fee will either be reduced ratably based on the elapsed operation term of the CDC or subject to a maximum amount. In addition to the above amounts, the relevant client is also required to pay the lower of fair market value or net book value for the assets to be transferred that have not already been charged to the client. If our clients exercise these rights, we may lose some of our business and key employees, or may be required to transfer our assets and employees to a third party, and our losses may not be fully covered by the contractual payment.

Our quarterly operating results are difficult to predict and could fall below investor expectations or estimates by securities research analysts, which may cause the trading price of our ADSs to decline.

Our revenues and operating results can vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control, such as variations in the volume of business from clients resulting from changes in our clients’ operations, the business decisions of our clients regarding the use of our services, delays or difficulties in expanding our operational facilities and infrastructure, changes to our pricing structure or that of our competitors, inaccurate estimates of resources and time required to complete ongoing projects and currency fluctuations. For example, some of our MSAs permit our clients to reduce or modify the volume of services under any SOW at any time. As many of our employees take long vacations during the Chinese New Year in the first quarter, our revenues in that quarter are relatively low compared to the other quarters. Moreover, our results may vary depending on our clients’ business needs and IT spending patterns. Due to the annual budget cycles of most of our clients, we may not be able to estimate accurately the demand for our services beyond the immediate calendar year, which could adversely affect our business planning and may have a material adverse effect on our business, results of operations and financial condition. In addition, the volume of work performed for specific clients is likely to vary from year to year, particularly since we typically are not the exclusive outside service provider to our clients. Thus, a major client in one year may not provide the same amount or percentage of our revenues in any subsequent year.

The long sales cycle for our services, which typically ranges from three to six months, and the internal budget and approval processes of our prospective clients make it difficult to predict the timing of new client engagements. Accordingly, the financial benefit of gaining a new client may be delayed due to delays in the implementation of our services. In addition, some of our testing projects and ADM projects last several months. Due to the foregoing and other factors, our operating results have fluctuated significantly from quarter to quarter. These fluctuations are likely to continue in the future and operating results for any period may not be indicative of our performance in any future period. If our operating results for any quarterly period fall below investor expectations or estimates by securities research analysts, the trading price of our ADSs may decline.

 

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We may face difficulties in offering new and existing service lines and managing increasingly large and complex projects, which could lead to clients discontinuing their work with us, thereby reducing our revenues and adversely affecting our ability to implement our growth plans.

We have been expanding the scope of our services by offering additional industry practices and service lines. The success of these new and expanded practices and service lines is dependent, in part, upon demand for such services by our existing and new clients and our ability to meet this demand in a cost-competitive and effective manner. We cannot be certain that we will be able to attract existing and new clients for such new services or effectively meet our clients’ needs.

We intend for the expansion of our practices and service lines to result in larger and more complex projects for our clients. To achieve this result, we need to establish closer relationships with our clients and develop a thorough understanding of their operations. Our ability to establish such relationships will depend on the proficiency of our management personnel, professionals and, if necessary, subcontractors, as well as other competitive factors such as our performance and delivery capabilities. Larger and more complex projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages or may cancel or delay additional planned engagements. Such cancellations or delays make it difficult to plan for project resource requirements, and failure to plan appropriately may have a negative impact on our business, results of operations and financial condition.

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

We have experienced rapid growth and significantly expanded our business recently. Our net revenues grew to US$29.1 million in 2006 from US$8.2 million in 2004. Since 2004, we have completed a number of acquisitions and established or acquired seven offices in China, three offices in the United States, and one office each in Japan and Hong Kong. We have also set up a number of CDCs. As of October 31, 2007, we had over 3,000 professionals, as compared to 536 professionals as of December 31, 2004. We are actively looking at additional locations to establish new offices and expand our current offices and CDCs. We intend to continue expansion in the foreseeable future to pursue existing and potential market opportunities.

This rapid growth places significant strain on our management personnel, systems and resources. To accommodate our growth, we will need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of our accounting and other internal management systems, all of which require substantial management efforts. We also will need to continue to expand, train, manage and motivate our workforce and manage our client relationships. Moreover, as we introduce new services or enter into new markets, we may face new market, technological and operational risks and challenges with which we are unfamiliar. All of these endeavors will involve risks and require substantial management effort and skill. As a result of any of these problems associated with expansion, our business, results of operations and financial condition could be materially and adversely affected. Furthermore, we may not be able to achieve anticipated growth, which could materially and adversely affect our business and prospects.

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

Historically, we have expanded our service capabilities and gained new clients through selective acquisitions such as our acquisitions of Beijing Prosoft Software Technology Co., Ltd., or Prosoft, Beijing Innovation Technology Co., Ltd., or ITC, Shanghai Solutions Software Co., Ltd., or Shanghai Solutions, the international business unit of Beijing SureKAM Technologies Co., Ltd., or SureKAM, and Beijing Chosen Technology Co., Ltd, or Chosen, in the past two years. Our growth strategy involves gaining new clients and expanding our

 

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service lines, both organically and through strategic acquisitions. Our ability to successfully integrate an acquired entity and its operations may be adversely affected by a number of factors. These factors include:

 

   

diversion of management’s attention;

 

   

difficulties in retaining clients of acquired companies;

 

   

difficulties in retaining personnel of acquired companies;

 

   

entry into unfamiliar markets;

 

   

unanticipated problems or legal liabilities; and

 

   

tax and accounting issues.

Furthermore, the acquired companies may not perform to our expectations for various reasons, including legislative or regulatory changes that affect the products or services in which a company specializes, and the loss of key clients and personnel, any of which could have a material adverse effect on our business and results of operations. If we are not able to realize the benefits envisioned for such acquisitions, our overall profitability and growth plans may be adversely affected.

We expect that a portion of our income may in the future be generated on a project basis with a fixed price; we may fail to accurately estimate costs and determine resource requirements in relation to our projects, which would reduce our margins and profitability.

We expect that a portion of our income may in the future be generated from fees we receive for our projects with a fixed price. Our projects often involve complex technologies and must often be completed within compressed timeframes and meet increasingly sophisticated client requirements. We may be unable to accurately assess the time and resources required for completing projects and to price our projects profitably. An underestimation of required time and resources may result in cost overruns and mismatches in project staffing. Conversely, an overestimation of our costs may result in our submitting uncompetitive bids and loss of business. Furthermore, any failure to complete a project within the stipulated timeframe could also expose us to contractual or other liabilities and may damage our reputation. These and other factors could adversely affect our business, results of operations and financial condition.

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

The IT services industry relies on skilled employees, and our success depends to a significant extent on our ability to attract, hire, train and retain qualified employees. The IT services industry experiences high employee turnover. We may encounter higher attrition rates in the future. There is significant competition in China for professionals with the skills necessary to perform the services we offer to our clients. Increased competition for these professionals, in the IT services industry or otherwise, could have an adverse effect on us. A significant increase in the attrition rate among employees with specialized skills could decrease our operating efficiency and productivity and could lead to a decline in demand for our services.

In addition, our ability to maintain and renew existing engagements and obtain new business will depend, in large part, on our ability to attract, train and retain skilled personnel that enable us to keep pace with growing demands for outsourcing, evolving industry standards and changing client preferences. Our failure to attract, train and retain personnel with the qualifications necessary to fulfill the needs of our existing and future clients or to assimilate new employees successfully could have a material adverse effect on our business, financial condition and results of operations. Our failure to retain our key personnel on client projects or find suitable replacements

 

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of the key personnel upon their departure may lead to termination of some of our MSAs or cancellation of some of our SOWs, which could materially adversely affect our business.

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

Wage costs for professionals in China are lower than comparable wage costs in more developed countries and India. However, the wage costs in China’s IT services industry may increase at a faster rate than in the past. In the long term, wage increases may make us less competitive unless we are able to increase the efficiency and productivity of our professionals as well as the prices we can charge for our services. Increases in wage costs, may reduce our profit margins. In addition, the issuance of equity-based compensation to our professionals would also result in additional dilution to our shareholders.

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

Our future success heavily depends upon the continued services of our senior executives and other key employees. In particular, we rely on the expertise and experience of Chris Shuning Chen, our founder, chairman and chief executive officer. In addition, we rely on David Lifeng Chen, our chief operating officer, Sidney Xuande Huang, our chief financial officer, Stanley Ying Zhou, our chief administration officer, and our four executive vice presidents, Junbo Liu, Kevin Zhong Liu, Gerry Jianxin Lu and Jeff Jian Wu, to run our business operations. If one or more of our senior executives or key employees are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all. We may incur additional expenses to recruit, train and retain personnel, our business may be severely disrupted, and our financial condition and results of operations may be materially adversely affected.

If any of our senior executives or key employees joins a competitor or forms a competing company, we may lose clients, suppliers, know-how and key professionals and staff members to them. Also, if any of our business development managers who keeps a close relationship with our clients joins a competitor or forms a competing company, we may lose clients, and our revenues may be materially adversely affected. Most of our executives have entered into employment agreements with us that contain non-competition provisions. However, if any dispute arises between our executive officers and us, such non-competition provisions may not be enforceable, especially in China, where most of these executive officers and key employees reside, in light of the uncertainties with China’s legal system. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely affect us.”

Because our business depends significantly on clients headquartered in the United States, Europe, Japan and China, any economic slowdown in these regions or other factors that affect the IT offshore outsourcing from the United States, Europe or Japan could have a material adverse effect on our business and operating results.

As of June 30, 2007, substantially all of our net revenues were derived from clients headquartered in the United States, Europe, Japan and China. If economic growth in one or more of those regions slows, our clients may suffer a reduced market share or their results of operations and financial condition may otherwise be adversely affected, and they may cancel, reduce or defer their IT spending or change their IT outsourcing strategy. In addition, in an economic downturn, our utilization and billing rates for our professionals could decline, which could have a material adverse effect on our business and operating results.

Furthermore, IT offshore outsourcing is becoming an increasingly politically sensitive issue in the United States, Europe and Japan. For example, many organizations and public figures in the United States and Europe have publicly expressed concern about a perceived association between offshore outsourcing providers and the loss of jobs in their home countries. As a result, current or prospective clients may elect to perform such services

 

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themselves or may be discouraged from transferring these services from onshore to offshore providers. Any slowdown or reversal of existing industry trends towards offshore outsourcing in response to political pressure would harm our ability to compete effectively with competitors that operate out of onshore facilities and adversely affect our business and financial results.

The growth and success of our business depends on our ability to anticipate and respond in a timely manner to the evolving demands for IT services.

The IT services market is characterized by rapid technological change, evolving industry standards, changing customer preferences and new product and service introductions. Our future growth and success depend significantly on our ability to anticipate developments in IT services, and offer and develop new product and service lines to meet our clients’ evolving needs. We may not be successful in anticipating or responding to these developments in a timely manner, or if we do respond, the services or technologies we develop may not be successful in the marketplace. Further, products, services or technologies that are developed by our competitors may render our services non-competitive or obsolete.

Moreover, the emergence of new national and international industry standards could render our products or those of our clients unmarketable or obsolete and may require us to incur substantial unanticipated costs to comply with any such new standards. Should we fail to adapt to the rapidly changing IT services market or if we fail to develop suitable services to meet the evolving and increasingly sophisticated requirements of our clients in a timely manner, our business and operating results could be materially and adversely affected.

Some of our client contracts contain provisions which, if triggered, could result in lower future revenues and have an adverse effect on our results of operations.

Some of our MSAs provide that, if during the term of such MSAs, we offer or accept lower prices for our services that are similar to those we provide under these MSAs, to or from any other clients while all other terms and conditions are similar, we will be obligated to offer equally favorable prices to the clients under these MSAs. Such provisions, if triggered, would result in lower future revenues and profits to us under these MSAs. Certain other contracts of ours allow clients in certain circumstances to request a semi-annual benchmarking report comparing our direct costs and operating costs, measured as a percentage of revenues, with those of an agreed list of other service providers for comparable services. Based on the results of the study and depending on the reasons for any unfavorable variance, we may be required to make improvements to future services we provide or there may be reduction in new business from the clients. The triggering of any of these contractual provisions could have an adverse effect on our business, results of operations and financial condition.

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

Certain of our existing MSAs and other agreements have non-competition clauses, which restrict us from providing services to customers of our existing clients. Many of our MSAs contain clauses that restrict our employees working for a particular client from providing services to a competitor of that client. Such clauses may restrict our ability to offer services to different clients in a specific industry or market.

Our MSAs with some of our clients provide that, during the term of the MSA and for a twelve-month period thereafter and under specified circumstances, we may not accept any assignments from, or render similar services to, those clients’ customers. Some of our contracts also provide that, although we are free to render other services to clients’ customers prior to the receipt of SOWs from our clients, such services may not create any conflicts of interest with the services we provide to those clients, and we must obtain our clients’ prior written consent to continue providing services to their customers before we begin rendering similar services to our clients. Moreover, we may not compete with our clients, or bid for or accept any assignment which our client is bidding for or is negotiating. These restrictions may hamper our ability to compete for and provide services to other

 

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clients in a specific industry or market in which we have expertise and may adversely affect our revenues and future profitability.

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

Most of our contracts with clients contain performance requirements. Failure to consistently meet service requirements of a client or errors made by our professionals in the course of delivering services to our clients could disrupt the client’s business and result in a reduction in revenues or a claim for substantial damages against us. In addition, a failure or inability to meet a contractual requirement could seriously damage our reputation and affect our ability to attract new business.

The services we provide are often critical to our clients’ businesses, and any failure to provide those services could result in a reduction in revenues or a claim for substantial damages against us, regardless of whether we are responsible for that failure. Our CDC methodology requires us to maintain active data and voice communications between our main development centers in China and our international clients’ offices. Any significant failure of our equipment or systems, or any major disruption to basic infrastructure like power and telecommunications in the locations in which we operate, could impede our ability to provide services to our clients, have a negative impact on our reputation, cause us to lose clients, reduce our revenues and harm our business.

Under our contracts with our clients, our liability for breach of our obligations is generally limited to actual damages suffered by the client. To the extent that our contracts contain limitations on liability, such limitations may be unenforceable or otherwise may not protect us from liability for damages. In addition, certain liabilities, such as claims of third parties for which we may be required to indemnify our clients, are generally not limited under our contracts. We currently do not have commercial general or public liability insurance. The successful assertion of one or more large claims against us could have a material adverse effect on our business, reputation, results of operations, financial condition and cash flows.

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

We are typically required to manage, utilize and store sensitive or confidential client data in connection with the services we provide. Under the terms of our client contracts, we are required to keep such information strictly confidential. We seek to implement specific measures to protect sensitive and confidential client data. We require our employees and subcontractors to enter into non-disclosure arrangements to limit access to and distribution of our clients’ sensitive and confidential information as well as our own trade secrets. We can give no assurance that the steps taken by us in this regard will be adequate to protect our clients’ confidential information. If our clients’ proprietary rights are misappropriated by our employees or our subcontractors or their employees, in violation of any applicable confidentiality agreements or otherwise, our clients may consider us liable for that act and seek damages and compensation from us. However, we currently do not have any insurance coverage for mismanagement or misappropriation of such information by our subcontractors or employees. Any litigation with respect to unauthorized disclosure of sensitive and confidential information might result in substantial costs and diversion of resources and management attention.

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

We rely on software licenses from our clients with respect to certain individual projects. To protect proprietary information and other intellectual property of our clients, we require our employees, consultants, advisors and collaborators to enter into confidentiality agreements with us. These agreements may not provide meaningful protection for trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. Implementation

 

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of intellectual property-related laws in China has historically been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, protection of intellectual property rights and confidentiality in China may not be as effective as that in the United States or other developed countries. Policing unauthorized use of proprietary technology is difficult and expensive. The steps we have taken may be inadequate to prevent the misappropriation of proprietary technology of our clients. Reverse engineering, unauthorized copying or other misappropriation of proprietary technologies of our clients could enable third parties to benefit from our or our clients’ technologies without paying us for doing so, and our clients may hold us liable for that act and seek damages and compensation from us, which could harm our business and competitive position.

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

It is critical that we use and develop our technology and services without infringing the intellectual property rights of third parties, including patents, copyrights, trade secrets and trademarks. Intellectual property litigation is expensive and time-consuming and could divert management’s attention from our business. A successful infringement claim against us, whether with or without merit, could, among others things, require us to pay substantial damages, develop non-infringing technology, or re-brand our name or enter into royalty or license agreements that may not be available on acceptable terms, if at all, and cease making, licensing or using products that have infringed a third party’s intellectual property rights. Protracted litigation could also result in existing or potential clients deferring or limiting their purchase or use of our products until resolution of such litigation, or could require us to indemnify our clients against infringement claims in certain instances. Also, we may be unaware of intellectual property registrations or applications relating to our services that may give rise to potential infringement claims against us. Parties making infringement claims may be able to obtain an injunction to prevent us from delivering our services or using technology containing the allegedly infringing intellectual property. Any intellectual property litigation could have a material adverse effect on our business, results of operations or financial condition.

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

We expect a portion of our future growth to come from acquisitions of high-quality IT services companies. It is possible that in the future we may not succeed in identifying suitable acquisition candidates. Even if we identify suitable candidates, we may not be able to consummate an acquisition on terms commercially acceptable to us. Many of our competitors are likely to be seeking to acquire the same targets that we are looking to acquire. Such competitors may have substantially greater financial resources than we do and may be able to outbid us for the targets. If we are unable to complete suitable acquisitions, our growth strategy may be impeded and our revenues and net income could be negatively affected.

In the course of auditing our consolidated financial statements for the two years ended December 31, 2005 and 2006, we and our auditors identified certain material weaknesses, significant deficiencies and other control deficiencies in our internal control over financial reporting; if we fail to maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our ADSs may be adversely affected.

Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Prior to this offering, we have been a private company and have limited accounting personnel and other resources with which to address our internal control over financial reporting. In the course of auditing our consolidated financial statements for the years ended December 31, 2005 and 2006, our independent registered public accounting firm identified and communicated to

 

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us two material weaknesses and one significant deficiency, as well as certain other control deficiencies, each as defined in Auditing Standard No. 2 of the U.S. Public Company Accounting Oversight Board, or Auditing Standard No. 2, in our internal control over financial reporting as of December 31, 2006. We have agreed with these findings. As defined in Auditing Standard No. 2, a “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected, and a “significant deficiency” is a control deficiency, or combination of control deficiencies, that adversely affects our ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of our annual or interim financial statements that is more than inconsequential will not be prevented or detected.

The material weaknesses identified by our independent registered public accounting firm were: (i) lack of a comprehensive accounting policies and procedures manual in accordance with U.S. GAAP accessible to accounting personnel to ensure that accounting policies and procedures are followed; and (ii) lack of dedicated resources to take responsibility for the finance and accounting function and the preparation of financial statements in compliance with U.S. GAAP. The significant deficiency identified by our independent registered public accounting firm was our lack of a qualified internal tax team that can address our income tax accounting and compliance matters from a U.S. GAAP perspective.

Following the identification of these material weaknesses, significant deficiency and other control deficiencies, we have taken measures and plan to continue to take measures to remediate these weaknesses and deficiencies. However, the implementation of these measures may not fully address these material weaknesses, significant deficiency and other control deficiencies in our internal control over financial reporting, and we cannot yet conclude that they have been fully remedied. Our failure to correct these material weaknesses, significant deficiency and other control deficiencies or our failure to discover and address any other control deficiencies could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, effective internal control over financial reporting is important to help prevent fraud. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, may be materially and adversely affected. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control Over Financial Reporting” in this prospectus.

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

Upon completion of this offering, we will become a public company in the United States that is subject to the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act will require that we include a report from management on the effectiveness of our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2008. In addition, beginning at the same time, our auditors must report on the effectiveness of our internal control over financial reporting. Our management or our auditors may conclude that efforts to remediate the problems identified above were not successful or that otherwise our internal control over financial reporting is not effective. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our reporting processes, which could adversely impact the market price of our ADSs. We will need to incur significant costs and use significant management and other resources in order to comply with Section 404 of the Sarbanes-Oxley Act.

 

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

Our clients’ business operations are subject to certain rules and regulations in China or otherwise. Our clients may contractually require that we perform our services in a manner that would enable them to comply with such rules and regulations. Some of our contracts concluded with clients headquartered in the United States and elsewhere provide that we shall comply with the United States export regulations while handling any information, process, product or service and that we shall adhere to regulations that apply to our clients’ businesses. Some of our IT services provided to certain banking clients for their Japanese operations are required to comply with the regulations promulgated by Japanese regulators. Failure to perform our services in such a manner could result in breaches of contract with our clients and, in some limited circumstances, civil fines and criminal penalties for us. In addition, we are required under various Chinese laws to obtain and maintain permits and licenses for the conduct of our business. If we do not maintain our licenses or other qualifications to provide our services, we may not be able to provide services to existing clients or be able to attract new clients and could lose revenues, which could have a material adverse effect on our business and results of operations.

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

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

Our business could be adversely affected by the effects of avian flu, severe acute respiratory syndrome, or SARS, or another epidemic or outbreak. From 2005 to 2007, there have been reports of avian flu in various parts of China and elsewhere in Asia, including a few confirmed human cases and deaths. Any prolonged recurrence of avian flu, SARS or other adverse public health developments in China may have a material adverse effect on our business operations. Our operations may be impacted by a number of health-related factors, including, among other things, quarantines or closures of our facilities which could severely disrupt our operations, the sickness or death of our key officers and employees, and a general slowdown in the Chinese economy. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of avian flu, SARS or any other epidemic.

Fluctuations in exchange rates could adversely affect our business.

A majority of our revenues and expenses are denominated in Renminbi, while a significant portion of our revenues and expenses are denominated in US dollars. The amount of our foreign exchange receipts generally exceeds the amount of our foreign exchange disbursements. Fluctuations in exchange rates, particularly among the U.S. dollar, Renminbi and Japanese Yen, could affect our net profit margins and could result in foreign exchange losses and operating losses. The change in value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 9.5% appreciation of

 

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the RMB against the U.S. dollar between July 21, 2005 and September 28, 2007. While international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and more significant appreciation of the Renminbi against the U.S. dollar. As substantially all of our costs and expenses are denominated in Renminbi, the revaluation beginning in July 2005 and potential future revaluation has and could further increase our costs in U.S. dollar terms. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.

We incurred net foreign exchange losses of US$32,000, US$93,000 and US$0.2 million in 2005, 2006 and the six months ended June 30, 2007, respectively. As very limited types of hedging transactions are available in the PRC to reduce our exposure to exchange rate fluctuations, we have not entered into any such hedging transactions. Accordingly, we cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign exchange losses in the future. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currencies. See “—Risks Related to Doing Business in China—Restrictions on currency exchange may limit our ability to receive and use our revenues or financing effectively.”

If tax benefits currently available to our subsidiaries are reduced or repealed, our business and results of operations could suffer.

Pursuant to the applicable tax laws in China, companies established in China are generally subject to a state and local enterprise income tax, or EIT, at statutory rates of 30% and 3% respectively. Under current PRC rules and policies, an enterprise qualified as a “high and new technology enterprise” located in the Beijing New Industry Development Pilot Zone is entitled to a preferential EIT rate of 15% and is further entitled to a three-year EIT exemption from either its first year of operation or, if it is incorporated in the second half of a calendar year, its second year of operation if so selected, and a 50% reduction of its applicable EIT rate for the succeeding three years. VanceInfo Beijing, Prosoft and ITC are currently qualified as “high and new technology enterprises” located in the Beijing New Industry Development Pilot Zone, and enjoying preferential tax treatment as a result of this status. VanceInfo Beijing was incorporated in the second half of 2004, and has elected to be exempted from EIT from 2005 to 2007 and be subject to a 7.5% EIT rate from 2008 to 2010. Prosoft and ITC were both incorporated in June 2004, and have been entitled to be exempted from EIT from 2004 to 2006 and be subject to a 7.5% EIT rate from 2007 to 2009. In addition, under the current PRC rules and policies, an enterprise qualified as a “software enterprise” is entitled to an exemption from EIT for the first two profitable years and a 50% reduction of its applicable EIT rate for the subsequent three years. Shanghai Solutions, one of our subsidiaries, was incorporated in 2002 and was recognized as a “software enterprise” in 2003, therefore, it was entitled to be exempted from EIT in 2003 and 2004, and has been subject to a 16.5% EIT rate from 2005 to 2007. Furthermore, Shanghai Solutions was recognized as a “key software enterprise under the State plan” in 2006, which entitled it to a 10% preferential income tax rate in 2007. However, all the above qualifications are subject to an annual assessment by the relevant government authority in China. There is no assurance that our subsidiaries will continue to meet the qualifications or that the relevant government authority will not revoke the company’s “high and new technology enterprise,” “software enterprise” or “key software enterprise under the State plan” statuses.

On March 16, 2007, the National People’s Congress of China enacted a new EIT law, under which foreign invested enterprises, or FIEs, such as VanceInfo Beijing, and Chinese domestic companies would be subject to EIT at a uniform rate of 25%. Preferential tax treatments will continue to be granted to entities that are classified as “high and new technology enterprises strongly supported by the State” or that conduct business in encouraged

 

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sectors, whether FIEs or domestic companies. The new tax law will become effective on January 1, 2008. Under the new tax law, enterprises that had been established and already enjoyed preferential tax treatment prior to March 16, 2007 will continue to enjoy it subject to the following qualifications: (i) in the case of preferential tax rates, for a period of five years from January 1, 2008, or (ii) in the case of a preferential tax exemption or reduction for a specified term, until the expiration of such term. The new tax law does not define “high and new technology enterprises strongly supported by the State,” nor does it specify which encouraged sectors will be eligible for preferential tax treatment. Because the detailed implementing rules for the new tax law have not yet been promulgated, we cannot assure you that VanceInfo Beijing, Prosoft, ITC and Shanghai Solutions will be classified as “high and new technology enterprises strongly supported by the State” or an enterprise that conducts business in encouraged sectors, and therefore will be able to enjoy a preferential EIT rate after the transition period expires. Moreover, under the new tax law, enterprises organized under the laws of jurisdictions outside China with their de facto management bodies located within China may be considered PRC resident enterprises and thus subject to PRC enterprise income tax at the rate of 25% on their worldwide income. The new tax law does not define the term “de facto management bodies.” If a majority of the members of our management team continue to be located in China after the effective date of the new tax law, we may be considered a PRC resident enterprise and therefore subject to PRC enterprise income tax at the rate of 25% on our worldwide income.

In addition, pursuant to relevant tax rules, each of VanceInfo Beijing, Prosoft, ITC, Shanghai Solutions, and our variable interest entity, Shanghai Megainfo Tech Co., Ltd., or Megainfo, is exempt from business tax with respect to the software development business and related technology consultancy services that it engages in, which falls within the definition of technology development business. Expiration of, or changes to, these tax benefits or treatments will have a material adverse effect on our operating results.

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

The vast majority of our employees are Chinese nationals. Some of our projects require a portion of the work to be undertaken at our clients’ facilities which are sometimes located outside China. The ability of our professionals to work in the United States, Europe, Japan and other countries outside China depends on their ability to obtain the necessary visas and work permits. Immigration laws in the United States and in other countries are subject to legislative change, as well as to variations in standards of application and enforcement due to political forces and economic conditions. It is difficult to predict the political and economic events that could affect immigration laws, or the restrictive impact they could have on obtaining or monitoring business visas for our employees. Our reliance on visas for a number of employees makes us vulnerable to such changes and variations as it affects our ability to staff projects with professionals who are not citizens of the country where the work is to be performed. As a result, we may not be able to obtain a sufficient number of visas for our employees or we may encounter delays or additional costs in obtaining or maintaining such visas.

We control Megainfo through contractual arrangements rather than direct legal ownership. If Megainfo or its shareholder breaches the contractual arrangements, we would have to rely on legal remedies under PRC law, which may not be available or effective, to enforce our rights.

We have no legal ownership interest in Megainfo. VanceInfo Beijing’s contractual arrangements with Megainfo and its shareholder provide us with effective control over Megainfo. See “Related Party Transactions—Contractual Arrangements with Megainfo and Its Shareholder.” Although we have been advised by Jun He Law Offices, our PRC legal counsel, that each contract under VanceInfo Beijing’s contractual arrangements with Megainfo and its shareholder is valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing us with control over Megainfo as direct legal ownership of Megainfo. In addition, Megainfo or its shareholder may breach the contractual arrangements. In any such event, we would have to rely on legal remedies under PRC law to enforce our rights. These remedies

 

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may not always be available or effective, particularly in light of the uncertainties in the PRC legal system. See “Risk Factors—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely affect us.”

Our corporate actions are substantially controlled by our principal shareholders, who can cause us to take actions in ways you may not agree with.

After this offering, our principal shareholders and their affiliated entities will own approximately 67.7% of our outstanding ordinary shares and voting power. These shareholders, acting individually or as a group, could exert control and substantial influence over matters such as electing directors and approving acquisitions, mergers or other business combination transactions. This concentration of ownership and voting power may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who purchase shares in this offering.

Risks Related to Doing Business in China

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our services and materially and adversely affect our competitive position.

Substantially all of our business operations are currently conducted in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. Since the late 1970s, the PRC government has been reforming the economic system in China. These reforms have resulted in significant economic growth. However, we cannot predict the future direction of economic reforms or the effects such measures may have on our business, financial position or results of operations. Furthermore, while the economy of China has experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. Any adverse change in the economic conditions in China, in policies of the PRC government or in laws and regulations in China, could have a material adverse effect on the overall economic growth of China and market demand for our IT services. Such developments could adversely affect our businesses, lead to reduction in demand for our services and adversely affect our competitive position.

Uncertainties with respect to the PRC legal system could adversely affect us.

We are a holding company, and we conduct our business primarily through our subsidiaries incorporated in China. The PRC legal system is based on written statutes. 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. However, since 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 involve uncertainties, which may limit legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

We rely principally on dividends and other distributions from our PRC subsidiaries for our cash needs, and limitations on the ability of our PRC subsidiaries and variable interest entity to make distributions to us could have a material adverse effect on our cash flows and our ability to conduct our business.

We rely on dividends and other distributions from our PRC subsidiaries for our cash needs, including the funds necessary to pay dividends and other cash distributions, if any, to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends and other distributions by entities organized

 

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in China is subject to limitations. Regulations in the PRC currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Our PRC subsidiaries are also required to set aside at least 10% of their respective after-tax profits based on PRC accounting standards each year in their general reserves until the accumulative amount of such reserves reach 50% of each subsidiary’s respective registered capital. These reserves are not distributable as cash dividends. Our PRC subsidiaries are also required to allocate a portion of their respective after-tax profits, as determined by its board of directors, to their staff welfare and bonus funds, which may not be distributed to equity owners. In addition, if our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us. Limitations on the ability of our PRC subsidiaries to pay dividends or make other distributions to us could adversely affect our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.

Under current PRC tax law, dividend payments to us made by our direct PRC subsidiary, VanceInfo Beijing, are exempt from PRC withholding tax. Pursuant to the new PRC enterprise income tax law to be effective on January 1, 2008, however, dividends payable by our PRC subsidiary will be subject to a 20% withholding tax, unless the Cayman Islands has a tax treaty with China that provides for a different withholding arrangement. The Cayman Islands, where we are incorporated, does not have such a tax treaty with China. Although the new tax law contemplates the possibility of exemptions from withholding taxes for China-sourced income of FIEs, the PRC tax authorities have not promulgated any related implementation rules and it remains unclear whether we would be able to obtain exemptions from PRC withholding taxes for dividends distributed by our PRC subsidiary to us.

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

A substantial portion of our revenues and expenses are denominated in Renminbi. If our revenues denominated in Renminbi increase or expenses denominated in Renminbi decrease in the future, we may need to convert a portion of our revenues into other currencies to meet our foreign currency obligations, including, among others, payment of dividends declared, if any, in respect of our ordinary shares or ADSs. Under China’s existing foreign exchange regulations, VanceInfo Beijing is able to pay dividends in foreign currencies, without prior approval from the State Administration of Foreign Exchange, or the SAFE, by complying with certain procedural requirements. However, we cannot assure you that the PRC government will not take further measures in the future to restrict access to foreign currencies for current account transactions.

Foreign exchange transactions by our PRC subsidiaries under capital accounts continue to be subject to significant foreign exchange controls and require the approval of, or registration with, PRC governmental authorities. In particular, if our PRC subsidiaries borrow foreign currency loans from us or other foreign lenders, these loans must be registered with or approved by the SAFE, and if we finance them by means of additional capital contributions using, for instance, proceeds from this offering, these capital contributions must be approved or registered by certain government authorities including the SAFE, the Ministry of Commerce or their local counterparts. These limitations could affect the ability of our PRC subsidiaries to obtain foreign exchange through debt or equity financing, and could affect our business and financial condition.

If we are required to obtain the prior approval of the China Securities Regulatory Commission, or CSRC, of the listing and trading of our ADSs on the New York Stock Exchange this offering could be delayed until we obtain the approval.

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for

 

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Industry and Commerce, the CSRC and the SAFE, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which became effective on September 8, 2006.

This regulation, among other things, includes provisions that purport to require that an offshore special purpose vehicle formed for the purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange.

On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures require the filing of a number of documents with the CSRC and it would take several months to complete the approval process.

The application of this new PRC regulation remains unclear with no consensus currently existing among leading PRC law firms regarding the scope of the applicability of the CSRC approval requirement.

Our PRC counsel, Jun He Law Offices, has advised us that, based on their understanding of the current PRC laws and regulations as well as the procedures announced on September 21, 2006:

 

   

The CSRC currently has not issued any definitive rule or interpretation concerning whether offerings like ours under this prospectus are subject to this new procedure;

 

   

In spite of the above, given that we have completed our restructuring before September 8, 2006, the effective date of the new regulation, this regulation does not require an application to be submitted to the CSRC for its approval of the issuance and sale of our ADSs and ordinary shares, or the listing and trading of our ADSs on the New York Stock Exchange; and

 

   

The issuance and sale of our ADSs and ordinary shares and the listing and trading of the ADSs on the New York Stock Exchange do not conflict with or violate this new PRC regulation.

If the CSRC requires that we obtain its approval prior to the completion of this offering, this offering will be delayed until we obtain CSRC approval, which may take several months. If prior CSRC approval is required but not obtained, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this offering into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur.

Also, if the CSRC subsequently requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our ADSs.

Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders and beneficial owners to personal liability and limit our ability to inject capital into our PRC subsidiary, limit our subsidiary’s ability to increase its registered capital, distribute profits to us, or otherwise adversely affect us.

On October 21, 2005, the SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special

 

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Purpose Companies, or Notice 75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity interests in an onshore enterprise located in the PRC, or offshore special purpose company. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore special purpose company or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore special purpose company. Moreover, Notice 75 applies retroactively. As a result, PRC residents who have established or acquired control of offshore special purpose companies that have made onshore investments in the PRC in the past are required to have completed the relevant registration procedures with the local SAFE branch by March 31, 2006. To further clarify the implementation of Circular 75, the SAFE issued Circular 106 on May 29, 2007. Under Circular 106, PRC subsidiaries of an offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore holding company’s shareholders or beneficial owners who are PRC residents in a timely manner. If these shareholders or beneficial owners fail to comply, the PRC subsidiaries are required to report to the local SAFE branches.

We have already urged our shareholders and beneficial owners who are PRC residents to make the necessary applications and filings as required under Notice 75 and other related rules. However, due to uncertainty concerning the reconciliation of Notice 75 with other approval or registration requirements, it remains unclear how Notice 75, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. We will attempt to comply, and attempt to ensure that our shareholders and beneficial owners who are subject to these rules comply, with the relevant requirements. However, we cannot provide any assurances that all of our shareholders and beneficial owners who are PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by Notice 75 or other related rules. In addition, certain of the holders of options to purchase our ordinary shares are PRC residents. Our PRC counsel, Jun He Law Offices, has advised us that it is unclear under Notice 75 whether these optionholders would be deemed to be beneficial owners of our company for purposes of Notice 75 as a result of holding these options. We are currently in the process of confirming the beneficial ownership status of these optionholders with the SAFE. The failure or inability of our PRC resident shareholders or beneficial owners to make any required registrations or comply with other requirements may subject such shareholders or beneficial owners to fines and legal sanctions and may also limit our ability to contribute additional capital into or provide loans to (including using the proceeds from this offering) our PRC subsidiary, VanceInfo Beijing, limit VanceInfo Beijing’s ability to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us.

Risks Related to Our ADSs and This Offering

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

Prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. Our ADSs have been approved for listing on the New York Stock Exchange. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

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

The market price for our ADSs may be volatile.

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

 

   

actual or anticipated fluctuations in our quarterly operating results;

 

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changes in financial estimates by securities research analysts;

 

   

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

 

   

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

 

   

technological breakthroughs in the IT services industry;

 

   

potential litigation or administrative investigations;

 

   

addition or departure of key personnel;

 

   

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

 

   

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

 

   

general market conditions or other developments affecting us or our industry.

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

You will experience immediate and substantial dilution in the net tangible book value of ADSs purchased.

The initial public offering price per ADSs will be substantially higher than the net tangible book value per ADS prior to the offering. Consequently, when you purchase ADSs in the offering at an assumed initial public offering price of US$8.50, you will incur immediate dilution of US$6.06 per ADS. See “Dilution.” In addition, you may experience further dilution to the extent that additional ordinary shares are issued upon the exercise of outstanding options or options we may grant from time to time.

We may need additional capital and may sell additional ADSs or other equity securities or incur indebtedness, which could result in additional dilution to our shareholders or increase our debt service obligations.

We believe that our current cash and cash equivalents, anticipated cash flow from operations and the proceeds from this offering will be sufficient to meet our anticipated cash needs for the foreseeable future. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

Substantial future sales of our ADSs in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.

Additional sales of our ordinary shares or ADSs in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon completion of this offering, we will have 36,051,407 ordinary shares outstanding. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, or the Securities Act. The remaining ordinary shares outstanding after this offering will be available for sale, upon the expiration of the 180-day lock-up period beginning from the closing of this offering, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act. Any or all of these shares may be released prior to expiration

 

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of the lock-up period at the discretion of the lead underwriters for this offering. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

In addition, certain holders of our ordinary shares after the completion of this offering will, upon the expiration of the lock-up period, have the right to cause us to register the sale of those shares under the Securities Act. 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 ADSs to decline.

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

Except as described in this prospectus and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.

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

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

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

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

You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited, because we are incorporated under Cayman Islands law, conduct substantially all of our operations in China and most of our officers and directors reside outside the United States.

We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our subsidiaries in China. Most of our officers and directors reside outside the United States and some or all of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for you to bring an original action against us or against these individuals in a Cayman Islands or China court in the event that you believe that your rights have been infringed under United States federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of

 

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China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law, Cap. 22 (Law 3 of 1961, as consolidated and revised) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws in comparison to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

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

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

We do not expect to be a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2007. However, the application of the PFIC rules is subject to ambiguity in several respects, and, in addition, we must make a separate determination each taxable year as to whether we are a PFIC (after the close of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2007 or any future taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if either (1) at least 75% of its gross income is passive income or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. The market value of our assets will generally be determined based on the market price of our ADSs and ordinary shares, which is likely to fluctuate after this offering. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raise in this offering. If we are treated as a PFIC for any taxable year during which a U.S. person holds an ADS or an ordinary share, certain adverse U.S. federal income tax consequences could apply to such U.S. person. See “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

We will incur increased costs as a result of being a public company.

As a public company, we will incur significantly higher legal, accounting and other expenses than we did as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the SEC and the New York Stock Exchange, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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Forward-Looking Statements

This prospectus contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include:

 

   

our expansion plans;

 

   

our anticipated growth strategy;

 

   

our plans to recruit more employees;

 

   

our plans to invest in research and development to enhance our service lines;

 

   

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

 

   

expected changes in our net revenues and certain cost or expense items;

 

   

our ability to attract and retain clients; and

 

   

trends and competition in the offshore IT services industry.

You should read thoroughly this prospectus with the understanding that our actual future results may be materially different from and/or worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this prospectus include additional factors which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

This prospectus also contains estimates, projections and statistical data related to the IT services market in several countries, including China. This market data, including data from IDC, Gartner Inc., or Gartner, a leading independent market research firm, and neoIT, an independent consulting firm, speaks as of the date it was published and includes projections that are based on a number of assumptions and are not representations of fact. The IT services market may not grow at the rates projected by the market data, or at all. The failure of the market to grow at the projected rates may materially and adversely affect our business and the market price of our ADSs. In addition, the rapidly changing nature of the IT services market subjects any projections or estimates relating to the growth prospects or future condition of our market to significant uncertainties. If any one or more of the assumptions underlying the market data proves to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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Use of Proceeds

We estimate that we will receive net proceeds from this offering of approximately US$45.8 million, or approximately US$54.9 million if the underwriters exercise in full their option to purchase additional ADSs, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. These estimates are based upon an assumed initial public offering price of US$8.50 per ADS, the midpoint of the range shown on the front cover page of this prospectus. We will not receive any of the proceeds from the sale of ADSs by the selling shareholders. A US$1.00 increase (decrease) in the assumed initial public offering price of US$8.50 per ADS would increase (decrease) the net proceeds of this offering by US$5.9 million, assuming the sale of 6,300,000 ADSs at US$8.50 per ADS, the midpoint of the range shown on the front cover page of this prospectus and after deducting underwriting discounts and commissions and the estimated offering expenses payable by us.

The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees by providing them with equity incentives, and obtain additional capital. We intend to use the net proceeds we receive from this offering for general corporate purposes, including capital expenditures, such as in connection with establishing new offices to expand our delivery platform, and funding possible future strategic acquisitions.

The foregoing represents our current intentions to use and allocate the net proceeds of this offering based upon our present plans and business conditions. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus.

Pending use of the net proceeds, we intend to hold our net proceeds in demand deposit accounts or invest them in interest-bearing government securities.

 

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Dividend Policy

In 2006, we declared and paid a dividend of US$0.3 million in the aggregate to Button Software Ltd., or Button, a principal holder of our ordinary shares controlled by members of our management, in recognition of the performance of our management. We treated this dividend as a bonus to members of our management and recognized it as part of our general and administrative expenses for the year ended December 31, 2005.

We have not declared or paid any other dividend. We have no present plan to declare or pay any dividends on our ordinary shares or ADSs in the near future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

We are a holding company incorporated in the Cayman Islands. We rely on dividends from our subsidiaries in China. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, our subsidiary in China is required to set aside a certain amount of its accumulated after-tax profits each year, if any, to fund certain statutory reserves. These reserves may not be distributed as cash dividends. Further, if our subsidiary in China incurs debt on its own behalf, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us.

Our board of directors has complete discretion as to whether to distribute dividends, subject, in certain cases, to the approval of our shareholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders to the same extent as if they were holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

 

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Capitalization

The following table sets forth our warrants and capitalization as of June 30, 2007:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect (i) the automatic conversion of all of our outstanding Series A, Series B-1 and Series B-2 preferred shares into ordinary shares immediately upon the closing of this offering; (ii) the issuance of Series B-3 preferred shares in November 2007 upon the exercise of some of our warrants; (iii) the issuance of Series B-3 preferred shares upon the exercise of our currently outstanding warrants immediately upon the closing of this offering; and (iv) the automatic conversion of all of our Series B-3 preferred shares issued and issuable pursuant to (ii) and (iii) above into ordinary shares immediately upon the closing of this offering; and

 

   

on a pro forma as adjusted basis to give effect to the sale of 6,300,000 ordinary shares in the form of ADSs by us in this offering at an assumed initial public offering price of US$8.50 per ADS, the midpoint of the estimated range of the initial public offering price shown on the front cover of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of June 30, 2007
     Actual    Pro forma    Pro forma
as adjusted(1)
     ( in $ thousands)

Warrants

   1,030      
              

Series A convertible redeemable preferred shares
$0.001 par value, 7,145,000 shares authorized, issued and outstanding, actual; and nil pro forma

   8,127      

Series B-1 convertible redeemable preferred shares
$0.001 par value, 2,990,000 shares authorized, issued and outstanding, actual; and nil pro forma

   6,246      

Series B-2 convertible redeemable preferred shares
$0.001 par value, 6,380,188 shares authorized, issued and outstanding, actual; and nil pro forma

   17,565      

Shareholders’ equity:

        

Ordinary shares $0.001 par value, 70,000,000 shares authorized and 10,671,586 shares issued and outstanding as of, actual; 29,443,424, pro forma; and 35,743,424, as adjusted

   11    29    36

Additional paid-in capital

   7,149    41,860    87,655

Statutory reserve

   55    55    55

Accumulated other comprehensive income

   1,052    1,052    1,052

Retained earnings

   3,593    3,593    3,593
              

Total shareholders’ equity(2)

   11,860    46,589    92,391
              

Total capitalization(2)

   43,798    46,589    92,391
              

 

(1)   The as adjusted information discussed above is illustrative only. Our additional paid-in capital, total shareholders’ equity (deficit) and total capitalization following the completion of this offering are subject to adjustment based on the actual initial public offering price and other terms of this offering determined at pricing. The pro forma information as adjusted excludes the issuance of 307,983 ordinary shares in July 2007 in connection with the Chosen acquisition. Should those shares be included, the ordinary shares outstanding as adjusted will be 36,051,407.
(2)   Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and commissions and the estimated offering expenses payable by us, a US$1.00 increase (decrease) in the assumed initial public offering price of US$8.50 per ADS would increase (decrease) each of additional paid-in capital, total shareholders’ equity and total capitalization by US$5.9 million.

 

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Dilution

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share of our ADSs is substantially in excess of the pro forma net tangible book value per ordinary share. Our pro forma net tangible book value as of June 30, 2007 was approximately US$1.41 per share and US$1.41 per ADS. Net tangible book value per share represents the amount of total tangible assets, minus the amount of total liabilities, divided by the total number of ordinary shares outstanding. Dilution is determined by subtracting pro forma net tangible book value per ordinary share, after giving effect to the conversion of our Series A, Series B-1, Series B-2 and Series B-3 preferred shares into ordinary shares immediately upon the closing of this offering, the exercise of the outstanding warrants to purchase our Series B-3 preferred shares and conversion of these Series B-3 preferred shares into ordinary shares immediately upon the closing of this offering and the additional proceeds we will receive from this offering, from the assumed initial public offering price per ordinary share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

Without taking into account any other changes in such net tangible book value after June 30, 2007, other than to give effect to our sale of ADSs offered in this offering at the initial public offering price of US$8.50 per ADS after deduction of underwriting discounts and commissions and estimated offering expenses payable by us and the exercise of all of our outstanding warrants and conversion of all of our outstanding preferred shares into ordinary shares upon the closing of this offering, our adjusted net tangible book value as of June 30, 2007 would have been US$2.44 per outstanding ordinary share, including ordinary shares underlying our outstanding ADSs, or US$2.44 per ADS. This represents an immediate increase in net tangible book value of US$1.03 per ordinary share, or US$1.03 per ADS, to existing shareholders and an immediate dilution in net tangible book value of US$6.06 per ordinary share, or US$6.06 per ADS, to purchasers of ADSs in this offering.

The following table illustrates such dilution on a per ordinary share and per ADS basis:

 

Assumed initial public offering price per ordinary share

   US$8.50

Assumed initial public offering price per ADS

   US$8.50

Net tangible book value per ordinary share as of June 30, 2007

   US$3.72

Pro forma net tangible book value per ordinary share as of June 30, 2007, assuming exercise of all outstanding warrants and conversion of all outstanding preferred shares into ordinary shares upon the completion of this offering

  


US$1.41

Increase in net tangible book value per ordinary share attributable to price paid by you and other new investors in this offering

  

US$1.03

Pro forma as adjusted net tangible book value per ordinary share after giving effect to this offering(1)

  

US$2.44

    

Dilution in net tangible book value per ordinary share to new investors in the offering

   US$6.06
    

Dilution in net tangible book value per ADS to new investors in the offering

   US$6.06
    
 
  (1)   The pro forma as adjusted information excludes the issuance of 307,983 ordinary shares in July 2007 related to the Chosen acquisition. Should these shares be included, the ordinary shares as adjusted will be 36,051,407 and pro forma as adjusted net tangible book value per share will be US$2.42.

A US$1.00 increase (decrease) in the assumed public offering price of US$8.50 per ADS would increase (decrease) our pro forma net tangible book value after giving effect to the offering by US$5.9 million, the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by US$0.16 per

 

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ordinary share and per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by US$0.84 per ordinary share and per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses. The pro forma information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

The following table summarizes, on a pro forma basis as of June 30, 2007, the differences between the shareholders as of June 30, 2007 and the new investors with respect to the number of ordinary shares purchased from us, the total consideration paid and the average price per ordinary share paid at an assumed initial public offering price of US$8.50 per ADS before deducting estimated underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include 1,147,500 ADSs issuable pursuant to the exercise of the over-allotment option granted to the underwriters.

 

     Ordinary shares
Purchased
    Total Consideration     Average
Price Per
Ordinary
Share
   Average
Price Per
ADS
     Number     Percent     Amount    Percent       
     (in thousands)

Existing shareholders

   29,443,424 (1)   82.4 %   $39,851    42.7 %   $1.35    $1.35

New investors

   6,300,000     17.6     53,550    57.3     8.50    8.50
                                

Total

   35,743,424     100.0 %   $93,401    100.0 %   $2.61    $2.61
                                

 

(1)   Reflects (i) the automatic conversion of all of our outstanding Series A, Series B-1 and Series B-2 preferred shares into ordinary shares immediately upon the closing of this offering; (ii) the issuance of Series B-3 preferred shares in November 2007 upon the exercise of some of our warrants; (iii) the issuance of Series B-3 preferred shares upon the exercise of our currently outstanding warrants immediately upon the closing of this offering; and (iv) the automatic conversion of all of our Series B-3 preferred shares issued and issuable pursuant to (ii) and (iii) above into ordinary shares immediately upon the closing of this offering.

A US$1.00 increase (decrease) in the assumed public offering price of US$8.50 per ADS would increase (decrease) total consideration paid by new investors, average price per ordinary share and per ADS paid by all shareholders by US$6,300,000, US$0.18 per ordinary share and US$0.18 per ADS, respectively, assuming sale of 6,300,000 ADSs at US$8.50, the midpoint of the range set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses payable by us.

The discussion and tables above assume no exercise of any outstanding stock options. As of June 30, 2007, there were 4,217,726 ordinary shares issuable upon exercise of outstanding stock options at a weighted average exercise price of US$1.84 per share, and there were 49,774 ordinary shares available for future issuance upon the exercise of future grants under our share incentive plans. To the extent that any of these options are exercised, there will be further dilution to new investors.

In connection with our recent acquisitions of ITC, Megainfo, Chosen, a 75% equity interest in Shanghai Solutions, a 48.99% equity interest in Worksoft Japan and the IT services business of SunBridges, we agreed to make contingent payments of up to US$18.5 million in a mix of cash and our ordinary shares, of which up to US$15.1 million may be paid with cash, up to US$1.6 million may be paid with our ordinary shares, and up to US$1.8 million may be paid with cash, our ordinary shares or a combination thereof at our option; and up to 20,058 of our ordinary shares, in each case subject to the achievement of certain financial targets for 2007 and 2008. See “Corporate History and Structure” for a more detailed description. To the extent that any ordinary shares are issued pursuant to these contingent payment obligations, there will be further dilution to new investors.

 

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Enforceability of Civil Liabilities

We were redomiciled in the Cayman Islands in order to enjoy certain benefits, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of exchange control or currency restrictions, and the availability of professional and support services. However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include a less developed body of Cayman Islands securities laws that provide significantly less protection to investors as compared to the laws of the United States, and the potential lack of standing by Cayman Islands companies to sue before the federal courts of the United States.

Our organizational documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be arbitrated.

Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. A majority of our officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

We have appointed CT Corporation System, 111 Eighth Avenue, New York, NY 10011, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Conyers Dill & Pearman, our counsel as to Cayman Islands law, and Jun He Law Offices, our counsel as to PRC law, have advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

 

   

recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

   

entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

Conyers Dill & Pearman has further advised us that the courts of the Cayman Islands would recognize as a valid judgment, a final and conclusive judgment in personam obtained in the federal or state courts in the United States under which a sum of money is payable (other than a sum of money payable in respect of multiple damages, taxes or other charges of a like nature or in respect of a fine or other penalty) and would give a judgment based thereon provided that (i) such courts had proper jurisdiction over the parties subject to such judgment, (ii) such courts did not contravene the rules of natural justice of the Cayman Islands, (iii) such judgment was not obtained by fraud, (iv) the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands, (v) no new admissible evidence relevant to the action is submitted prior to the rendering of the judgment by the courts of the Cayman Islands, and (vi) there is due compliance with the correct procedures under the laws of the Cayman Islands.

Jun He Law Offices has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other agreements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. So, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

 

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Corporate History and Structure

Corporate History

We commenced operations in 1995 through Wensi Chuangyi, a limited liability company established in China. In 1999 and 2002, two subsidiaries of Wensi Chuangyi, Shanghai Wensi Chuangyi and Wuhan Wensi Chuangyi, were incorporated in China as part of the expansion of our IT services businesses.

Our holding company, VanceInfo, was incorporated under the laws of the British Virgin Islands in April 2004. In July 2004, we formed VanceInfo Beijing, a wholly owned subsidiary of VanceInfo, in China. In August 2004, VanceInfo Beijing acquired the IT services business and related assets of Wensi Chuangyi, including those of Shanghai Wensi Chuangyi and Wuhan Wensi Chuangyi. In October 2005, VanceInfo was redomiciled to the Cayman Islands.

In June and July 2004, we issued an aggregate of 100,000 ordinary shares to Inno Global Technology Limited, Team Dragon International Limited and Button Software Ltd. for US$3.0 million.

In March 2005, we issued in a private placement an aggregate of 7,175,000 shares of Series A preferred shares to LC Fund II, DCM IV, L.P., DCM Affiliates Fund IV, L.P. and Harper Capital for US$7.0 million and certain finance consulting services provided by a shareholder of Harper Capital.

In May 2006, we issued in a private placement an aggregate of 2,990,000 shares of Series B-1 preferred shares and 6,380,188 shares of Series B-2 preferred shares together with certain warrants to acquire Series B-3 preferred shares to Sequoia Capital China I, L.P., Sequoia Capital China Partners Fund I, L.P., Sequoia Capital China Principals Fund I, L.P., Sequoia Capital Growth Fund III, Sequoia Capital Growth Partners III, Sequoia Capital Growth III Principals Fund, LC Fund II, DCM IV, L.P., and DCM Affiliates Fund IV, L.P.. The proceeds we received from this private placement were US$25.1 million.

Since 2005, we have acquired a number of businesses in China. The following are our recent acquisitions:

 

   

In September 2005, we acquired the international business division of SureKAM, a software development outsourcing service provider, for a mix of cash consideration of US$0.3 million and 100,000 shares of our ordinary shares.

 

   

In December 2005, we acquired the IT services business of Envisys System Co., Ltd., or Envisys, for a mix of cash consideration of US$0.2 million and 86,219 shares of our ordinary shares.

 

   

In September 2006, we acquired 100% of the equity interest in Prosoft, an IT service provider primarily focusing on R&D services, from Shenzhen Yun Gong Investment Co., Ltd., Ms. Hong Zhang, Mr. Wei Chen, Mr. Li Ma and Ms. Lin Zhao, for initial cash consideration of RMB5.0 million (US$0.7 million). Additional consideration of RMB3.9 million (US$0.5 million) in cash and 155,901 shares of our ordinary shares was paid in April 2007.

 

   

In December 2006, we acquired the IT services business of Beijing SunBridges Technologies Development Co., Ltd., or SunBridges, for initial cash consideration of RMB1.5 million (US$0.2 million). Additional contingent consideration of RMB0.8 million (US$0.1 million) in cash and 2,331 shares of our ordinary shares was paid in April 2007. We are obligated to pay additional contingent consideration of up to 20,058 shares of our ordinary shares based on defined gross margin target of the SunBridges for the year ending December 31, 2007.

 

   

In March 2007, we acquired ITC, an IT service provider primarily focusing on R&D services, from Mr. Hao Yu and Mr. Wei Wei for initial consideration of 793,548 shares of our ordinary shares. We paid additional cash consideration of RMB26 million (US$3.4 million) in September 2007. We are still obligated to pay additional contingent consideration of up to RMB8.7 million (US$1.1 million) in cash based on the net profit of ITC for the year ending December 31, 2007.

 

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In March 2007, we entered into certain contractual arrangements with Megainfo through which we gained effective control over the operations of Megainfo for initial consideration of RMB6.0 million (US$0.8 million) in cash and 147,272 shares of our ordinary shares. We are obligated to pay additional consideration of up to RMB49.1 million (US$6.4 million) in a mix of cash and our ordinary shares, of which up to RMB6.8 million (US$0.9 million) may be paid with our ordinary share, based on the net profit of Megainfo for the 12-month period ending March 31, 2008.

 

   

In May 2007, we acquired a 75% of equity interest in Shanghai Solutions, an IT service provider primarily focusing on ADM services, from Mr. Zhang Jilun and Mr. Shi Rongbin for initial consideration of 913,393 shares of our ordinary shares. We are obligated to pay additional contingent consideration of up to RMB7.4 million (US$1.0 million) in cash, our ordinary shares or a combination thereof at our option, based on the net profit of Shanghai Solutions for the year ending December 31, 2007.

 

   

In May 2007, we acquired an additional 48.99% of the equity interest of Worksoft Japan Inc., or Worksoft Japan, from Mr. Tang Jinsong for initial consideration of US$0.1 million in cash and 49,141 shares of our ordinary shares. We are obligated to pay additional contingent consideration of up to Japanese Yen 14.9 million (US$0.1 million) in cash and our ordinary shares with a value of up to Japanese Yen 22.4 million (US$0.2 million) based on the net profit of Worksoft Japan for the 12-month period ending May 31, 2008.

 

   

In July 2007, we acquired Chosen, an IT service provider primarily focusing on SAP consulting and implementation services, from Mr. Li Gang, Mr. Liu Tong and Mr. Huang Bin for initial consideration of US$0.9 million in cash and 307,983 of our ordinary shares. We are obligated to pay additional contingent consideration of up to RMB40.3 million (US$5.3 million) in cash and our ordinary shares with a value of up to RMB11.0 million (US$1.4 million) based on the net profit of Chosen for the six months ending December 31, 2007 and the year ending December 31, 2008.

 

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Corporate Ownership Structure

The following diagram illustrates our current corporate structure and the place of formation and affiliation of each our subsidiaries and affiliates as of the date of this prospectus, excluding one subsidiary being liquidated. After our acquisitions of Prosoft and ITC, we started the liquidation of their respective subsidiaries to streamline our corporate structure. As of the date of this prospectus, the administrative procedures for the liquidation of one of these subsidiaries has not been completed yet.

LOGO

 

LOGO

LOGO

   Beneficial Interest
  

 

Contractual Arrangements

 


 

(1)   VanceInfo Creative Software Technology Ltd., or VanceInfo Beijing, 100% owned by VanceInfo.
(2)   Beijing Prosoft Technology Co., Ltd., or Prosoft, a Chinese limited liability company, 100% owned by VanceInfo Beijing.
(3)   Beijing Innovation Technology Co., Ltd., or ITC, a Chinese limited liability company, 100% owned by VanceInfo Beijing.
(4)   Shanghai Megainfo Tech Co., Ltd., or Megainfo, a Chinese limited liability company, 100% owned by Mr. Ming Zhao. VanceInfo Beijing has entered into contractual arrangements with Megainfo and Mr. Ming Zhao through which, we have the ability to effectively control Megainfo’s daily operations and financial affairs, appoint senior executives and approve all matters subject to shareholders’ approval and receive substantially all the economic benefits of Megainfo. See “Related Party Transactions” for a description of these contractual arrangements. As a result of these contractual arrangements, we are considered to be the primary beneficiary of Megainfo and Megainfo is a variable interest entity, or VIE, of our company under U.S. GAAP.
(5)   Shanghai Solutions Software Co., Ltd., or Shanghai Solutions, a Chinese limited liability company, 75% owned by VanceInfo Beijing, 10% owned by Mr. Jilun Zhang, a Chinese citizen, 5% owned by Mr. Rongbin Shi, a Chinese citizen, and 10% owned by NEC System Technologies Ltd., a Japanese company.
(6)   Worksoft Japan Inc., or Worksoft Japan, has 1,400,000 outstanding shares, with 1,399,900 shares owned by VanceInfo, 100 shares owned by Mr. Xiaolai Wang, a Chinese citizen.
(7)   VanceInfo Technologies Inc., formerly named Worksoft Creative Software Technology Inc., a corporation incorporated under the laws of the State of Delaware in the United States, 100% owned by VanceInfo.
(8)   VanceInfo Creative Software Technology Ltd., formerly named Worksoft Creative Software Technology Ltd., a holding company incorporated the laws of the British Virgin Islands, 100% owned by VanceInfo.
(9)   VanceInfo Technologies Limited, formerly named Worksoft Information Technology Service Ltd., a company incorporated the laws of Hong Kong, 100% owned by Worksoft BVI.
(10)   Beijing Chosen Technology Co., Ltd., or Chosen, a Chinese limited liability company, 100% owned by VanceInfo Beijing.
(11)   VanceInfo Information Technology Limited, a Chinese Limited liability company, 100% owned by VanceInfo Technologies Limited.

 

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Recent Developments

The following is a summary of our selected unaudited consolidated financial results for the three months ended September 30, 2007 compared to our selected unaudited consolidated financial results for the three months ended September 30, 2006 and June 30, 2007, respectively. Results for the third quarter of 2007 may not be indicative of our full year results for the year ending December 31, 2007 or future quarterly periods. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus for information regarding trends and other factors that may influence our results of operations and for recent quarterly operating results.

 

     For the Three Months Ended  
    

September 30,

2006

   

June 30,

2007

   

September 30,

2007

 
     (in $ thousands)  

Consolidated Statements of Operations Data

      

Net revenues

   8,109     14,963     18,048  

Cost of revenues(1)

   (4,812 )   (9,178 )   (11,033 )
                  

Gross profit

   3,297     5,785     7,015  

General and administrative expenses(1)

   (1,650 )   (3,054 )   (3,881 )

Selling and marketing expenses(1)

   (224 )   (496 )   (657 )
                  

Total operating expense

   (1,874 )   (3,550 )   (4,538 )
                  

Government subsidies

   2     20     118  

Income from operations

   1,425     2,255     2,595  

Interest income

   171     219     218  

Interest expense

           (20 )

Exchange differences

   (57 )   (120 )   325  

Change in fair value of the warrants

   (159 )   (86 )   (230 )
                  

Income tax expense

       15     60  

Minority interest in net income of consolidated subsidiary

   (10 )   (12 )   (47 )
                  

Net income

   1,370     2,271     2,901  
                  

Deemed dividend on Series A convertible redeemable preferred shares

   155     162     167  

Income attributable to holder of ordinary shares

   1,215     2,109     2,749  

(1)   Includes share-based compensation expenses as follows:

 

     For the Three Months Ended
     September 30,
2006
  

June 30,

2007

   September 30,
2007
     (in $ thousands)

Share-based compensation included in:

        

Cost of revenues

   12    19    31

General and administrative expenses

   164    207    202

Selling and marketing expenses

   9    10    17

 

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Set forth below is our net revenue breakdown by service lines for the period indicated:

 

     For the Three
Months Ended
September 30, 2007
 
     (in $ thousands,
except percentages)
 

R&D services

   9,769    54.1 %

Enterprise solutions

   3,351    18.6  

ADM

   2,652    14.7  

Quality assurance and testing

   1,273    7.1  

Globalization and localization

   1,003    5.5  
           

Total net revenues

   18,048    100.0 %
           

For the three months ended September 30, 2007, our net revenues increased by 122.6% to US$18.0 million from US$8.1 million for the same period in 2006. The growth in our net revenues was primarily due to an increase in sales volumes, which was due to a US$3.9 million increase in sales to our existing clients as of September 30, 2006, as a result of our enhanced relationships with them, and to US$6.0 million of sales to new clients. The number of our clients increased to 168 for the third quarter of 2007 from 97 for the third quarter of 2006.

We acquired approximately 570 professionals through our acquisitions of the IT service business of SunBridges, ITC, Megainfo, Shanghai Solutions and Chosen in the fourth quarter of 2006 and the nine months ended September 30, 2007. These acquisitions strengthened our service line capabilities and industry expertise, as well as broadened our client base and geographic coverage. We were able to leverage the additional capabilities and expertise to win new projects and to cross-sell our service offerings to our broadened client base. Revenues from these acquired businesses’ client relationships also contributed to our net revenues in the third quarter of 2007 compared to the third quarter of 2006.

For the three months ended September 30, 2007, our cost of revenues increased by 129.3% to US$11.0 million from US$4.8 million for the same period in 2006. The increase was primarily due to a US$3.9 million increase in our professionals’ compensation and benefit expenses as the number of our professionals increased, a US$1.5 million increase in our subcontracting costs due to increases in business volumes and scale of our projects, and a US$0.5 million increase in our professionals’ travel expenses due to the growth of our overseas onsite services and domestic enterprise solutions services.

For the three months ended September 30, 2007, our net revenues increased by 20.6% to US$18.0 million from US$15.0 million for the three months ended June 30, 2007. The growth in our net revenues was primarily due to an increase in sales volumes, which was in turn due to a US$1.3 million increase in sales to our existing clients as of June 30, 2007, as a result of our enhanced relationships with them, and to US$1.7 million of sales to new clients. The number of our clients increased to 168 for the third quarter of 2007 from 142 for the second quarter of 2007. The increase in our net revenues was also attributable to more working days and higher man-hours in the third quarter of 2007 as a result of fewer public holidays in that quarter. In addition, our acquisition of Chosen on July 31, 2007 contributed to the increase in our net revenues in the third quarter of 2007 compared to the previous quarter.

Our cost of revenues for the three months ended September 30, 2007 increased by 20.2%, or US$1.9 million, to US$11.0 million from US$9.2 million in the three months ended June 30, 2007, primarily due to a US$1.0 million increase in our professionals’ compensation and benefit expenses as the number of our professionals increased, and a US$0.9 million increase in our subcontracting costs primarily due to increases in business volumes and scale of our projects. Our acquisition of Chosen in July 2007 added approximately 60 professionals to our company and contributed to the increase in our cost of revenues in the third quarter of 2007 compared to the previous quarter.

 

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For the three months ended September 30, 2007, our total operating expenses were US$4.5 million, compared to total operating expenses of US$1.9 million for the same period in 2006 and total operating expenses of US$3.6 million for the three months ended June 30, 2007. For the third quarter of 2007, our general and administrative expenses were US$3.9 million, which represented increases of US$2.2 million and US$0.8 million compared to our general and administrative expenses in the third quarter of 2006 and the second quarter of 2007, respectively. The increases were primarily due to increased compensation and benefit expenses as we hired more administrative employees to manage our growing business, and increases in our rental expenses as we entered into new leases in Beijing in the third quarter of 2007. For the third quarter of 2007, our selling and marketing expenses were US$0.7 million, which represented a US$0.4 million increase from our selling and marketing expenses in the third quarter of 2006. This increase was primarily due to increases in compensation and benefit expenses for the selling and marketing employees we hired in China and the United States in the fourth quarter of 2006 and the first nine months of 2007, as well as amortization of customer base and relationships and contract backlog acquired from business combinations. Our selling and marketing expenses increased by US$0.2 million in the third quarter of 2007 compared to the previous quarter due primarily to increases in compensation and benefit expenses for our selling and marketing employees in the United States in the third quarter of 2007.

In the third quarter of 2007, we were granted US$0.1 million of government subsidies, compared to government subsidies of US$2,000 in the same period in 2006 and US$20,000 in the second quarter of 2007. The increase in our government subsidies in the third quarter of 2007 was primarily due to a grant by Zhongguancun Software Park for our internal process management system.

In the third quarter of 2007, we recorded foreign exchange gains of US$0.3 million, compared to foreign exchange losses of US$57,000 in the same period in 2006 and US$0.1 million in the second quarter of 2007. Our foreign exchange gains in the third quarter of 2007 were primarily due to the appreciation of the Japanese Yen against the RMB.

As a result of the foregoing, we had net income of US$2.9 million for the three months ended September 30, 2007, compared to net income of US$1.4 million for the same period in 2006 and US$2.3 million for the second quarter of 2007.

As of September 30, 2007, we had US$16.8 million in cash and cash equivalents. Our accrued expenses and other current liabilities increased to approximately US$9.3 million as of September 30, 2007 from approximately US$7.8 million as of June 30, 2007, primarily as the result of a US$1.2 million short-term bank loan that one of our subsidiaries borrowed in August 2007. As of September 30, 2007, our accounts receivable were US$21.8 million, of which 51.5% was attributable to our top five clients for the three months ended September 30, 2007. Our days of sales outstanding in the third quarter of 2007 were 98 days. We define our days of sales outstanding as the ratio of the average accounts receivable to revenues in a year, multiplied by 365. We establish an allowance for doubtful accounts based upon estimates, historical experience and other factors surrounding the credit risk of specific clients. As of September 30, 2007, the provision for doubtful accounts was US$302,000.

 

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Selected Consolidated Financial Data

You should read the following information in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

We were incorporated in April 2004 and acquired our predecessor, the IT services business of Wensi Chuangyi, in August 2004. The acquisition was accounted for using the purchase accounting method with a new accounting basis. The selected consolidated statement of operations data of our predecessor from January 1, 2004 to August 31, 2004 are presented below.

The following selected consolidated statement of operations data for the years ended December 31, 2005 and 2006 and the consolidated balance sheet data as of December 31, 2005 and 2006 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our selected consolidated statement of operations data for the six months ended June 30, 2006 and 2007 and the consolidated balance sheet data as of June 30, 2007 have been derived from our unaudited financial statements included elsewhere in this prospectus. Our selected consolidated statement of operations data from January 1 to August 31, 2004 have been derived from our unaudited consolidated management accounts which are not included in this prospectus. Our selected consolidated statement of operations data from September 1 to December 31, 2004 and our consolidated balance sheet data as of December 31, 2004 have been derived from our unaudited consolidated financial statements which are not included in this prospectus. We have prepared the unaudited consolidated financial information on the same basis as our audited consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The historical results are not necessarily indicative of results to be expected in any future period.

We have not included financial information for the years ended December 31, 2002 and 2003, as such information is not available on a basis that is consistent with the consolidated financial information for the years ended December 31, 2005 and 2006, and cannot be provided on a U.S. GAAP basis without unreasonable effort or expense.

For a description of our selected unaudited consolidated financial results for the three months ended September 30, 2007, see “Recent Developments.”

 

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    Predecessor     VanceInfo  
    Period from
January 1 to
August 31, 2004
    Period from
September 1 to
December 31, 2004
   

For the Year Ended December 31,

   

For the Six Months

Ended June 30,

 
       

2004

(Combined)(1)

    2005     2006         2006             2007      
    (in $ thousands, except percentage, share, per share and per ADS data)  

Consolidated Statement of Operations Data

             

Net revenues

  4,851     3,312     8,163     15,481     29,051     11,118     25,398  

Cost of revenues(2)

  (2,566 )   (1,980 )   (4,546 )   (9,125 )   (17,961 )   (6,983 )   (15,671 )
                                         

Gross profit

  2,285     1,332     3,617     6,356     11,090     4,135     9,727  
                                         

General and administrative expenses(2)

  (941 )   (1,128 )   (2,069 )   (3,026 )   (6,140 )   (2,356 )   (5,393 )

Selling and marketing expenses(2)

  (70 )   (68 )   (138 )   (270 )   (681 )   (252 )   (780 )
                                         

Total operating expenses

  (1,011 )   (1,196 )   (2,207 )   (3,296 )   (6,821 )   (2,608 )   (6,173 )
                                         

Government subsidies

              102     54     50     21  
                                         

Income from operations

  1,274     136     1,410     3,162     4,323     1,577     3,575  

Interest income

              148     592     163     429  

Interest expense

  (8 )   (13 )   (21 )   (17 )   (4 )        

Exchange differences

              (32 )   (93 )   (3 )   (193 )

Change in fair value of the warrants

                  (405 )   (67 )   (127 )
                                         

Income before income taxes and minority interest

  1,266     123     1,389     3,261     4,413     1,670     3,684  

Income tax expense

  (186 )   (81 )   (267 )   (2 )   (2 )   (1 )   (91 )
                                         

Income before minority interest

  1,080     42     1,122     3,259     4,411     1,669     3,593  

Minority interest in net income of consolidated subsidiary

              (24 )   (35 )   19     (38 )
                                         

Net income

  1,080     42     1,122     3,235     4,376     1,688     3,555  

Deemed dividend on Series A convertible redeemable preferred shares accretion of redemption premium

              (462 )   (611 )   (297 )   (320 )
                                         

Income attributable to holders of ordinary shares

  1,080     42     1,122     2,773     3,765     1,391     3,235  
                                         

Income per share:

             

Basic—ordinary share

      0.00         0.13     0.08     0.04     0.07  

Basic—Series A convertible redeemable preferred share

              0.29     0.24     0.12     0.15  

Basic—Series B-1 convertible redeemable preferred share

                  0.25     0.12     0.16  

Basic—Series B-2 convertible redeemable preferred share

                  0.33     0.16     0.20  

Diluted—ordinary share

      0.00         0.13     0.07     0.04     0.06  

Income per ADS:

             

Basic

             

Diluted

             

Weighted average shares used in calculating net income per share:

             

Basic—ordinary share

      5,169,710         11,530,684     9,605,507     10,513,346     9,759,935  

Basic—Series A convertible redeemable preferred share

              5,838,288     7,175,000     7,175,000     7,164,724  

Basic—Series B-1 convertible redeemable preferred share

                  1,998,795     991,160     2,990,000  

Basic—Series B-2 convertible redeemable preferred share

                  4,265,112     2,114,979     6,380,188  

Diluted—ordinary share

      5,169,710         11,530,684     10,205,449     10,829,887     11,047,626  

Pro forma income per ordinary share(3):

             

Basic

      0.00         0.19     0.20     0.08     0.13  

Diluted

      0.00         0.19     0.19     0.08     0.13  

Other Consolidated Financial Data

             

Gross margin(4)

  47.1 %   40.2 %   44.3 %   41.1 %   38.2 %   37.2 %   38.3 %

Operating margin(5)

  26.3     4.1     17.3     20.4     14.9     14.2     14.1  

Net margin(6)

  22.3     1.3     13.7     20.9     15.1     15.2     14.0  

 

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(1)   The 2004 full-year financial data presented in this section are the combination of the data for the period from January 1 to August 31, 2004 and the period from September 1 to December 31, 2004. This aggregation of the results for certain periods should not be construed as a measure of performance in conformity with U.S. GAAP because:

 

   

the earnings of our predecessor for the period from January 1 to August 31, 2004 have been determined using the historical cost method; and

 

   

the earnings of VanceInfo from September 1 to December 31, 2004 have been determined using the purchase accounting method in accordance with SFAS No. 141.

Nevertheless, although the presentation of the combined full year financial data for the year ended December 31, 2004 is not in accordance with U.S. GAAP, we believe that this combination is useful and can provide users with a more complete understanding of our results of operations from year to year.

 

(2)   Includes share-based compensation expenses as follows:

 

     Predecessor    VanceInfo  
     Period from
January 1 to
August 31, 2004
   Period from
September 1 to
December 31, 2004
   

For the Year Ended
December 31,

   

For the Six Months

Ended June 30

 
         

2004

(Combined)

    2005     2006     2006     2007  
     (in $ thousands)  

Share-based compensation expenses included in:

               

Cost of revenues

                  (45 )   (22 )   (37 )

General and administrative expenses

      (297 )   (297 )   (67 )   (632 )   (308 )   (402 )

Selling and marketing expenses

                  (36 )   (17 )   (20 )

 

(3)   Pro forma basic and diluted net income per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding for the year plus the number of ordinary shares resulting from the assumed exercise of all outstanding warrants and the assumed conversion of the outstanding Series A, Series B-1, Series B-2 and Series B-3 convertible preferred shares upon the closing of this offering.

 

(4)   Gross margin represents gross profit as a percentage of net revenues.

 

(5)   Operating margin represents income from operations as a percentage of net revenues.

 

(6)   Net margin represents net income as a percentage of net revenues.

 

     As of December 31,    As of June 30,
     2004    2005    2006    2007
     (in $ thousands)

Consolidated Balance Sheet Data

           

Cash and cash equivalents

   721    4,437    20,565    15,697

Total assets

   5,853    15,700    42,044    55,282

Total liabilities

   2,382    2,171    5,583    10,841

Series A convertible redeemable preferred shares

      7,226    7,837    8,127

Series B-1 convertible redeemable preferred shares

         6,246    6,246

Series B-2 convertible redeemable preferred shares

         17,565    17,565

Shareholders’ equity

   3,359    6,165    4,640    11,860

Total liabilities, minority interest, convertible redeemable preferred shares and shareholders’ equity

   5,853    15,700    42,044    55,282

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

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

Overview

We are an IT service provider and one of the leading offshore software development companies in China. We deliver a comprehensive range of IT services through our globally integrated network of onsite and offsite delivery locations, primarily in China, to enable our clients to focus on their core competencies and improve operating efficiencies. Our IT services include R&D services, enterprise solutions, ADM, quality assurance and testing, as well as globalization and localization. We provide these services primarily to corporations headquartered in the United States, Europe, Japan and China, targeting high-growth industries such as technology, telecommunications, financial services, manufacturing, retail and distribution. We have a team of over 3,000 professionals as of October 31, 2007 and operate a number of CDCs, and also deliver our services at clients’ facilities or via our offices in major cities across China. Our net revenues grew from US$8.2 million in 2004 to US$29.1 million in 2006, representing a CAGR of 88.6%. Our net income grew from US$1.1 million in 2004 to US$4.4 million in 2006, representing a CAGR of 97.5%. For the six months ended June 30, 2007, we generated net revenues of US$25.4 million and net income of US$3.6 million, representing a 128.5% increase and a 110.6% increase from our net revenues of US$11.1 million and net income of US$1.7 million for the six months ended June 30, 2006, respectively.

Factors Affecting Our Results of Operations

We believe the most significant factors that affect our business and results of operations are:

 

   

the overall economic growth in our principal geographic markets, which may affect market demand for offshore IT services;

 

   

the quality and portfolio of our service lines and industry expertise compared with those of our competitors;

 

   

the billing rates and utilization rates of our professionals, our compensation and benefit expenses and other operating costs and expenses;

 

   

the availability of a large talent pool in China and supply of qualified professionals; and

 

   

the PRC government’s investment in infrastructure construction and adoption of various incentives in the IT services industry.

Our management evaluates our results of operations by examining financial and operating data in a variety of categories, including service lines, clients, geographic markets and delivery locations. We manage and market our business according to our service lines and industry practices. Our IT services include R&D services, enterprise solutions, ADM, quality assurance and testing, as well as globalization and localization. We provide these services primarily to corporations headquartered in the United States, Europe, Japan and China.

Net Revenues

Our net revenues are net of business tax and other sales tax. In recent years, we have experienced rapid growth and significantly expanded our business. Our net revenues grew by 87.7% to US$29.1 million in 2006 from

 

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US$15.5 million in 2005. Our net revenues grew by 128.5% to US$25.4 million in the six months ended June 30, 2007 from US$11.1 million in the six months ended June 30, 2006.

We discuss below the breakdown of our net revenues by service lines, clients, geographic markets and delivery locations.

Net Revenues by Service Lines

We derive net revenues from the provision of our IT services, including R&D services, enterprise solutions, ADM, quality assurance and testing, and globalization and localization.

Set forth below is our net revenue breakdown by service lines for the periods indicated:

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2005     2006     2006     2007  
     (in $ thousands, except percentages)  

R&D services

   9,178    59.3 %   18,266    62.9 %   6,561    59.0 %   15,719    61.9 %

Enterprise solutions

   239    1.5     2,163    7.4     677    6.1     2,259    8.9  

ADM

   1,643    10.6     2,328    8.1     915    8.2     3,206    12.6  

Quality assurance and testing

   1,734    11.2     3,208    11.0     1,462    13.2     2,281    9.0  

Globalization and localization

   2,687    17.4     3,086    10.6     1,503    13.5     1,933    7.6  
                                            

Total net revenues

   15,481    100.0 %   29,051    100.0 %   11,118    100.0 %   25,398    100.0 %
                                            

R&D services have accounted for a majority of our net revenues in recent years. We focus on growing our business in high-margin service lines and service lines that present high-margin potential. For example, our net revenues from enterprise solutions increased significantly from US$0.2 million in 2005 to US$2.2 million in 2006 and from US$0.7 million in the six months ended June 30, 2006 to US$2.3 million in the six months ended June 30, 2007 as we increased our efforts in this service line. Our net revenues from quality assurance and testing and globalization and localization services also increased in absolute numbers, but decreased as a percentage of our total net revenues, as the growth in our net revenues from R&D services and enterprise solutions outpaced the increase in our net revenues from these service lines.

Net Revenues by Clients

We have achieved strong revenue growth by focusing on select, long-term client relationships that we refer to as strategic accounts. Currently, our strategic accounts include Citibank, IBM, Microsoft and TIBCO, and we commenced our relationships with them in 2003, 1995, 1997 and 2005, respectively, and we have steadily expanded our service offerings to these clients since then. Net revenues from these clients grew from US$10.6 million, or 68.2% of our total net revenues, in 2005, to US$19.0 million, or 65.5% of our total net revenues, in 2006. Net revenues from the same clients grew from US$7.6 million, or 68.1% of our total net revenues, in the six months ended June 30, 2006, to US$14.1 million, or 55.6% of our total net revenues, in the six months ended June 30, 2007. Shanghai Solutions, which we acquired in 2007, carried out its first engagement for NEC System Technologies Inc., or NEC System, in 2004, and we have maintained this relationship after the acquisition.

As illustrated in the table below, a significant proportion of our net revenues has been derived from a limited number of clients. Microsoft and IBM, our top two clients, each accounted for over 20% of our net revenues in 2005 and 2006. In the six months ended June 30, 2007, one of these clients accounted for over 20% and the other accounted for over 15% of our net revenues. In the aggregate, these two clients accounted for approximately

 

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57.8%, 53.1% and 40.5% of our net revenues for the years ended December 31, 2005 and 2006 and the six months ended June 30, 2007, respectively. We initially developed relationships with certain divisions of Microsoft and IBM, based on which we have cross-sold our wide range of services to their other departments and regional offices. The increases in net revenues from Microsoft and IBM were primarily attributable to cross-selling and enhanced relationships.

In recent years, we have been diversifying our client base by implementing various initiatives, including adding new strategic accounts, expanding our industry practices and increasing our service lines. The number of our clients increased significantly from 66 for 2004 to 187 for the nine months ended September 30, 2007. The percentage of our net revenues derived from our top five clients decreased from 77.8% in 2005 to 69.3% in 2006 and 59.9% in the six months ended June 30, 2007. The percentage of our net revenues derived from our top ten clients decreased from 83.9% in 2005 to 79.7% in 2006 and to 73.2% in the six months ended June 30, 2007. We expect that this trend toward greater client diversification will continue.

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2005     2006     2006     2007  
    

(in $ thousands, except percentages)

 

Microsoft and IBM

   8,953    57.8 %   15,418    53.1 %   6,047    54.4 %   10,296    40.5 %

Top five clients

   12,037    77.8     20,143    69.3     8,113    73.0     15,226    59.9  

Top 10 clients

   12,993    83.9     23,167    79.7     9,234    83.1     18,585    73.2  

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

Net Revenues by Geographic Markets

We record our net revenues based on the geographic regions in which the headquarters of our clients are located irrespective of the location of the specific client entity which we serve or the locations at which our services are delivered or the invoice is rendered. We classify our net revenues primarily into four geographic markets: the United States, Europe, Japan and China. We typically provide IT services to our clients to enhance and facilitate their operations in China. As the table below illustrates, a significant portion of our net revenues is derived from clients headquartered in the United States.

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2005     2006     2006     2007  
     (in $ thousands, except percentages)  

United States(1)

   13,325    86.1 %   24,717    85.1 %   9,560    86.0 %   19,733    77.7 %

Europe(1)

   337    2.2     714    2.5     336    3.0     1,843    7.3  

Japan(1)

   1,040    6.7     1,548    5.3     672    6.1     1,837    7.2  

China(1)

   718    4.6     2,065    7.1     547    4.9     1,958    7.7  

Others

   61    0.4     7    0.0     3    0.0     27    0.1  
                                            

Total net revenues

   15,481    100.0 %   29,051    100.0 %   11,118    100.0 %   25,398    100.0 %
                                            

 

(1)   Countries or regions where the headquarters of our clients are located.

While we expect that a substantial majority of our net revenues will continue to be derived from strategic clients headquartered in the United States, we expect that, as a result of our recent acquisitions of Shanghai Solutions and Megainfo, we will derive an increasing portion of our net revenues from clients headquartered in Japan.

 

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Net Revenues by Delivery Locations

We derive a majority of our net revenues from our IT services delivered in China, or offshore services. We also derive a portion of our net revenues from our services delivered on our clients’ or their customers’ premises abroad, or overseas onsite services. Set forth below is our net revenues breakdown by offshore and overseas onsite services for the periods indicated.

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2005     2006     2006     2007  
     (in $ thousands, except percentages)  

Offshore services

   14,728    95.1 %   27,025    93.0 %   10,407    93.6 %   23,887    94.1 %

Overseas onsite services

   753    4.9     2,026    7.0     711    6.4     1,511    5.9  
                                            

Total net revenues

   15,481    100.0 %   29,051    100.0 %   11,118    100.0 %   25,398    100.0 %
                                            

We measure our service efforts that can be billed to clients in units of billed man-months or billed man-hours. We have not experienced significant changes in our billing rates since 2004. Some of our larger clients receive reduced pricing through volume rebates. Consistent with the general practice of our industry, services performed at a client site outside China typically generate higher revenues per professional, but a lower gross margin, than the same services performed in China. These differences are attributable to the higher billing rates, offset by the higher compensation and benefit expenses, in the United States, Japan and other countries in which work is performed as compared to China. Recently, the percentages of our net revenues derived from offshore and overseas onsite services have stayed relatively stable. We do not expect that the mix of our offshore and overseas onsite net revenues will change significantly in the near future. We expect that our overall number of professionals will increase as we add employees for both offshore and overseas onsite work.

Cost of Revenues

Cost of revenues represented 58.9% and 61.8% of our net revenues for the years ended December 31, 2005 and 2006, respectively. Cost of revenues represented 62.8% and 61.7% of our net revenues for the six months ended June 30, 2006 and 2007, respectively. Our cost of revenues largely consists of compensation and benefit expenses of our professionals, including share-based compensation expenses, subcontracting costs, travel expenses, depreciation expenses relating to computers and equipment used by our professionals, telecommunications expenses and office expenses.

The principal component of our cost of revenues is the compensation and benefit expenses of our professionals. A majority of our professionals are located in China, where labor costs in the IT services industry are relatively low. In 2006, our compensation and benefit expenses were US$13.8 million, compared to US$6.8 million in 2005. In the six months ended June 30, 2007, our compensation and benefit expenses were US$11.8 million, compared to US$5.5 million in the six months ended June 30, 2006. As wages in China continue to increase, we may experience increases in our compensation and benefit expenses, particularly expenses for project managers and other mid-level professionals. To control our compensation cost, we will continue to recruit professionals from outside the major cities in China where compensation tends to be lower. We seek to maintain compensation levels in accordance with prevailing trends in our industry in China.

The utilization rates of our professionals also affect our gross profits. We define professionals’ utilization rate as the proportion of total billed man-months or man-hours to total available man-months or man-hours, including professionals in training, during holidays and on vacation. We manage utilization by monitoring project requirements and timetables. The number of professionals assigned to a project varies according to the size, complexity, duration and demands of the project. An unanticipated termination of a significant project could also cause us to experience lower professional utilization resulting from a higher than expected number of unassigned professionals. In addition, we do not fully utilize our professionals when they are enrolled in training programs.

 

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Our subcontractor cost includes expenses we incur for hiring subcontractors and freelancers from time to time. We use subcontractors and freelancers primarily to perform short-term assignments in certain specialty areas in connection with large projects. In 2006, we incurred subcontracting cost of US$2.0 million, compared to US$1.1 million in 2005. In the six months ended June 30, 2007, our subcontracting cost was US$1.8 million, compared to US$0.7 million in the six months ended June 30, 2006.

We incur travel expenses primarily due to our professionals’ traveling to perform onsite work for projects. In 2006, our travel expenses were US$1.2 million, compared to US$0.5 million in 2005. In the six months ended June 30, 2007, our travel expenses were US$1.4 million, compared to US$0.4 million in the six months ended June 30, 2006. We expect our travel expenses to increase as our overseas onsite services and enterprise solutions services provided to domestic clients grow. We plan to explore opportunities to establish additional overseas delivery offices and expand into second-tier cities in China according to market demand and client preferences, which will also increase our professionals’ travel expenses overseas and in China.

We expect our cost of revenues to increase in line with the growth of our business.

Operating Expenses

General and Administrative Expenses

General and administrative expenses represented 19.5% and 21.1% of our net revenues for the years ended December 31, 2005 and 2006, respectively. General and administrative expenses represented 21.2% and 21.2% of our net revenues in the six months ended June 30, 2006 and 2007, respectively. General and administrative expenses consist primarily of compensation and benefit expenses, including share-based compensation expenses, relating to personnel other than professionals and our business development team, rental expenses, depreciation and amortization expenses and overhead expenses. General and administrative expenses also include legal and other professional fees and other miscellaneous administrative costs. Depreciation and amortization expenses as a component of general and administrative expenses excluded those included in the cost of revenues and selling and marketing expenses. We expect our general and administrative expenses to increase as we hire additional personnel and otherwise incur additional expenses to support our operations as a public company, including compliance-related costs.

Selling and Marketing Expenses

Selling and marketing expenses represented 1.7% and 2.3% of our net revenues for the years ended December 31, 2005 and 2006, respectively. Selling and marketing expenses represented 2.3% and 3.1% of our net revenues in the six months ended June 30, 2006 and 2007, respectively. Selling and marketing expenses consist primarily of compensation and benefit expenses relating to our business development and marketing personnel, including share-based compensation expenses, travel expenses, advertising expenses, selling and marketing-related office expenses and amortization expenses. Amortization expenses as a component of selling and marketing expenses include amortization of customer base and relationships and contract backlog acquired from business combinations. We expect our selling and marketing expenses to increase in the near future as we increase our sales efforts, hire additional sales personnel, target new markets, establish new sales offices both in China and overseas and initiate additional marketing programs to further build our brand.

Share-based Compensation Expenses

We adopted our 2005 Stock Plan in November 2005 and amended the plan in April 2006 to increase the total number of ordinary shares underlying the options issuable under the plan. We granted options to purchase up to 4,411,286 ordinary shares to our directors, officers and other employees in 2006 and in the six months ended June 30, 2007. As of June 30, 2007, there were 4,217,726 ordinary shares issuable upon exercise of outstanding options under our 2005 Stock Plan, as amended. We recorded share-based compensation expenses for the fair

 

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value of options at the grant dates and recognized such share-based compensation expenses using a graded-vesting attribution method over the vesting period of the options.

A shareholder of Button Software Ltd., one of our principal shareholders, entered into agreements to transfer 50,000 ordinary shares of Button Software Ltd. held by him for US$0.24 per share to each of two of our executives on September 9, 2005 and October 3, 2005, respectively. These 100,000 ordinary shares of Button Software Ltd. represented 112,700 ordinary shares of our company, and the transfer prices represented an equivalent of US$0.21 for each of our ordinary shares. However, we determined that the fair value of our ordinary shares was US$0.81 per share after considering a number of factors, including the valuation result of a third-party appraisal by American Appraisal China Limited on September 9, 2005. We recorded share-based compensation of $67,000 for the excess of the fair value of the shares over the consideration. As we believed that there was no material change in our operations in the short period between September 9, 2005 and October 3, 2005 that would materially impact the fair value of our ordinary shares, US$0.81 was applied in determining the amounts of share-based compensation.

The amounts of these share-based compensation expenses are set forth below:

 

     For the Year Ended December 31,    For the Six Months Ended June 30,
     2005    2006    2006    2007
     (in $ thousands)

Share-based compensation expenses:

           

Cost of revenues

      45    22    37

General and administrative expenses

   67    632    308    402

Selling and marketing expenses

      36    17    20
                   

Total

   67    713    347    459
                   

As of June 30, 2007, the unamortized compensation expenses in connection with our outstanding options were US$1.4 million. This amount does not include share-based compensation expenses for our options granted after June 30, 2007.

Government Subsidies

Government subsidies primarily relate to subsidies received from the PRC local government for meeting the conditions required by various incentive policies, such as our office location in the Haidian district in Beijing and our passing certain technological certification. Our continued eligibility for such subsidies is subject to the discretion of the PRC local government. Moreover, the PRC central government or local government could determine at any time to immediately eliminate or reduce these government subsidies. Upon expiration of these government subsidies, we will consider available options, in accordance with applicable laws, that would enable us to qualify for further government subsidies to the extent they are then available to us.

Taxes

Under the current laws of the Cayman Islands, the Company is not subject to tax on its income or capital gains. In addition, payment of dividends by the Company is not subject to withholding tax in the Cayman Islands.

PRC Enterprise Income Tax, or EIT

PRC EIT is generally assessed at the rate of 33% of taxable income. Under current PRC rules and policies, an enterprise qualified as a “high and new technology enterprise” located in the Beijing New Industry Development

 

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Pilot Zone is entitled to a preferential EIT rate of 15% and is further entitled to a three-year EIT exemption from either its first year of operation or, if it is incorporated in the second half of a calendar year, its second year of operation if so selected, and a 50% reduction of its applicable EIT rate for the succeeding three years.

VanceInfo Beijing, Prosoft and ITC, are currently qualified as “high and new technology enterprises” located in the Beijing New Industry Development Pilot Zone, and enjoying preferential tax treatment as a result of this status. VanceInfo Beijing was incorporated in the second half of 2004, and has elected to be exempted from EIT from 2005 to 2007 and be subject to a 7.5% EIT rate from 2008 to 2010. Prosoft and ITC were both incorporated in June 2004, and have been entitled to be exempted from EIT from 2004 to 2006 and to be subject to a 7.5% EIT rate from 2007 to 2009.

In addition, under the current PRC rules and policies, an enterprise qualified as a “software enterprise” is entitled to an exemption from EIT for the first two profitable years and a 50% reduction of its applicable EIT rate for the subsequent three years. Shanghai Solutions, one of our subsidiaries, was incorporated in 2002 and was recognized as a “software enterprise” in 2003, therefore, it was entitled to be exempted from EIT in 2003 and 2004, and has been subject to a 16.5% EIT rate from 2005 to 2007. Furthermore, Shanghai Solutions was recognized as a “key software enterprise under the State plan” in 2006, which entitled it to a 10% preferential income tax rate in 2007. However, all the above qualifications are subject to an annual assessment by the relevant government authority in China. There is no assurance that our subsidiaries will continue to meet the qualifications or that the relevant government authority will not revoke the company’s “high and new technology enterprise,” “software enterprise” or “key software enterprise under the State plan” statuses.

Megainfo was incorporated in 2001, and it was recognized as a “software enterprise” in 2001. Therefore, it was exempted from EIT from 2002 to 2003 and was subject to an 18% EIT rate from 2004 to 2006. Since 2007, a 33% EIT has been applicable to Megainfo.

Chosen was incorporated in 2006 and is subject to a 33% EIT.

On March 16, 2007, the National People’s Congress of China enacted a new EIT law, under which foreign invested enterprises, or FIEs, such as VanceInfo Beijing, and Chinese domestic companies would be subject to EIT at a uniform rate of 25%. Preferential tax treatments will continue to be granted to entities that are classified as “high and new technology enterprises strongly supported by the State” or that conduct business in encouraged sectors, whether FIEs or domestic companies. The new tax law will become effective on January 1, 2008. Under the new tax law, enterprises that had been established and already enjoyed preferential tax treatment prior to March 16, 2007 will continue to enjoy it subject to the following qualifications: (i) in the case of preferential tax rates, for a period of five years from January 1, 2008, or (ii) in the case of a preferential tax exemption or reduction for a specified term, until the expiration of such term. The new tax law does not define “high and new technology enterprises strongly supported by the State,” nor does it specify which encouraged sectors will be eligible for preferential tax treatment. Because the detailed implementing rules for the new tax law have not yet been promulgated, we cannot assure you that VanceInfo Beijing, Prosoft, ITC and Shanghai Solutions will be classified as “high and new technology enterprises strongly supported by the State” or an enterprise that conducts business in encouraged sectors, and therefore will be able to enjoy a preferential EIT rate after the transition period expires.

PRC Business Tax

Taxpayers providing taxable services in China are required to pay a business tax at a statutory tax rate of 5% of their revenues. According to applicable tax rules, each of VanceInfo Beijing, Prosoft, ITC, Shanghai Solutions and Megainfo is exempt from business tax with respect to the technology development services that they engage in that fall within the definition of technology development business.

 

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Minority Interest

In 2005 and 2006, we held a 51% equity interest in Worksoft Japan. Minority interest in 2005 and 2006 represented minority shareholders’ share of the net income of Worksoft Japan. We subsequently acquired an additional 48.99% equity interest in Worksoft Japan and a 75% equity interest in Shanghai Solutions in May 2007. Minority interest in the six months ended June 30, 2007 represented minority shareholders’ share of the net income of Shanghai Solutions and Worksoft Japan.

Deemed Dividends

We issued our Series A preferred shares in November 2005. The Series A preferred shares, unless previously converted, are redeemable at a premium at the option of the holders 60 days after we have redeemed our Series B preferred shares. We recognized accretion to the redemption value of our Series A preferred shares as deemed dividends for the years ended December 31, 2005 and 2006 and the six months ended June 30, 2007, respectively.

Critical Accounting Policies

Our consolidated financial information has been prepared in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, and revenue and expenses in the financial statements and accompanying notes. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates.

Some of our accounting policies require a higher degree of judgment than others in their application.

When reviewing our financial statements, you should consider (1) our selection of critical accounting policies, (2) the judgment and other uncertainties affecting the application of those policies, and (3) the sensitivity of reported results to changes in conditions and assumptions. We believe that the following accounting policies involve the most significant judgment and estimates used in the preparation of our financial statements.

Revenue recognition

Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We follow very specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue recognition policy.

We derive revenues from provision of IT services. The majority of our contracts are for the provision of services performed on a time-and-material basis. Revenues from this type of contracts are recognized as billable services are rendered. The client is billed for related services based on pre-agreed billing rates. There are no significant assumptions related to time-and-material arrangements.

The remaining revenues are earned from fixed-price contracts. Fixed-price contracts require us to perform services throughout the contractual period, which is generally less than one year. Revenues from fixed-price contracts are generally recognized using a proportional performance method. The use of this method requires management to exercise judgment and careful consideration. Our contracts refer to milestones related to the completion of specific tasks such as planning documentation and testing reports. We estimate the man-hours required to achieve each of these milestones and, when the milestone is achieved, we recognize a proportion of the total revenue under the contract based on the hours incurred in achieving that milestone against our latest estimate of the total man-hours to be incurred to complete the contract.

 

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Some of our contracts with customers include provision for inspection, test, acceptance or rejection in accordance with the acceptance or completion criteria as specified in the relevant SOW and/or work authorization. We do not believe that there is uncertainty about customer acceptance once the services have been rendered. We are able to reliably demonstrate that the criteria specified in the acceptance provisions and all other revenue recognition criteria are met prior to formal customer sign-off. We believe that we would be successful in enforcing a claim for payment even in the absence of formal sign-off.

We do not enter into maintenance service arrangements for our fixed-price contracts. For our time-and-material contracts, we may render initial development and maintenance services, typically for a period of less than one year and are subject to the terms of the master agreement which fixes the billing rates for man-hours based on level of experience of the engineers regardless of the type of engaged services.

Reimbursable out-of-pocket expenses and material costs are recognized as revenues when billed in accordance with Emerging Issues Task Force, or EITF, 01-14: Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred.

We account for volume discounts and pricing incentives to clients using the guidance of EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). The discount terms in our arrangements with clients generally entitle the client to discounts if the client completes a specified cumulative level of revenue transactions. The discounts are passed on to the client either as cash payments or as a reduction of payments due from the client. We have recorded the revenue rebate as reduction in revenues.

Income taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations.

Share-based compensation

Share-based payment transactions with employees are measured based on the grant date fair value of the equity instrument issued in accordance with the FASB Statement of Financial Accounting Standard, or SFAS, No. 123(R), Share-Based Payment, and recognized as compensation expense over the requisite service period based on a graded vesting attribution method, with a corresponding impact reflected in additional paid-in capital.

Share-based payment transactions with non-employees are accounted for as share based compensation expense in accordance with EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

In 2006 and 2007, we granted options to purchase our ordinary shares to our directors, officers and employees. See “Management — Share Incentive Plans.”

 

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The table below sets forth certain information concerning options granted to our directors, executives and employees on the dates indicated.

 

Grant Date

  Number of Ordinary
Shares Underlying
Options Granted
  Option Exercise
Price Per Share
(US$/Share)
 

Fair Value of
Options at
Date of Grant

(US$/Share)

 

Fair value of
ordinary
shares

(US$/Share)

  Type of Valuation   Intrinsic
Value(1)

January 7, 2006

  512,600   0.30   1.26   1.47   Retrospective   8.20

June 6, 2006

  1,296,200   0.30   0.73   0.90   Retrospective   8.20

June 10, 2006

  200,000   0.97   0.51   0.90   Retrospective   7.53

September 15, 2006

  386,000   1.60   0.44   0.97   Retrospective   6.90

September 19, 2006

  52,900   1.60   0.44   0.97   Retrospective   6.90

November 10, 2006

  12,000   1.60   0.51   1.11   *   6.90

November 16, 2006

  20,000   1.60   0.52   1.12   *   6.90

December 1, 2006

  32,000   1.60   0.55   1.16   Retrospective   6.90

December 29, 2006

  500,000   2.00   0.53   1.23   *   6.50

February 15, 2007

  275,900   3.00   0.56   1.53   *   5.50

March 16, 2007

  501,670   3.50   0.60   1.71   Retrospective   5.00

April 1, 2007

  103,701   4.00   0.55   1.71   Retrospective   4.50

April 15, 2007

  280,905   4.00   0.58   1.77   *   4.50

June 1, 2007

  162,410   5.00   0.25   1.99   Retrospective   3.50

June 30, 2007

  75,000   5.50   0.42   2.60   *   3.00

July 31, 2007

  294,600   6.00   0.60   3.21   Retrospective   2.50

August 31, 2007

  68,964   7.50   0.64   3.90   *   1.00

September 30, 2007

  267,900   8.50   0.81   4.59   Contemporaneous   0.00

October 31, 2007

  372,000   9.00   1.61   6.39   **   0.00

November 20, 2007(2)

  55,000   9.50   2.19   7.55   **   0.00

 


(1)   Intrinsic value is determined based on the difference between the estimated initial public offering price of US$8.50 per ADS, being the midpoint of the initial offering price range shown on the cover page of this prospectus, and the exercise price of options.
(2)   All the options granted on November 20, 2007 were subsequently cancelled on November 28, 2007.
*   For the grant dates that fell between two valuation dates, we used a linear regression model to establish mathematical relationships between the two neighboring valuation dates and the fair value of our ordinary shares determined as of such valuation dates. These mathematical relationships were then used to determine the fair value of our ordinary shares on the relevant grant dates.
**   We used a linear regression model to establish mathematical relationships between (i) September 30, 2007 and December 15, 2007, the expected commencement date of this offering, and (ii) US$4.59, the fair value of our ordinary shares as of September 30, 2007, and US$9.00, the preliminary indicative price range of this offering estimated as of October 31, 2007. These mathematical relationships were then used to determine the fair value of our ordinary shares on October 31, 2007 and November 20, 2007.

In addition, on November 28, 2007, we granted options to purchase 65,000 shares of our ordinary shares at an exercise price of US$9.00 per share. We have not yet determined the fair value of the ordinary shares underlying the options we granted on such date or the fair value of these options.

We have engaged American Appraisal China Limited, or AAC, an independent third-party appraisal firm, to assist us in determining the fair value of our ordinary shares and our stock options as of the following grant dates: January 7, 2006, June 6, 2006, September 15, 2006, December 1, 2006, March 16, 2007, June 1, 2007, July 31, 2007 and September 30, 2007.

AAC used a combination of (i) the discounted cash flow, or DCF, method of the income approach and (ii) the market approach, to assess the fair value of the ordinary shares underlying the options we granted in 2006 and 2007.

AAC believed that both the DCF method and the market approach are appropriate in appraising our equity value. In addition, AAC did not believe that one approach is more appropriate than the other. Therefore, both approaches were evaluated and weighted.

The determination of the fair value of our ordinary shares requires complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risks, the liquidity of our shares and our operating history and prospects at the time of each grant.

 

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The major assumptions used in calculating the fair value of ordinary shares include:

 

 

Weighting of DCF and market multiples. AAC assigned a 55% weight to the DCF approach and 45% weight to the market multiple approach. AAC believes that the DCF approach, with a consideration of the company’s projected performance in the coming few years, would allow for more of the company specific factors to be reflected in the projections and the valuation results obtained from that approach. Thus, a relatively high weight of 55% is applied to results obtained from DCF approach.

 

 

Weighted average cost of capital, or WACC. WACCs of between 15% and 28% were used. The WACC used decreased from 28% in January 2006 to 15% in September 2007. The change in WACC was the combined result of the changes in the risk-free rate, industry-average correlated relative volatility coefficient beta, equity risk premium, size of our company, scale of our business and our ability in achieving forecast projections.

 

 

Comparable companies. In deriving discount rates and market multiples, AAC selected several companies in the software outsourcing industry publicly traded on securities markets for reference as our comparable companies.

 

 

Capital market valuation multiples. AAC obtained and assessed updated capital market data of selected comparable companies and used multiples of enterprise value to revenue, or EV/Revenue, enterprise value to earnings before interest, taxes, depreciation and amortization, or EV/EBITDA, and enterprise value to earnings before interest and taxes, or EV/EBIT, for its valuations.

 

 

Discount for lack of marketability, or DLOM. AAC quantified DLOM using the Black-Scholes option-pricing model. Under this method, the cost of the put option, which can hedge the price change before the privately held shares can be sold, was considered as a basis to determine the DLOM. The nearer the valuation date is to an expected initial public offering, the lower the DLOM. DLOMs of between 21% in January 2006 and 9% in September 2007 were used in AAC’s valuations.

The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts developed by us. The assumptions used in deriving the fair values were consistent with our business plan at the time of each valuation. These assumptions include: no material changes in the existing political, legal and economic conditions in China; no major changes in the tax rates applicable to our subsidiaries and consolidated affiliated entities in China; our ability to retain competent management, key personnel and staff to support our ongoing operations; and no material deviation in market conditions from economic forecasts. These assumptions are inherently uncertain. The risks associated with achieving our forecasts were assessed in selecting the appropriate discount rates to estimated cash flows, which decreased from 28% in January 2006 to 15% in September 2007.

Under the market approach, different value measures and market multiples of comparable companies were calculated and analyzed to induce a series of multiples that were considered representative of the industry average. The market multiples were then adjusted based on our growth rate, business risks and profitability. Thereafter, the adjusted multiples were applied to our performance indicators to determine our value on a minority basis. AAC specifically applied the financial ratios of EV/Revenue, EV/EBITDA and EV/EBIT in arriving at an indicative value of our company under the market approach.

AAC used the option-pricing method to allocate equity value of our company to preferred and ordinary shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid “Valuation of Privately-Held-Company Equity Securities Issued as Compensation,” or the Practice Aid. This method involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of our company or an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing is based on the plans of our board and management. Estimating the volatility of the share price of a privately held company is complex because there is no readily available market for the shares. AAC estimated the volatility of our shares based on historical volatility of comparable companies’ shares. Had we used different estimates of volatility, the allocations between preferred and ordinary shares would have been different.

 

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For the June 6, 2006 grant, we have attributed to the ordinary shares underlying the options a fair value of US$0.90 per share, representing a 38.8% decrease compared to a fair value of US$1.47 per share for the January 2006 grant, as we sold Series B-1 and B-2 preferred shares to a group of investors and, concurrently, warrants to purchase Series B-3 preferred shares were granted by us to these investors. The proceeds we received from this private placement were US$25.1 million, and our total equity value increased to approximately US$53.3 million in June 2006. AAC adopted an allocation model to allocate the total equity value of our company into different classes of shares to come up with the fair value for each class of shares. As Series B-1 and B-2 preferred shares were issued in May 2006 with rights, privileges and preferences that ordinary shares are not entitled to, the dilution effect of the Series B-1 and B-2 preferred shares reduced the fair value of our ordinary shares to US$0.90 per share in May 2006. However, this effect was temporary as the injection of the funds contributed to our growth and benefited all classes of shares in the long term.

The determined fair value of the ordinary shares underlying the options increased from US$0.90 per share for the June 6, 2006 grants to US$3.21 per share for July 31, 2007 grants. We believe the increase in the fair value of ordinary shares in this period is primarily attributable to the following factors:

 

   

the overall economic growth in our principal geographic markets led to an increased market demand for our IT services;

 

   

we ramped up new services lines such as enterprise solutions;

 

   

we completed a number of acquisitions since September 2006, which further strengthened our service lines and industry expertise;

 

   

we experienced a 76.4% increase in net revenues from US$5.9 million for the second quarter of 2006 to US$10.4 million for the first quarter of 2007;

 

   

due to the increased likelihood of marketability of our ordinary shares as a result of this pending offering, DLOM decreased from 21% for the June 6, 2006 valuation to 9% for the July 31, 2007 valuation.

The fair value of the ordinary shares underlying the options increased from US$3.21 per share for the July 31, 2007 grants to US$4.59 per share for September 30, 2007 grants. We believe the increase in the fair value of the ordinary shares during this period was primarily attributable to the following factors:

 

   

We made our first confidential submission with respect to this offering to the Securities and Exchange Commission in August 2007, and hence the probability of a successful offering increased.

 

   

We completed the acquisition of Chosen, an IT services provider primarily focusing on SAP consulting and implementation services, on July 31, 2007. This transaction helped to further expand our capabilities in the enterprise solutions service line and improved our competitive position in capturing the market potential presented by the fast-growing enterprise solutions business.

 

   

In September 2007, we further strengthened our U.S. sales team by hiring our vice president of sales, Mr. Ravi Ramachandran, who has over 10 years of experience in selling offshore IT services to U.S. clients, and two other highly experienced sales professionals based on the West Coast of the United States.

Since September 30, 2007, a number of events have occurred, which has significantly affected the valuation of our ordinary shares, including the following:

 

   

We have made significant progress toward converting some new customers into strategic accounts through successful completion of pilot projects or start-up phase. For instance, in October 2007, we started to operate two new CDCs for two clients in the technology industry.

 

   

In October 2007, our TIBCO CDC started operations after relocating to a new facility and doubling its space. With the enhanced capacities and additional professionals we hired after the relocation, the TIBCO CDC is able to provide consulting and implementation services in addition to the R&D services.

 

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We have further benefited from synergies from our acquisitions. For example, we completed the restructuring of our Japanese business unit in October 2007 by integrating various resources of our acquired businesses, so that our office in Japan now focuses on sales and marketing, while our China-based team now focuses on service deliveries. With our streamlined delivery capabilities and integrated sales force, we have successfully expanded our service offerings to Japanese-headquartered clients. For example, through the joint efforts of the overseas onsite and offshore teams, we established a relationship with one of the most sought after IT outsourcing clients in Japan and began to build a dedicated service facility for the client in October 2007.

 

   

We have appointed an independent director and confirmed the appointment of another independent director who will take up his directorship immediately prior to the effectiveness of our registration statement on Form F-1, of which this prospectus is a part, which we believe contributed to the enhancement of our corporate governance.

Since October 31, 2007, a number of events have occurred, which has significantly affected the valuation of our ordinary shares, including the following:

 

   

In November 2007, we started to operate one additional CDC for a client in the technology industry after successful completion of pilot projects.

 

   

We made progress in opening our first office in Southeast Asia by signing a lease for the facilities in November 2007. This new office will focus on enterprise solutions services and further strengthen our delivery capabilities.

 

   

We confirmed, in November 2007, the appointment of our internal audit director, who is experienced in internal control processes and compliance with Section 404 of the Sarbanes-Oxley Act. He will begin working in January 2008, which we believe will contribute to the enhancement of our internal control.

 

   

We made our first public filing with the Securities and Exchange Commission with respect to this offering in November 2007, and the probability of a successful offering further increased.

The Black-Scholes-option pricing model is used to determine the fair value of the options to purchase our ordinary shares. As we did not have historical share option exercise experience, we estimated the expected term as the average between the vesting term of the options and the original contractual term. The volatility of the underlying ordinary shares during the life of the options was estimated based on the historical stock price volatility of listed comparable companies over a period comparable to the expected term of the options. The risk-free interest rate was estimated based on the yield to maturity of China international government bonds with a maturity period close to the expected term of the options. The dividend yield was estimated by us based on its expected dividend policy over the expected term of the options. We are required to estimate forfeitures at the time of grant and record share-based compensation expenses only for those awards that are expected to vest. If actual forfeitures differ from these estimates, we may need to revise those estimates used in subsequent periods.

If factors change and we employ different assumptions for estimating share-based compensation expense in future periods or if we decide to use a different valuation model, our share-based compensation in future periods may differ significantly from what we have recorded in prior periods and could materially affect our operating income, net income and net income per share.

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, which are characteristics not present in our option grants. Existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair value of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may be significantly different from the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based compensation awards, such as employee share options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair value originally estimated on the grant date and reported in our financial statements. Alternatively, values that are significantly higher than fair values originally estimated on the grant date and reported in our financial statements may be realized from these instruments.

 

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There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values.

Financing instruments

We have determined that our convertible redeemable preferred shares are participating securities as the preferred shares participate in undistributed earnings on an as-if-converted basis. Accordingly, we have used the two-class method of computing net income per share for ordinary and preferred shares according to participation rights in undistributed earnings. Significant assumptions have been made related to the point in time recognition may impact net income per share.

In April 2006, in connection with our issuance of Series B-1 and B-2 shares, we issued warrants to all holders of Series B-1 and B-2 preferred shares to purchase up to an aggregate amount of US$2 million of our Series B-3 preferred shares at the exercise price of US$2.8996 per share. The warrants are exercisable upon issuance by cash or by net exercise. The warrants will expire upon the closing of this offering.

We have determined that the warrants are a liability under FASB Statement No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” because the exercise of the warrants will result in the delivery of redeemable preferred shares. The fair values of the warrants were determined using the Black-Scholes option pricing model. Significant assumptions including dividend yield and expected volatility were used in determining the fair value of the warrants. The assumptions used in calculating the fair value of warrants represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, the change in fair value of the warrants included in the consolidated statement of operations could be materially different in the future.

Accounts receivable

Our accounts receivable as of December 31, 2005 and 2006 were US$5.8 million and US$11.8 million, respectively. Our days of sales outstanding in 2005 and 2006 were 104 and 107 days, respectively. Our accounts receivable as of June 30, 2007 was US$18.0 million. Our days of sales outstanding in the six months ended June 30, 2007 was 103. We define our days of sales outstanding as the ratio of the average accounts receivable to revenues in a year, multiplied by 365.

We conduct credit evaluations of clients and generally do not require collateral or other security from our clients.

We establish an allowance for doubtful accounts based upon estimates, historical experience and other factors surrounding the credit risk of specific clients. The amount of receivables ultimately not collected by us has generally been consistent with our expectations and the allowance established for doubtful accounts. In 2005 and 2006, the provision made for doubtful accounts was US$52,000 and US$53,000, respectively. If the frequency and amount of customer defaults change due to our clients’ financial condition or general economic conditions, our allowance for uncollectible accounts may require adjustment. As a result, we continuously monitor outstanding receivables and adjust allowances for accounts where collection may be in doubt. In the six months ended June 30, 2006 and 2007, the provision made for doubtful accounts was US$53,000 and US$0.1 million, respectively.

The following table presents a profile of our accounts receivable in terms of days for which accounts receivable were outstanding:

 

     As of
December 31,
   As of
June 30,
     2005    2006    2007
     ( in $ thousands)

Period in days

        

0-90

   5,443    11,482    17,161

91-180

   308    179    631

More than 180

   75    207    300
              

Total

   5,826    11,868    18,092
              

 

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Acquisitions and Goodwill

We account for acquired businesses using the purchase method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations. Accordingly, for significant items, we typically obtain assistance from third party valuation specialists. The valuations are based on information available near the acquisition date and are based on expectations and assumptions that have been deemed reasonable by management.

There are several methods that can be used to determine the fair value of assets acquired and liabilities assumed. For intangible assets, we typically use the income method. This method starts with a forecast of all of the expected future net cash flows. These cash flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions inherent in the income method or other methods include the amount and timing of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal, regulatory, or economic barriers to entry. Determining the useful life of an intangible asset also requires judgment as different types of intangible assets will have different useful lives and certain assets may even be considered to have indefinite useful lives.

Specifically, goodwill impairment is determined using a two-step process. The first step compares the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill. Estimating fair value is performed by utilizing various valuation techniques, with the primary technique being a discounted cash flow.

Some of the more significant estimates and assumptions inherent in the goodwill impairment estimation process using the market approach include the selection of appropriate comparable companies, the determination of market value multiples for the comparable companies, the subsequent selection of an appropriate market value multiple for the business based on a comparison of the business to the comparable companies, the determination of applicable premiums and discounts based on any differences in marketability between the business and the comparable companies and, when considering the income approach, include the required rate of return used in the discounted cash flow method, which reflects capital market conditions and the specific risks associated with the business. Other estimates inherent in the income approach include long-term growth rates and cash flow forecasts for the business.

Estimates of fair value result from a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions at a point in time. The judgments made in determining an estimate of fair value can materially impact our results of operations. The valuations are based on information available as of the impairment review date and are based on expectations and assumptions that have been deemed reasonable by management. Any changes in key assumptions, including unanticipated events and circumstances, may affect the accuracy or validity of such estimates and could potentially result in an impairment charge.

 

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Internal Control over Financial Reporting

Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, we and our independent registered public accounting firm, in connection with the preparation and external audit of our consolidated financial statements for the years ended December 31, 2005 and 2006, noted two material weaknesses, one significant deficiency and other control deficiencies in our internal control over financial reporting. A “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected by the entity’s internal control over financial reporting. A “significant deficiency” is a control deficiency, or combination of control deficiencies, that adversely affects our ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of our annual or interim financial statements that is more than inconsequential will not be prevented or detected.

The material weaknesses identified by our independent registered public accounting firm were: (i) lack of a comprehensive accounting policies and procedures manual in accordance with U.S. GAAP accessible to accounting personnel to ensure that accounting policies and procedures are followed; and (ii) lack of dedicated resources to take responsibility for the finance and accounting function and the preparation of financial statements in compliance with U.S. GAAP. The significant deficiency identified by our independent registered public accounting firm was our lack of a qualified internal tax team that can address our income tax accounting and compliance matters from a U.S. GAAP perspective.

Following the identification of the material weaknesses, significant deficiency and other control deficiencies, we undertook certain remedial steps to address them, including hiring additional personnel with relevant experience for our finance and accounting department and providing additional accounting and financial reporting training for our existing personnel. However, the implementation of these measures may not fully address the material weaknesses and other control deficiencies in our internal control over financial reporting that might have been identified, had we performed a formal assessment of our internal controls over financial reporting, and we cannot yet conclude that they have been fully remedied.

We plan to take additional initiatives to improve our internal control over financial reporting and disclosure controls, including: (i) developing a comprehensive accounting policies and procedures manual, making such manual readily accessible to guide the day-to-day operations of our accounting and finance personnel; (ii) hiring and training of qualified financial reporting and accounting personnel with experience in U.S. GAAP reporting; (iii) hiring additional qualified personnel with knowledge and experience to ensure our compliance with tax laws and regulations in the various jurisdictions where we operate our business; (iv) engaging an advisory firm to advise us on compliance with Section 404 of the Sarbanes-Oxley Act; and (v) hiring an internal audit manager to assist in our internal control compliance efforts. We are working to implement these measures during the remainder of 2007 and 2008, although we cannot assure you that we will complete such implementation. The process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments. We currently expect to incur an aggregate cost of approximately US$1.0 million in connection with our internal control compliance efforts in 2007 and 2008. However, the actual cost that we will incur may differ from our current estimate. See “Risk Factors—Risks Related to Our Business— In the course of auditing our consolidated financial statements for the two years ended December 31, 2005 and 2006, we and our auditors identified certain material weaknesses, significant deficiencies and other control deficiencies in our internal control over financial reporting; if we fail to maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our ADSs may be adversely affected.”

 

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Our Selected Quarterly Results of Operations

The following table presents our selected unaudited quarterly results of operations for the six quarters in the period from January 1, 2006 to June 30, 2007. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited consolidated quarterly financial information on the same basis as our audited consolidated financial statements. This unaudited consolidated financial information includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair representation of our financial position and operating results for the quarters presented. Our quarterly operating results have experienced fluctuations and may continue to fluctuate in the future. The historical quarterly results set forth below should not be relied upon as being indicative of results for any future quarters or for a full year. We have not included below our quarterly results of operations for the four quarters in 2005 because (i) such information is relatively stale compared to the quarterly results of operations disclosed below, taking into consideration our significant organic growth complemented by acquisitions in 2006 compared to 2005, and therefore we believe such information would not materially contribute to the disclosure below; and (ii) the quarterly operating results for 2005 cannot be provided on a U.S. GAAP basis without unreasonable effort or expense.

 

     For the Three Months Ended  
    

March 31,

2006

   

June 30,

2006

    September 30,
2006
   

December 31,

2006

   

March 31,

2007

   

June 30,

2007

 
     (in $ thousands, except percentage, share, per share and per ADS data)  

Consolidated Statement of Operations Data

            

Net revenues

   5,201     5,917     8,109     9,824     10,435     14,963  

Cost of revenues(1)

   (3,322 )   (3,661 )   (4,812 )   (6,166 )   (6,493 )   (9,178 )

Gross profit

   1,879     2,256     3,297     3,658     3,942     5,785  

General and administrative expenses(1)

   (1,106 )   (1,250 )   (1,650 )   (2,134 )   (2,339 )   (3,054 )

Selling and marketing expenses(1)

   (128 )   (124 )   (224 )   (205 )   (284 )   (496 )

Total operating expenses

   (1,234 )   (1,374 )   (1,874 )   (2,339 )   (2,623 )   (3,550 )

Government subsidies

       50     2     2     1     20  

Income from operations

   645     932     1,425     1,321     1,320     2,255  

Interest income

   15     148     171     258     210     219  

Interest expense

               (4 )        

Exchange differences

   (6 )   3     (57 )   (33 )   (73 )   (120 )

Change in fair value of the warrants

       (67 )   (159 )   (179 )   (41 )   (86 )

Net income

   678     1,010     1,370     1,318     1,284     2,271  

Deemed dividend on Series A convertible redeemable preferred shares—accretion of redemption premium

   146     151     156     158     158     162  

Income attributable to holders of ordinary shares

   532     859     1,214     1,160     1,126     2,109  

Other Consolidated Financial Data

            

Gross margin(2)

   36.1 %   38.1 %   40.7 %   37.2 %   37.8 %   38.7 %

Operating margin(3)

   12.4 %   15.7 %   17.6 %   13.4 %   12.6 %   15.1 %

Net margin(4)

   13.0 %   17.1 %   16.9 %   13.4 %   12.3 %   15.2 %

(1)   Includes share-based compensation expenses as follows:

 

    For the Three Months Ended
    March 31,
2006
  June 30,
2006
  September 30,
2006
  December 31,
2006
  March 31,
2007
  June 30,
2007
    (in $ thousands, except percentage, share, per share and per ADS data)

Share-based compensation expenses included in:

           

Cost of revenues

  11   11   12   11   18   19

General and administrative expenses

  153   155   164   160   195   207

Selling and marketing expenses

  8   9   9   10   10   10

 

(2)   Gross margin represents gross profit as a percentage of net revenues.
(3)   Operating margin represents income from operations as a percentage of net revenues.
(4)   Net margin represents net income as a percentage of net revenues.

 

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The following table presents our unaudited quarterly results of operations as a percentage of total net revenues for the six quarters ended June 30, 2007.

 

    For the Three Months Ended  
   

March 31,

2006

   

June 30,

2006

   

September 30,

2006

   

December 31,

2006

   

March 31,

2007

   

June 30,

2007

 

Consolidated Statement of Operations Data

           

Net revenues

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of revenues

  (63.9 )   (61.9 )   (59.3 )   (62.8 )   (62.2 )   (61.3 )

Gross profit

  36.1     38.1     40.7     37.2     37.8     38.7  

General and administrative expenses

  (21.3 )   (21.1 )   (20.3 )   (21.7 )   (22.4 )   (20.4 )

Selling and marketing expenses

  (2.5 )   (2.1 )   (2.8 )   (2.1 )   (2.7 )   (3.3 )

Total operating expenses

  (23.7 )   (23.2 )   (23.1 )   (23.8 )   (25.1 )   (23.7 )

Government subsidies

      0.8     *     *     *     0.1  

Income from operations

  12.4     15.8     17.6     13.4     12.6     15.1  

Interest income

  0.3     2.5     2.1     2.6     2.0     1.5  

Interest expense

              *          

Exchange differences

  (0.1 )   0.1     (0.7 )   (0.3 )   (0.7 )   (0.8 )

Change in fair value of the warrants

      (1.1 )   (2.0 )   (1.8 )   (0.4 )   (0.6 )

Net income

  13.0     17.1     16.9     13.4     12.3     15.2  

Deemed dividend on Series A convertible redeemable preferred shares—accretion of redemption premium

  2.8     2.6     1.9     1.6     1.5     1.1  

Income attributable to holders of ordinary shares

  10.2     14.5     15.0     11.8     10.8     14.1  

*   Less than 0.1%

Our operating results can fluctuate from quarter to quarter and are affected by many factors such as business volume from clients, clients’ business decisions and seasonality. Our net revenues in the first quarter of each year are relatively low compared to the other quarters, as many of our professionals take annual vacations in the first quarter together with the public holidays around the Chinese New Year’s Day resulting in decreased man-months in that quarter. Our net revenues in the third quarter are relatively high compared to the other quarters as there are fewer public holidays in China resulting in more working days and higher man-months in that quarter.

We experienced relatively high growth in net revenues in the third quarter of 2006 compared to the previous quarter primarily because of the seasonality described above. In addition to our organic growth, the 43.4% increase in our quarterly net revenues in the second quarter of 2007 compared to the previous quarter was also attributable to our acquisitions of ITC in March 2007 and Megainfo and Shanghai Solutions in May 2007 and the relatively low net revenues in the first quarter of 2007 as a result of the seasonality described above.

The growth rate of our cost of revenues for the fourth quarter of 2006 outpaced the growth rate of our net revenues in the same period, primarily because our integrated cost of revenues for the fourth quarter of 2006 increased after we acquired Prosoft in September 2006, while our utilization rate of the professionals of Prosoft was relatively low during the initial integration period.

The increases in our net income in the second and third quarters of 2006 and the second quarter of 2007 are primarily driven by our increased sales volumes in these periods. Our net income decreased in the fourth quarter of 2006 and the first quarter of 2007, as there were fewer working days in those two quarters. Furthermore, in the fourth quarter of 2006, our general and administrative expenses increased as we hired more staff in that quarter and incurred more compensation and benefit expenses and recruiting and training expenses. In the first quarter of 2007, our general and administrative expenses increased primarily due to increased compensation and benefit expenses as we hired more staff and to increased rental expenses as we entered into additional leases.

 

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Results of Operations

The following table sets forth certain financial information derived from our consolidated financial statements under U.S. GAAP:

 

    For the Year
Ended
December 31,
    For the Six
Months Ended
June 30,
 
    2005     2006     2006     2007  
    (in $ thousands)  

Consolidated Statement of Operations Data

       

Net revenues

  15,481     29,051     11,118     25,398  

Cost of revenues

  (9,125 )   (17,961 )   (6,983 )   (15,671 )
                       

Gross profit

  6,356     11,090     4,135     9,727  
                       

General and administrative expenses

  (3,026 )   (6,140 )   (2,356 )   (5,393 )

Selling and marketing expenses

  (270 )   (681 )   (252 )   (780 )
                       

Total operating expenses

  (3,296 )   (6,821 )   (2,608 )   (6,173 )
                       

Government subsidies

  102     54     50     21  
                       

Income from operations

  3,162     4,323     1,577     3,575  

Interest income

  148     592     163     429  

Interest expense

  (17 )   (4 )        

Exchange differences

  (32 )   (93 )   (3 )   (193 )

Change in fair value of the warrants

      (405 )   (67 )   (127 )
                       

Income before income tax and minority interest

  3,261     4,413     1,670     3,684  

Income tax expense

  (2 )   (2 )   (1 )   (91 )
                       

Income before minority interest

  3,259     4,411     1,669     3,593  

Minority interest in net income of consolidated subsidiary

  (24 )   (35 )   19     (38 )
                       

Net income

  3,235     4,376     1,688     3,555  

Deemed dividend on Series A convertible redeemable preferred shares — accretion of redemption premium

  (462 )   (611 )   (297 )   (320 )
                       

Income attributable to holders of ordinary shares

  2,773     3,765     1,391     3,235  
                       

 

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The following table sets forth certain financial information as a percentage of our net revenues:

 

     For the Year
Ended
December 31,
    For the Six
Months Ended
June 30,
 
     2005     2006     2006     2007  

Consolidated Statement of Operations Data

        

Net revenues

   100.0 %   100.0 %   100.0 %   100.0 %

Cost of revenues

   (58.9 )   (61.8 )   (62.8 )   (61.7 )
                        

Gross profit

   41.1     38.2     37.2     38.3  
                        

General and administrative expenses

   (19.5 )   (21.1 )   (21.2 )   (21.2 )

Selling and marketing expenses

   (1.7 )   (2.3 )   (2.3 )   (3.1 )
                        

Total operating expenses

   (21.3 )   (23.5 )   (23.5 )   (24.3 )
                        

Government subsidies

   0.7     0.2     0.4     0.1  
                        

Income from operations

   20.4     14.9     14.2     14.1  

Interest income

   1.0     2.0     1.5     1.7  

Interest expense

   (0.1 )   *          

Exchange differences

   (0.2 )   (0.3 )   0.0     (0.8 )

Change in fair value of the warrants

       (1.4 )   (0.6 )   (0.5 )
                        

Income before income tax and minority interest

   21.1     15.2     15.0     14.5  

Income tax expense

               0.4  
                        

Income before minority interest

   21.1     15.2     15.0     14.1  

Minority interest in net income of consolidated subsidiary

   (0.2 )   (0.1 )   0.2     (0.1 )
                        

Net income

   20.9     15.1     15.2     14.0  

Deemed dividend on Series A convertible redeemable preferred shares-accretion of redemption premium

   (3.0 )   (2.1 )   (2.7 )   (1.3 )
                        

Income attributable to holders of ordinary shares

   17.9     13.0     12.5     12.7  
                        

*   less than 0.1%

Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006

Our results of operations for the six months ended June 30, 2007 compared to the six months ended June 30, 2006 were impacted by the inclusion of the operating results for the first six months of 2007 of Prosoft, the IT services business of SunBridges, ITC, Megainfo and Shanghai Solutions, which we acquired in September 2006, December 2006, March 2007, March 2007 and May 2007, respectively.

Net Revenues

Our net revenues were US$25.4 million in the six months ended June 30, 2007, representing an increase of 128.4% from our net revenues of US$11.1 million in the six months ended June 30, 2006. The growth in our net revenues was primarily due to an increase in sales volumes, which was due primarily to a US$8.6 million increase in our sales to our existing clients as of June 30, 2006, as a result of our enhanced relationships with these clients, and to US$5.7 million of sales to new clients. The number of our clients increased to 152 for the six months ended June 30, 2007 from 88 for the six months ended June 30, 2006. In addition, the total number of clients that individually accounted for over US$0.5 million of our net revenues on an annualized basis increased to 14 for the six months ended June 30, 2007 from seven for the six months ended June 30, 2006.

 

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We hired more than 700 professionals through our acquisitions of Prosoft, the IT service business of SunBridges, ITC, Megainfo and Shanghai Solutions in the second half of 2006 and the first half of 2007. These acquisitions strengthened our service line capabilities and industry expertise, as well as broadened our client base. We were able to leverage the additional capabilities and expertise to win new projects and to cross-sell our service offerings to our broadened client base. Revenues from these acquired businesses’ client relationships also contributed to our net revenues in the six months ended June 30, 2007.

Cost of Revenues

In the six months ended June 30, 2007, our cost of revenues was US$15.7 million, representing an increase of 124.4% from US$7.0 million in the six months ended June 30, 2006. Cost of revenues represented 62.8% and 61.7% of our net revenues in the six months ended June 30, 2006 and 2007, respectively. The increase was primarily due to increases in compensation and benefit expenses of our professionals, our subcontracting costs and our professionals’ travel expenses, as explained further below.

In the six months ended June 30, 2007, our compensation and benefit expenses in respect of our professionals increased by 115.9% to US$11.8 million from US$5.5 million in the six months ended June 30, 2006, primarily due to an increase in our number of professionals. Our cost of revenues in the six months ended June 30, 2007 and June 30, 2006 also included US$37,000 and US$22,000 of share-based compensation expenses arising from share options granted to our professionals.

Our subcontracting costs increased by 159.9% to US$1.8 million in the six months ended June 30, 2007 from US$0.7 million in the six months ended June 30, 2006, primarily due to increases in business volumes and project scale.

Our travel expenses increased by 206.8% to US$1.4 million in the six months ended June 30, 2007 from US$0.4 million in the six months ended June 30, 2006, as our professionals incurred more travel expenses with the growth of our overseas onsite services and domestic enterprise solutions services.

Our depreciation expenses included in cost of revenues increased to US$0.3 million in the six months ended June 30, 2007 from US$0.1 million in the six months ended June 30, 2006, primarily due to increased depreciation expenses relating to computers and equipment used by our professionals.

Our acquisitions of Prosoft, SunBridges, ITC, Megainfo and Shanghai Solutions in the second half of 2006 and the first six months of 2007 added approximately 690 professionals to our company and contributed to the increase of our cost of revenues for the six months ended June 30, 2007.

Gross Profit

Our gross profit in the six months ended June 30, 2007 was US$9.7 million, representing an increase of 135.3% from US$4.1 million in the six months ended June 30, 2006. Gross profit as a percentage of our net revenues increased to 38.3% in the six months ended June 30, 2007 from 37.2% in the six months ended June 30, 2006, as we benefited from enhanced economies of scale and we ramped up new service lines, particularly enterprise solutions services.

General and Administrative Expenses

Our general and administrative expenses were US$5.4 million in the six months ended June 30, 2007, representing an increase of 128.9% from US$2.4 million in the six months ended June 30, 2006.

Compensation and benefit expenses in respect of administrative employees increased by 170.5% to US$1.6 million in the six months ended June 30, 2007 from US$0.6 million in the six months ended June 30, 2006, primarily due to an increase in our number of administrative employees from 249 as of June 30, 2006 to 402 as of June 30, 2007. The increase in compensation and benefit expenses was also attributable to an increase in the

 

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average salary of our administrative employees. Our general and administrative expenses in the six months ended June 30, 2007 also included US$0.4 million of share-based compensation expenses arising from share options granted to our administrative employees in the six months ended June 30, 2007 compared to US$0.3 million of share-based compensation expenses in the six months ended June 30, 2006. Rental expenses increased to US$1.2 million in the six months ended June 30, 2007 from US$0.5 million in the six months ended June 30, 2006, primarily due to our entering into new leases in major cities across China, and in Seattle in the second half of 2006 and the first half of 2007.

Selling and Marketing Expenses

During the six months ended June 30, 2007, our selling and marketing expenses increased to US$0.8 million from US$0.3 million in the six months ended June 30, 2006.

Compensation and benefit expenses in respect of selling and marketing employees increased to US$0.3 million in the six months ended June 30, 2007 from US$0.1 million in the six months ended June 30, 2006, as we hired more selling and marketing employees and their average salary increased. Our selling and marketing expenses in the six months ended June 30, 2007 and 2006 included US$20,000 and US$17,000, respectively, of share-based compensation expenses arising from share options granted to our selling and marketing employees in the six months ended June 30, 2007 and 2006, respectively. Our amortization of intangible assets acquired in mergers and acquisitions increased to US$0.3 million in the six months ended June 30, 2007 from US$52,000 in the six months ended June 30, 2006 because we made more acquisitions in the six months ended June 30, 2007. Our travel and advertising expenses also increased in the six months ended June 30, 2007 compared to the six months ended June 30, 2006 primarily due to enhanced marketing efforts.

Government Subsidies

During the six months ended June 30, 2007, our government subsidies were US$21,000, representing a decrease of 58.0% from US$50,000 in the six months ended June 30, 2006. In the six months ended June 30, 2007, we were granted US$20,000 of government subsidies for our obtaining certain technological certification and US$1,000 of subsidies for loan interest from the local authorities of the Zhongguancun Software Park, where our principal offices are located. In the six months ended June 30, 2006, we were granted US$39,000 of government subsidies for our participation in an overseas industry exhibition and US$11,000 of government subsidies for our marketing activities.

Income from Operations

Our income from operations was US$3.6 million in the six months ended June 30, 2007, representing an increase of 126.8% from US$1.6 million in the six months ended June 30, 2006. The increase was due to an increase in our net revenues in the six months ended June 30, 2007 compared to the six months ended June 30, 2006, partly offset by the increases in our cost of revenues and operating expenses during the same period. Income from operations as a percentage of net revenues decreased slightly to 14.1% in the six months ended June 30, 2007 from 14.2% in the six months ended June 30, 2006.

Interest Income

Our interest income increased to US$0.4 million in the six months ended June 30, 2007 from US$0.2 million in the six months ended June 30, 2006. The increase was due to an increase in our cash balances in the six months ended June 30, 2007 compared to the six months ended June 30, 2006.

Foreign Exchange Loss

For the six months ended June 30, 2007, we incurred foreign exchange losses of US$0.2 million, as compared to foreign exchange losses of US$3,000 for the six months ended June 30, 2006. Our foreign exchange losses in the six months ended June 30, 2007 were due to appreciation of the RMB against the U.S. dollar and Japanese Yen.

 

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Change in Fair Value of Warrants

We have recorded the warrants we issued to purchase our Series B-3 preferred shares as a liability and a derivative financial instrument. Changes in fair value of the warrants of US$0.1 million and US$67,000 were charged to our consolidated statement of operations for the six months ended June 30, 2007 and 2006, respectively.

Income Tax Expense

Our income tax expense increased to US$91,000 for the six months ended June 30, 2007 from US$1,000 for the six months ended June 30, 2006, primarily due to an increase in our deferred tax expense resulting from a one-time adjustment to our deferred tax liabilities. Due to the enactment of the new tax law in China in March 2007, we calculated deferred tax balances as of January 1, 2007 based on the newly enacted tax rate that may become applicable to us as of January 1, 2008, thus resulting in a one-time adjustment of US$0.1 million to our deferred tax liabilities.

Minority Interest

For the six months ended June 30, 2006, minority interest represented the minority shareholders’ 49% share of the net loss of Worksoft Japan. We acquired a 75% equity interest in Shanghai Solutions in May 2007 and an additional 48.99% equity interest in Worksoft Japan in May 2007. For the six months ended June 30, 2007, minority interest represented the minority shareholders’ share of the net income of Shanghai Solutions and Worksoft Japan.

Net Income

As a result of the foregoing, our net income was US$3.6 million in the six months ended June 30, 2007, representing an increase of 110.6% from US$1.7 million in the six months ended June 30, 2006. Net income as a percentage of our net revenues decreased to 14.0% in the six months ended June 30, 2007 from 15.2% in the six months ended June 30, 2006.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Our results of operations in 2006 compared to 2005 were impacted by the inclusion of the operating results for the full year of 2006 of the international business unit of SureKAM and the IT services business of Envisys, which we acquired in September and December 2005, respectively, and by our acquisition of Prosoft in September 2006.

Net Revenues

Our net revenues were US$29.1 million in 2006, representing an increase of 87.7% from our net revenues of US$15.5 million in 2005. The growth in our net revenues was primarily attributed to an increase in sales volumes, which was due primarily to a US$10.2 million increase in our sales to our existing clients as of December 31, 2005, as a result of our enhanced relationships with these clients, and US$3.4 million of sales to new clients. The number of our clients increased to 144 for 2006 from 98 for 2005. In addition, the total number of clients that individually accounted for over US$0.5 million in annual net revenues increased to eight for 2006 from four for 2005. SureKAM and Envisys’s businesses, which we acquired in September and December 2005, respectively, contributed to part of the increase in our net revenues in 2006 from 2005, as their operating results were accounted for the full year for 2006 compared to the shorter periods for 2005. Our acquisition of Prosoft in September 2006 also contributed to part of the increase in our net revenues in 2006.

 

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Cost of Revenues

In 2006, our cost of revenues was US$18.0 million, representing an increase of 96.6% from US$9.1 million in 2005. Cost of revenues represented 61.8% and 58.9% of our net revenues in 2006 and 2005, respectively. The increase is primarily due to an increase in compensation and benefit expenses of our professionals, an increase in our subcontracting costs and an increase in our professionals’ travel expenses as explained further below.

During 2006, our compensation and benefit expenses in respect of our professionals increased by 102.3% to US$13.8 million from US$6.8 million in 2005, primarily due to an increase in our number of professionals, from 1,015 as of December 31, 2005 to 1,962 as of December 31, 2006. The increase was also attributable to an increase in the average salary of our professionals. Our cost of revenues in 2006 also included US$45,000 of share-based compensation expenses arising from share options granted to our professionals in 2006 under our 2005 Stock Plan.

Our subcontracting costs increased by 87.0% to US$2.0 million in 2006 from US$1.1 million in 2005, primarily due to increases in business volumes and project scale.

Our travel expenses increased by 162.3% to US$1.2 million in 2006 from US$0.5 million in 2005, as our professionals incurred more travel expenses with the growth of our overseas onsite services and domestic enterprise solutions services.

Our depreciation expenses included in cost of revenues increased to US$0.4 million in 2006 from US$0.1 million in 2005, primarily due to increased depreciation expenses relating to computers and equipment used by our professionals.

Our acquisitions of SureKAM and Envisys in the second half of 2005 added 33 and seven professionals, respectively, to our company and contributed to the increase of our cost of revenues. These additional professionals accounted in part for the increase in our cost of revenues in 2006 from 2005, as they were included in our full year results in 2006 compared to only part of the year in 2005. Our Prosoft acquisition in September 2006, with the addition of approximately 170 professionals, also contributed to part of the increase in our cost of revenues in 2006.

The increase in our cost of revenues outpaces the increase in our net revenues, primarily because we hired more professionals to strengthen our relatively new service lines, particularly enterprise solutions services, and the utilization rate of the professionals in these service lines was relatively low while we were building up our client base and training these professionals.

Gross Profit

Our gross profit during 2006 was US$11.1 million, representing an increase of 74.5% from US$6.4 million in 2005. Gross profit as a percentage of our net revenues decreased to 38.2% in 2006 from 41.1% in 2005, as we were in the process of ramping up our relatively new service lines, particularly enterprise solutions services.

General and Administrative Expenses

Our general and administrative expenses were US$6.1 million in 2006, representing an increase of 102.9% from US$3.0 million in 2005.

Compensation and benefit expenses in respect of our administrative employees increased by 49.9% to US$1.6 million in 2006 from US$1.1 million in 2005, primarily due to an increase in our number of administrative employees, from 171 as of December 31, 2005 to 328 as of December 31, 2006. The increase was also attributable to an increase in the average salary of our administrative employees. Our general and administrative

 

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expenses in 2006 also included US$0.6 million of share-based compensation expenses arising from share options granted to our administrative employees in 2006 under our 2005 Stock Plan compared to US$67,000 of share-based compensation expenses in 2005 in connection with ordinary shares awarded to our administrative employees by principal shareholders. Our general and administrative expenses in 2005 included a US$0.3 million dividend we declared and paid to Button Software Ltd., a principal holder of our ordinary shares controlled by members of our management, in recognition of the performance of our management.

Rental expenses increased to US$1.2 million in 2006 from US$0.2 million in 2005, primarily due to our entering into new leases in Beijing, Shanghai, Shenzhen and Xi’an.

During 2006, we incurred foreign exchange losses of US$93,000, as compared to foreign exchange losses of US$32,000 in 2005. Our foreign exchange losses in 2006 were due to the appreciation of the RMB against the U.S. dollar.

Selling and Marketing Expenses

During 2006, our selling and marketing expenses increased to US$0.7 million from US$0.3 million in 2005.

Compensation and benefit expenses in respect of our selling and marketing employees increased to US$0.3 million in 2006 from US$0.1 million in 2005, as we hired more selling and marketing and business development employees and their average salary increased. Our travel and advertising expenses and amortization of certain intangible assets also increased in 2006 compared to 2005. Our selling and marketing expenses in 2006 included US$36,000 of share-based compensation expenses arising from share options granted to our selling and marketing employees in 2006 under our 2005 Stock Plan.

Government Subsidies

During 2006, our government subsidies were US$54,000, representing a decrease of 47.0% from US$0.1 million in 2005. As we relocated our office to the Haidian district in Beijing in 2005, we were entitled to government subsidies in the amount of US$79,000 from the local government, which subsidies expired in 2005.

Income from Operations

Our income from operations was US$4.3 million in 2006, representing an increase of 36.7% from US$3.1 million in 2005. This increase was due to an increase in our net revenues in 2006 compared to 2005, partly offset by the increases in our cost of revenues and operating expenses during the same period. As a percentage of net revenues, income from operations decreased to 14.9% in 2006 from 20.4% in 2005 as a result of the increases in our operating costs and expenses as described above.

Interest Income

Our interest income increased to US$0.6 million in 2006 from US$0.1 million in 2005. The increase was attributed to an increase in our cash balances in 2006, primarily due to net proceeds received from our Series B-1 and Series B-2 private placements.

Interest Expense

Our interest expense was US$4,000 in 2006 compared to US$17,000 in 2005. We recorded interest expense in 2005 in connection with our short-term borrowings to finance working capital requirements, which were repaid in 2005. We recorded interest expense in 2006 for a loan we assumed in connection with our acquisition of Prosoft. The loan was repaid in 2006.

 

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Foreign Exchange Loss

During 2006, we incurred foreign exchange losses of US$93,000, as compared to foreign exchange losses of US$32,000 in 2005. Our foreign exchange losses in 2006 were due to the appreciation of the RMB against the U.S. dollar.

Change in Fair Value of Warrants

We have recorded the warrants we issued to purchase our Series B-3 preferred shares as a liability and a derivative financial instrument. Changes in fair value of the warrants of US$0.4 million was charged to our consolidated statement of operations for the year ended December 31, 2006.

Income Tax Expense

Our income tax expense was US$2,000 for each of the year ended December 31, 2005 and the year ended December 31, 2006. Our deferred income tax expense for these two years was nil.

Minority Interest

Minority interest represented the minority shareholders’ 49% share of the net income of Worksoft Japan. Minority interest increased from US$24,000 in 2005 to US$35,000 in 2006, due to Worksoft Japan’s increased net income in 2006 compared to 2005.

Net Income

As a result of the foregoing, our net income was US$4.4 million in 2006, representing an increase of 35.3% from US$3.2 million in 2005. Net income as a percentage of our net revenues decreased to 15.1% in 2006 from 20.9% in 2005.

Liquidity and Capital Resources

Cash Flows and Working Capital

Our operations and our growth have been financed by cash generated from operations and from private placements of our preferred shares. As of December 31, 2006, we had US$20.6 million in cash and cash equivalents, compared to US$4.4 million as of December 31, 2005. As of June 30, 2007, we had US$15.7 million in cash and cash equivalents, compared to US$21.5 million as of June 30, 2006. The decrease in our cash and cash equivalents from December 31, 2006 to June 30, 2007 was primarily due to an increase in our capital expenditures relating to purchase of computers and improvement of leased premises and cash consideration paid for our acquisitions.

Our working capital as of December 31, 2005 and 2006 was US$8.5 million and US$28.0 million, respectively. We had nil and US$0.3 million outstanding bank borrowings as of such dates. Our working capital as of June 30, 2007 was US$32.5 million.

 

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The following table shows our cash flows with respect to operating activities, investing activities and financing activities in 2005 and 2006, and in the six months ended June 30, 2006 and 2007:

 

     For the Year Ended
December 31,
   

For the Six Months
Ended June 30,

 
     2005     2006     2006     2007  
     (in $ thousands)  

Net cash provided by operating activities

   1,754     2,427     562     1,851  

Net cash used in investing activities

   (3,585 )   (3,729 )   (1,204 )   (5,806 )

Net cash provided by financing activities

   5,559     17,363     17,725     (989 )

Effect of exchange rate changes

   (12 )   67     17     76  

Net increase in cash and cash equivalents

   3,728     16,061     17,083     (4,944 )

Cash and cash equivalents at beginning of year/period

   721     4,437     4,437     20,565  

Cash and cash equivalents at end of year/period

   4,437     20,565     21,537     15,697  

Operating Activities

Net cash provided by operating activities for the six months ended June 30, 2007 amounted to US$1.9 million, compared to US$0.6 million for the six months ended June 30, 2006. Net cash provided by operating activities for the six months ended June 30, 2007 was primarily attributable to net income of US$3.6 million; depreciation and amortization of property and equipment of US$0.7 million and share-based compensation expenses of US$0.5 million, which did not affect our operating cash flow; an increase of US$2.9 million in accounts receivable as a result of an increase in sales, particularly sales in the second quarter of 2007 for which payment had not been received by the end of the quarter, which negatively affected operating cash flow; and an increase of US$0.7 million in prepaid expenses and other current assets incurred by us, including expenses for purchases of computers for our clients, advances to our employees for their travel expenses and prepayments to service providers, which negatively affected operating cash flow.

Net cash provided by operating activities for the six months ended June 30, 2006 was primarily attributable to net income of US$1.7 million; an increase of US$0.6 million in accrued expenses and other payables to our professionals and business development managers for their travel expenses, the latter of which increased primarily because we enhanced our sales and marketing efforts in the six months ended June 30, 2006; an increase of US$0.4 million in accounts payable to our service providers; share-based compensation expenses of US$0.3 million, which did not affect our operating cash flow; an increase of US$2.0 million in accounts receivable as a result of an increase in sales, which negatively affected operating cash flow; and an increase of US$0.7 million in prepaid expenses and other current assets as a result of an increase in prepaid expenses incurred by us, including advances to our employees for their travel expenses and prepayments to service providers, which negatively affected operating cash flow.

Our growing business generated substantial net cash inflow as our net revenues increased from

US$11.1 million for the six months ended June 30, 2006 to US$25.4 million for the six months ended June 30, 2007, while cost of revenues and operating expenses, after deducting non-cash items and items that did not affect our operating cash flow, increased to US$20.3 million for the six months ended June 30, 2007 from US$8.9 million for the six months ended June 30, 2006.

Net cash provided by operating activities increased to US$2.4 million for the year ended December 31, 2006 from US$1.8 million for the year ended December 31, 2005. Net cash provided by operating activities for the year ended December 31, 2006 was primarily attributable to net income of US$4.4 million; an increase of US$0.9 million in accrued expenses and other payables to our professionals and our business development managers for their travel expenses; an increase of US$0.5 million in accounts payable to our service providers; depreciation and amortization of property and equipment of US$0.7 million and share-based compensation

 

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expenses of US$0.7 million, which did not affect our operating cash flow; an increase of US$4.7 million in accounts receivable as a result of an increase in sales, particularly sales in the fourth quarter of 2006 for which payment had not been received by the end of 2006, which negatively affected operating cash flow; and an increase of US$0.4 million in prepaid expenses and other current assets as a result of an increase in prepaid expenses incurred by us, including advances to our employees and prepayments to service providers, which negatively affected operating cash flow.

Net cash provided by operating activities for the year ended December 31, 2005 was primarily attributable to net income of US$3.2 million; an increase of US$0.6 million in accrued expenses and other payables to our professionals and business development managers for their travel expenses; and an increase of US$2.3 million in accounts receivable, which negatively affected operating cash flow.

Our growing business generated substantial net cash inflow as our net revenues increased from US$15.5 million for the year ended December 31, 2005 to US$29.1 million for the year ended December 31, 2006, while cost of revenues and operating expenses, after deducting non-cash items and items that did not affect our operating cash flow, increased to US$23.2 million for the year ended December 31, 2006 from US$12.1 million for the year ended December 31, 2005.

Investing Activities

Net cash used in investing activities was US$5.8 million for the six months ended June 30, 2007, primarily attributable to US$4.0 million of loans to shareholders and US$2.2 million for purchase of property and equipment, partly offset by US$0.4 million of net cash obtained from business acquisitions. Loans to shareholders included RMB20 million (US$2.6 million) lent to Airland International Limited and Bizexpress Limited, two holders of our ordinary shares, in March 2007 in connection with our acquisition of Shanghai Solutions; RMB3.2 million (US$0.4 million) lent to One Silver Development Limited, a holder of our ordinary shares, in April 2007 in connection with our acquisition of Megainfo; and RMB8.0 million (US$1.1 million) lent to Mr. Hao Yu and Mr. Wei Wei, two beneficial owners of our ordinary shares, in March 2007 in connection with our acquisition of ITC. See “Related Party Transactions—Transactions with Certain Directors, Shareholders and Affiliates.” Net cash used in purchase of property and equipment was primarily due to purchase of fixed assets and improvement of leased premises as we set up new offices in major cities across China and in Seattle in the first six months of 2007. Net cash obtained from business combinations was primarily due to a cash inflow from the acquired enterprises, net of our cash payment for these acquisitions. Net cash used in investing activities was US$1.2 million for the six months ended June 30, 2006, mainly attributable to US$1.7 million for purchase of fixed assets and improvement of leased premises as we entered into new leases in Beijing and Shanghai, and US$0.2 million paid for acquisitions of the IT service business of Envisys, partly offset by US$0.6 million repaid by Team Dragon International Limited, or Team Dragon, a holder of our ordinary shares. See “Related Party Transaction—Transactions with Certain Directors, Shareholders and Affiliates.”

Net cash used in investing activities was US$3.7 million for the year ended December 31, 2006 and US$3.6 million for the year ended December 31, 2005. Net cash used in investing activities in 2006 included US$3.6 million for purchase of fixed assets and improvement of leased premises as we entered into new leases in China; and US$0.9 million paid for acquisitions of Prosoft and SunBridges, partly offset by US$0.8 million repaid by Team Dragon in May 2006. Net cash used in investing activities in 2005 included US$1.9 million of loans lent to Button Software Ltd. and Team Dragon, two holders of our ordinary shares, and US$1.5 million for purchase of fixed assets and improvement of leased premises as we entered into new leases in Beijing and Shanghai, China.

Financing Activities

Net cash used in financing activities was US$1.0 million for the six months ended June 30, 2007, compared to net cash provided by financing activities of US$17.7 million for the six months ended June 30, 2006. Net cash used in financing activities for the six months ended June 30, 2007 included repayment of US$0.5 million loans of Prosoft and Shanghai Solutions that we assumed after we acquired these two companies; payment of

 

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US$90,000 to Harper Capital as we repurchased 30,000 Series A preferred shares from Harper Capital; US$0.1 million paid to Mr. Yonghui Zhu as partial payment for our repurchase of 86,219 ordinary shares from Mr. Zhu; and US$0.3 million of deferred costs in connection with this offering. Net cash provided by financing activities for the six months ended June 30, 2006 was primarily due to proceeds of US$24.3 million for issuance of our Series B-1 and B-2 preferred shares, partly offset by US$6.6 million we paid for repurchase of our ordinary shares from Team Dragon. See “Related Party Transactions—Transactions with Certain Directors, Shareholders and Affiliates.”

Net cash provided by financing activities was US$17.4 million for the year ended December 31, 2006, compared to US$5.6 million for the year ended December 31, 2005. We received net proceeds of US$6.8 million and US$24.3 million from the issuance and allotment of our Series A preferred shares and Series B-1 and Series B-2 preferred shares for the years ended December 31, 2005 and 2006, respectively. We paid US$6.6 million in 2006 to repurchase certain of our ordinary shares from Team Dragon. In 2005, we paid US$1.2 million to repay certain loans we borrowed from our shareholders. See “Related Party Transaction—Transactions with Certain Directors, Shareholders and Affiliates.”

Capital Expenditures

Our capital expenditures in 2005, 2006 and in the six months ended June 30, 2007 were US$1.5 million, US$3.6 million and US$2.2 million, respectively. Our capital expenditures related primarily to purchase of computers and improvement of leased premises. We expect our capital expenditures to increase in the future as we expand our business to implement our growth strategy.

We estimate that our capital expenditures will be approximately US$4.5 million in 2007, primarily used to purchase computer equipment and improve leased premises. We believe that our current cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures, for at least the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities, debt securities or borrow from lending institutions. We cannot assure you that financing will be available in the amounts we need or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would dilute our shareholders. The incurrence of debt would divert cash for working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business operations and prospects may suffer.

Contingent Acquisition Payments

In connection with our recent acquisitions of ITC, Megainfo, Chosen, a 75% equity interest in Shanghai Solutions, a 48.99% equity interest in Worksoft Japan and the IT services business of SunBridges, we agreed to make contingent payments of up to US$15.5 million in a mix of cash and our ordinary shares, of which up to US$12.1 million may be paid with cash, up to US$1.6 million may be paid with our ordinary shares, and up to US$1.8 million may be paid with cash, our ordinary shares or a combination thereof at our option; and up to 20,058 of our ordinary shares, in each case subject to the achievement of certain financial performance targets in 2007 and 2008. See “Corporate History and Structure” for a more detailed description. These contingent payments, if made, will be reflected as an increase of goodwill.

 

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Contractual Obligations

The following table sets forth our contractual obligations to make future payments as of December 31, 2006.

 

     Payments due
     Total    Within 1 year    1-3 years    3-5 years    After 5 years
     (in $ thousands)

Operating leases

   2,312    1,391    921      

Purchase obligations

   222    222         

Other short term liabilities

   256    256         
                        

Total contractual obligations

   2,790    1,869    921      
                        

Other than the obligations set forth above and the contingent payments described under “—Contingent Acquisition Payments,” we did not have any long-term debt obligations, operating lease obligations, purchase obligations or other long-term liabilities as of December 31, 2006.

Off-Balance Sheet Commitments and Arrangements

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

Inflation

Inflation in China has not materially impacted our results of operations in recent years. According to the National Bureau of Statistics of China, the change of consumer price index in China was 3.9%, 1.8% and 1.5% in 2004, 2005 and 2006, respectively.

Holding Company Structure

We are a holding company with no material operations of our own. We conduct our operations primarily through VanceInfo Beijing, our wholly owned subsidiary in China, and its subsidiaries. As a result, our ability to pay dividends and to finance any debt we may incur depends upon dividends paid by VanceInfo Beijing. If VanceInfo Beijing or any newly formed subsidiaries incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, VanceInfo Beijing is permitted to pay dividends to us only out of its retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our subsidiaries in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital, and to further set aside a portion of its after-tax profits to fund the employee welfare fund at the discretion of the board. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation of the companies.

Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our exposure to interest rate risk primarily relates to interest income generated by excess cash invested in money market securities or demand deposits with original maturities of three months or less. Interest earning

 

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instruments carry a degree of interest rate risk. We have not used derivative financial instruments to manage our interest rate risk exposure. Most of our borrowings bear fixed interest rates.

We have not been exposed to material risks due to changes in market interest rates. However, our future interest expense may increase and interest income may fall due to changes in market interest rates.

Foreign Exchange Risk

A majority of our revenues and expenses are denominated in Renminbi, while a significant portion of our revenues and expenses are denominated in U.S. dollars. The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. The conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under this policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 9.5% appreciation of the Renminbi against the U.S. dollar by September 28, 2007. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar.

The results of our operations can be adversely affected as Renminbi appreciates against the U.S. dollar. Our exchange rate risk primarily arises from our foreign currency revenues, receivables, costs and expenses, payables and other foreign currency assets and liabilities. In addition, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No.157, Fair Value Measurements, or SFAS No. 157, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 will apply to us from January 1, 2008. Earlier adoption is permitted, provided we have not yet issued financial statements, including for interim periods, for that fiscal year. We do not expect the adoption of SFAS No. 157 to have a material impact on our financial statements.

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, an amendment of SFAS 115, or SFAS 159. This Statement permits entities to choose to measure many financial instruments at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring different assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal year beginning after November 15, 2007. We do not expect the adoption of SFAS No. 159 to have a material impact on our financial statements.

In July 2006, the FASB issued Interpretation, or FIN, No. 48 Accounting for Uncertainty in Income Taxes-an interpretation of SFAS No. 109, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109 Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We adopted FIN No. 48 on January 1, 2007. The adoption of FIN No. 48 had no significant impact on our accounting for income taxes for the six months ended June 30, 2007.

 

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Business

Company Overview

We are an IT service provider and one of the leading offshore software development companies in China. We ranked among the top three Chinese offshore software development service providers for the North American and European markets as measured by 2006 revenues, according to IDC, which defines offshore software development services to include mainly ADM, testing, embedded software development, localization, as well as software research and development outsourcing. Our comprehensive range of IT services includes R&D services, enterprise solutions, ADM, quality assurance and testing, as well as globalization and localization. We provide these services primarily to corporations headquartered in the United States, Europe, Japan and China targeting high-growth industries such as technology, telecommunications, financial services, manufacturing, retail and distribution.

We offer our services through our globally integrated network of onsite and offsite delivery locations, primarily in China, to enable our clients to focus on their core competencies and improve operating efficiencies. With over 3,000 professionals as of October 31, 2007, we operate a number of CDCs, each with dedicated project teams and facilities designed to provide tailored solutions to individual clients. We believe that these dedicated CDCs provide our clients with differentiated services and enhance their confidence in our capabilities. We also deliver our services at clients’ facilities or via our offices in major cities across China.

Our major clients include Citibank, HP, IBM, Microsoft, Motorola and TIBCO. The number of our clients increased significantly from 66 for 2004 to 187 for the nine months ended September 30, 2007. We deploy our sales and marketing teams in several of our key target markets and in close proximity to our clients, which enables us to better understand our clients’ needs, effectively cross-sell our services and develop new client relationships. We have received a number of awards recognizing our service capabilities and our growth potential, including:

 

   

Second place in “China’s Most Promising Ventures” in 2006, a ranking of top 50 high-growth companies in China by venture capitalists organized by Zero2IPO Group;

 

   

Inclusion in the “Global Services 100” in 2006, a list of 100 excellent global service providers for IT outsourcing and business process outsourcing, based on studies conducted by Global Services magazine and neoIT;

 

   

The “Red Herring Top 100 Companies in Asia” award conferred by the Red Herring magazine in 2006 to innovative technology companies; and

 

   

The “Award for the Outstanding Contribution to Software Outsourcing Services” given by the Chinese Ministry of Commerce in 2005.

We began offering IT services in 1995 and have experienced significant organic growth, complemented by selective strategic acquisitions. Since 2005, we have made a number of acquisitions to strengthen our service lines and industry expertise, diversify our client base, and expand our sales network and delivery platform. Our net revenues grew from US$8.2 million in 2004 to US$29.1 million in 2006, representing a CAGR of 88.6%. Our net income grew from US$1.1 million to US$4.4 million over the same period, representing a CAGR of 97.5%. For the six months ended June 30, 2007, we generated net revenues of US$25.4 million and net income of US$3.6 million, representing a 128.5% increase and a 110.6% increase from our net revenues of US$11.1 million and net income of US$1.7 million for the six months ended June 30, 2006, respectively.

 

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Our Industry

Global IT services industry

According to Gartner, the IT services industry worldwide amounted to US$674.1 billion in 2006, representing an annual growth rate of 6.7% from 2005. Continued economic growth and increased IT spending by businesses have led to ongoing growth in the global IT services industry. Gartner estimates that this market will grow to US$964.4 billion in 2011, representing a CAGR of 7.4% from 2006. The following graph illustrates the forecasted revenue growth trend in the worldwide IT services industry from 2006 through 2011.

LOGO


 

Source:   Gartner Inc.: “IT Services Market Metrics worldwide: Forecast Database”, by Kathryn Hale; September 2007.

The following chart illustrates the worldwide IT services spending in 2006 by regions where the users of the services are headquartered, together with each region’s projected CAGR in IT services spending from 2006 to 2011.

LOGO


 

Source:   Gartner Inc.: “IT Services Market Metrics worldwide: Forecast Database”, by Kathryn Hale; September 2007.

 

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Global offshore IT services industry

Businesses globally are outsourcing a growing portion of their IT processes to improve operating efficiencies, focus on core competencies and maximize shareholder returns. More significantly, many of these businesses are increasingly outsourcing IT processes to offshore locations, such as China and India to access a high-quality and cost-effective workforce. IDC has predicted that by 2011, the global offshore IT services market will grow to US$38.0 billion, representing a CAGR of 17.1% from 2006. We believe that established China-based IT services companies like us are well positioned to benefit from these favorable trends.

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Source:   IDC (September 2007)

Key growth drivers of the global offshore IT services industry:

The following factors have contributed, and are expected to continue to contribute, to the growth of the global offshore IT services industry:

 

   

Cost savings—Due to increased competitive pressure, businesses are increasingly seeking to manage their IT spending and reduce costs. Offshore outsourcing, or offshoring, enables businesses to optimize their IT cost structure by converting a portion of their fixed cost into variable cost. Globalization and a rapidly evolving economic and business environment have driven the trend towards offshoring of IT services. To acquire high-quality IT services more cost-effectively, businesses are increasingly using offshore IT service providers. The availability of a large pool of relatively inexpensive, highly skilled offshore labor talent, particularly in China and India, has presented potential to further reduce IT service costs and created a robust offshore market.

 

   

Focus on innovation and core competencies—In order to remain competitive, businesses must focus on and continually invest in innovation and core competencies. Various IT-related processes, ranging from development to quality assurance and maintenance, are difficult to sustain internally without proper resources. Global delivery models, such as the delivery of IT services via offshore development centers, enable businesses to capitalize on labor arbitrage and build on their core competencies in a cost-effective manner.

 

   

Opportunities through all phases of the economic cycle—Continued economic development in the United States, Europe and Japan, and strong economic growth in China, are expected to support business expansion

 

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and capital investment, thereby bolstering spending on new IT services outsourcing projects. On the other hand, while slower economic growth may curb investments in new IT services outsourcing projects, businesses may be more likely to outsource existing IT-related processes to third-party vendors to maintain profitability.

 

   

Growing complexity and globalization of IT processes—Many multinational corporations need to outsource a wide range of IT services that often require global IT support. As IT processes become increasingly complex and can be implemented globally, businesses are more likely to outsource these processes to offshore vendors to capitalize on the more cost-efficient and flexible offshore talent pool.

China-based IT services industry

We believe that the growth of the China-based IT services industry is expected to significantly outpace the overall global IT services industry. According to Gartner’s forecast below, the IT services industry in China is projected to grow at a CAGR of 16.2% from 2006 to 2011, a much higher rate than the expected growth of the global IT services industry.

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Source:   Gartner Inc.: “IT Services Asia Pacific Forecast Database”, by Freddie Ng; September 2007.

China-based offshore IT services industry

As part of the growth of the IT services industry in China, China is rapidly developing as an emerging alternative destination for U.S., European and Japanese companies offshoring their IT services. By outsourcing to China, overseas companies are able to access its fast growing supply of professionals while aligning their IT offshoring initiatives with their overall China business development strategy. As shown in the graph below, IDC has estimated that the China-based offshore software development industry, including services in ADM, testing, embedded software development, localization, as well as software research and development outsourcing, is estimated to grow from US$1.4 billion in 2006 to US$6.9 billion in 2011, representing a CAGR of 37.9%. The growth of the China-based offshore IT services industry is expected to far outpace those of the global IT services and global offshore IT services industries.

 

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Source:   IDC (March 2007)

Key growth drivers of the China-based offshore IT services industry:

The China-based offshore IT services industry is expected to experience significant growth mainly driven by:

 

   

Diversification away from more established Indian IT offshoring companies—Businesses generally prefer diversifying their offshore IT service providers in order to control risks resulting from IT offshoring. China has become an increasingly attractive alternative offshoring destination due to increases in the labor costs and attrition rates in India. According to IDC, a growing number of North American and European businesses are increasing their offshore IT spending in China, and revenues from these clients grew by 93.6% in 2006 from 2005. Whereas the offshoring industry has become relatively mature in India, offshoring in China is still at an early stage of its development, but is expected to experience rapid growth in the next few years.

 

   

Access to Japanese and Korean markets—Due to the geographic proximity and cultural similarities between China, Japan and Korea, many Japanese and Korean companies employ Chinese professionals to leverage the lower cost of labor in China. This has created, and is expected to continue to create, opportunities for China-based IT service providers to access to Japanese and Korean markets. According to IDC, approximately US$772.5 million of the China-based offshore software development revenues was derived from the Japanese and Korean markets in 2006.

 

   

Rapid growth in domestic IT services market—Fueled by the continuous domestic economic growth, the China-based IT services market is expected to grow rapidly at a CAGR of 16.2% from 2006 to 2011, according to Gartner. This presents additional opportunities for established China-based IT services companies, which generally have advantages in being accustomed to the local business environment and understanding Chinese clients’ needs.

 

   

Labor talent—According to the National Bureau of Statistics in China, China has established a large-scale educational system that graduated approximately 600,000 advanced degree holders in engineering in 2005. This large talent pool provides an abundant supply of qualified candidates for IT services professionals.

 

   

Cost advantage—According to IDC, China-based IT service providers enjoy greater cost advantages than those in India. According to neoIT, salary levels in the Chinese IT services industry are projected to grow at a CAGR of 7.2% from 2005 to 2010, compared to 8.7% in India.(1)


(1)   Source: neoIT (June 2006)

 

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Government support—The Chinese government has adopted various incentives, including favorable tax treatment, to support the growth of the IT services industry. In addition, government authorities in various parts of the country have invested in infrastructure construction to create a favorable business environment. In particular, the Beijing municipal government has established Zhongguancun Software Park, where our principal offices are located, which offers superior infrastructure such as utilities, facilities and transportation services.

Our Competitive Strengths

We believe that the following strengths differentiate us from our competitors and enable us to capitalize on the projected growth in the IT services industry based in China.

Proven Ability to Grow Rapidly and Sustain Profitability

We have experienced significant organic growth in recent years, complemented by selective strategic acquisitions. We ranked among the top three Chinese offshore software development service providers for the North American and European markets as measured by 2006 revenues, according to IDC. The number of our professionals increased from 536 as of December 31, 2004 to 3,047 as of October 31, 2007. The number of our clients increased from 66 for 2004 to 187 for the nine months ended September 30, 2007. Our net revenues grew from US$8.2 million in 2004 to US$29.1 million in 2006, representing a CAGR of 88.6%. We have successfully managed our growth in the number of our professionals and clients, as well as our revenues and net income, by investing in infrastructure and by recruiting, training and rapidly deploying new professionals. We have achieved and maintained profitability even as we have rapidly expanded our business operations and continued to upgrade and expand our service lines.

Extensive Suite of Sophisticated IT Services and Flexible Delivery Model

We have over ten years of experience in R&D services and have accumulated a variety of skill sets with respect to the outsourced development of computer software and hardware products over a broad spectrum of technology areas. On the strength of our core competencies in R&D services, we now provide a comprehensive suite of IT services that span the entire software development life cycle, ranging from enterprise solutions, ADM, quality assurance and testing to globalization and localization. These comprehensive offerings enable us to capture a greater share of our clients’ IT budgets, extend our network of relationships, broaden our dialogue with key decision makers within each client and reduce our service-mix concentration. We have a well-defined methodology to update and extend our service lines to meet the evolving needs of the global marketplace.

We have established a broad and flexible delivery base for our services. We currently operate a number of CDCs with dedicated project teams and facilities designed to tailoring solutions for individual clients. We employ advanced technology to ensure a high level of security and address our clients’ concerns regarding confidentiality and intellectual property protection. Our professionals also serve our clients at clients’ facilities or via our offices in major cities across China and overseas offices in the United States and Japan. We believe our delivery base offers us a number of important business advantages, including a scalable infrastructure to efficiently deploy resources, an enhanced ability to service major clients with dedicated resources and enhanced business continuity capability.

Long-standing Relationships with Blue-Chip Clients

We have established long-standing relationships with some of the world’s leading companies. We have achieved strong revenue growth by focusing on select, long-term customer relationships that we refer to as strategic accounts. Our established, long-term relationships typically develop from initially performing discrete projects to providing multiple services spreading across the clients’ various businesses. On the strength of our execution capabilities, quality delivery results and diversified service lines, we have provided IT services to our strategic

 

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accounts, including Citibank, IBM, Microsoft, NEC System and TIBCO. Net revenues from these clients, excluding NEC System which has been served by a business we acquired in 2007, grew from US$10.6 million, or 68.2% of our total net revenues in 2005, to US$19.0 million, or 65.5% of our total net revenues in 2006. Net revenues from the same four clients grew from US$7.6 million, or 68.1% of our total net revenues, in the six months ended June 30, 2006 to US$14.1 million, or 55.6% of our total net revenues, in the six months ended June 30, 2007. By leveraging our long-standing client relationships, we can gain a better understanding of our clients’ needs and effectively cross-sell our services. We also solidify and expand our client relationships by actively participating in our clients’ own marketing efforts. In addition, our success with existing clients provides us with strong references and validation to help secure new clients.

Strategic Positioning in High-Growth Industries and Geographic Markets

Our business is diversified across a range of industries and geographic markets. We have targeted a number of high-growth industries such as technology, telecommunications and financial services through a combination of organic growth and focused acquisitions and are thus strategically positioned to benefit from the attractive growth opportunities in these industries. Our clients include Microsoft and TIBCO in the technology industry, Huawei and Motorola in the telecommunications industry, and Bank of Communications and Citibank in the financial services industry. Our expertise and experience in these industries enable us to better respond to the technological challenges faced by our clients and expand our service lines and client base.

Our client base is geographically diverse, encompassing corporations headquartered in the United States, Europe, Japan and China. We believe that our diversified geographic coverage will assist us in weathering potential downturns in one particular region. We typically provide IT services to our clients to enhance and facilitate their operations in China. In addition, our recent acquisitions of two companies with Japanese client bases and execution capabilities position us well to capture greater business opportunities in Japan. We believe that our diversified business model will assist us in achieving relatively stable revenue and cash flow, which will allow us to more effectively plan and invest in the growth of our business.

Experienced Management Team and High-Quality Professionals

We benefit from the effective leadership of a management team with diverse backgrounds and extensive experience in IT services. Our top eight senior managers have an average of 15 years of industry experience in their relevant fields. Our management team has extensive experience in working outside of China and managing the business operations of multinational corporations. Moreover, we believe that our management team has successfully guided our rapid expansion while increasing client satisfaction.

We were named one of the “Top 100 Employers Most Favored by University Graduates” by the China Central Television Economic Affairs Channel and two career services organizations in 2006. Our reputation as a leading offshore software development service provider in China and our relationships with high-profile clients allow us to attract and retain talent in China. As of October 31, 2007, we had over 3,000 skilled professionals. Our investment in employee recruitment, training and retention enables us to rapidly increase the scale of our operations. In addition, our internship programs at 14 Chinese universities and various on-campus training activities give us a high profile within a high-quality talent pool and hence a competitive edge in recruiting the best candidates.

Disciplined Acquisition Strategy and Proven Integration Capability

The primary driver of our growth has been organic business development, complemented by selective strategic acquisitions. Since 2005, we have completed a number of acquisitions and have demonstrated our ability to successfully integrate our acquisitions into our business. These acquisitions have strengthened our service lines and industry expertise, diversified our client base and expanded our delivery platform. For example, our acquisition of SureKAM’s international business has expanded our service capabilities and added several key

 

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management members to our team. Our acquisition of Prosoft brought us a group of approximately 170 highly experienced and motivated professionals and strengthened our expertise in telecommunications industry. Our acquisition of ITC strengthened our R&D services capabilities and telecommunications expertise and provided us with access to cooperation with more clients in the telecommunications industry. Our acquisition of a majority interest in Shanghai Solutions and our acquisition of Megainfo have broadened our Japanese client base and added executives with Japanese expertise. Our acquisition of Chosen has strengthened our expertise in enterprise solutions.

Our Strategy

Our goal is to become the leader in the rapidly growing IT services industry in China. Our growth strategy consists of the following elements:

Further Strengthen and Expand Service Line Expertise

We intend to distinguish ourselves by further enhancing our capabilities in the full spectrum of IT services. We aim to continue leveraging our current technical capabilities and expertise to expand into new lines of business that require a more complex skill set and offer higher billing rates. While we continue to strengthen our competencies in R&D services, ADM, quality assurance and testing, and globalization and localization, we will devote greater resources to enterprise solutions, consulting services, business process outsourcing and infrastructure outsourcing, which present significant market potential. We aim to provide our clients with a “one-stop shop” solution to meet all of their external IT service needs. We also plan to obtain additional quality control certifications to inspire greater client confidence in our services. Furthermore, as many of our existing services are complementary, we intend to bundle them and provide more sophisticated and higher value-adding IT services to our clients.

Continue to Penetrate and Grow Strategic Client Accounts

With broader service line capabilities, we are well positioned to expand our relationships with our strategic accounts. Building on our established relationships with contacts within existing clients, we will continue cross-selling our wide range of services to other departments and regional offices of our clients. We plan to leverage our strong presence in China and Japan and our better understanding of the cultures and markets of these countries to provide more technical support for our clients’ marketing activities in these countries. We believe that our participation in these marketing efforts presents new opportunities to further develop our partnerships with our clients and will contribute to our revenue growth while creating additional value for our clients through high-quality performance and delivery.

Expand Geographic and Industry Reach

We plan to continue to grow our client base in the United States and Europe by strengthening our sales and marketing efforts targeting these markets. We will also continue to focus on gaining market share in the Japanese outsourcing market based on our recently enhanced Japanese capabilities. In addition, as China is one of the fastest-growing economies in the world and has a substantial IT services market, we intend to devote greater efforts to capturing the increasing market opportunities presented by the expected growth in the Chinese domestic demand for IT service expertise.

We also intend to broaden our expertise to cover a wider range of industries. We will maintain and enhance our core competencies in the technology and telecommunications industries, and strengthen our competencies in the financial services industry. Furthermore, we intend to strengthen our position in the manufacturing, retail and distribution industries while diversifying into other industries in which clients are seeking to outsource their IT service requirements.

 

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Continue to Improve and Optimize Delivery Capabilities

We intend to develop and maintain a robust delivery infrastructure that will enable us to accommodate volume increases, add new processes, rapidly scale existing processes and meet clients’ evolving demands. We plan to build a multi-shore, global delivery model by exploring opportunities to establish additional overseas delivery offices and expand into other parts of China in response to market demand and client preference. We intend to enhance our human resource management by capitalizing on China’s large talent pool, especially the cost-effective talent supply from outside the major cities, while enhancing our retention efforts. To keep abreast of advances in technologies, we will continue our focus on systematic knowledge management and internal education by leveraging the learning and experiences of our employees. We are committed to improving our methodologies and toolsets and will continue to invest in refining our processes. We have invested heavily in the customization and application of our technical process management system, which we refer to as the VanceInfo Technical Delivery Platform, in order to better streamline our delivery process and project management.

Pursue Strategic Acquisitions and Alliances

Our disciplined and selective approach in acquisitions has allowed us to integrate our operations into the same platform while simultaneously expanding the breadth of our service lines and our industry and geographic coverage. Building on our strong acquisition track record, we plan to continue to selectively consider strategic relationships with industry leaders or acquisitions that would complement our existing services or client base, add to our industrial expertise coverage, or expand our geographic reach. Particularly, we plan to strengthen our industry competencies and enhance our onshore delivery capabilities through acquisitions of and partnerships with synergistic IT services companies in the United States and China.

Service Lines

We categorize our service lines into R&D services, enterprise solutions, ADM, quality assurance and testing, as well as globalization and localization, which we develop in response to client requirements and technology life cycles.

Set forth below is our net revenues breakdown by service lines for the periods indicated:

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2005     2006     2006     2007  
     (in $ thousands, except percentages)  

R&D services

   9,178    59.3 %   18,266    62.9 %   6,561    59.0 %   15,719    61.9 %

Enterprise solutions

   239    1.5     2,163    7.4     677    6.1     2,259    8.9  

ADM

   1,643    10.6     2,328    8.1     915    8.2     3,206    12.6  

Quality assurance and testing

   1,734    11.2     3,208    11.0     1,462    13.1     2,281    9.0  

Globalization and localization

   2,687    17.4     3,086    10.6     1,503    13.5     1,933    7.6  
                                            

Total net revenues

   15,481    100.0 %   29,051    100.0 %   11,118    100.0 %   25,398    100.0 %
                                            

We are capable of offering each of our service lines to clients in a variety of industries, including the technology, telecommunications, financial services, manufacturing, retail and distribution industries.

Research and Development Services

We provide product development services for software systems that are implemented in computers and embedded systems. We typically market these services to the chief technology officers, engineering vice presidents or outsourcing project heads of technology product development companies, ranging from independent software vendors to telecommunications equipment developers.

 

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We have accumulated a variety of skill sets from over ten years of experience in the outsourced development of computer software and hardware products. We provide R&D services in all phases of development, from requirements analysis, concept generation, product realization, to quality assurance and testing and technology and information transfer to the client. We offer our services over a broad spectrum of technology areas and are able to provide our clients complete subsystems or entire products.

We develop various software products, including middlewares, Internet protocols and other software. We also focus on embedded software technologies that involve the design and development of software solutions embedded in the hardware of a particular device. In addition, we provide cost-effective testing services to help technology product development companies improve their hardware and software. Our research and development resources allow us to serve clients that seek highly skilled product development services, including services for their core technologies. Our timely delivery capabilities help our clients to gain a time-to-market advantage during their product development process. We also employ advanced processes and tools to ensure a high level of protection of clients’ intellectual property.

The following case studies describe the R&D services we provide to three of our clients:

TIBCO (a Nasdaq-listed software company with over 3,000 customers and offices in 40 countries)

Client’s Project Requirements.    TIBCO, which we have served since 2005, sought to improve the operating efficiency, price competitiveness and time-to-market of its core products to remain competitive. To achieve its goals, TIBCO sought to lower its software research and development costs through outsourcing. TIBCO chose us as a partner to assist with the full development cycle of several of its product lines. One such product line was TIBCO’s B2B suite, which is a standards-based business-to-business integration platform for secure transmission of business documents and messages among disparate partner systems.

Our Solutions.    Our team worked closely with the managers and engineers at TIBCO’s global headquarters to understand the client’s requirements, which included the development of several new B2B protocols. We performed extensive studies and analyses to meet the following technical requirements of TIBCO’s B2B suite project:

 

   

understanding of leading industry standard B2B protocols;

 

   

Extensible Markup Language, or XML, processing and parsing;

 

   

security and authentication based on product key infrastructure, or PKI platform;

 

   

TIBCO infrastructure products; and

 

   

Java language for platform independence.

During the course of the B2B suite project, our TIBCO CDC actively worked in every key aspect of the structuring and formation of the B2B platform, including framework design, concrete coding, quality assurance and testing, and particularly, the documentation of the development process, which enables TIBCO to access critical know-how for the buildup of the B2B platform in the future and thus enhances the operation efficiency of the platform. The new product was released in January 2007, and is now widely used by TIBCO’s customers.

Current Relationship with Client.    We have been involved in the ongoing enhancement of over 30 products across all areas of research and development at TIBCO.

We have a team of approximately 20 professionals dedicated to the B2B suite project. Following the release of the new version of the B2B suite, our B2B team continues to play a significant role in building up additional B2B protocols. Additionally, due to our experience working with TIBCO products, we have also had the opportunity to work on additional professional services for local TIBCO customers under separately billed assignments.

 

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A Fortune 100 multinational software company

Client’s Project Requirements.    The software company is mainly engaged in operating system development for personal computers. Application compatibility is typically a critical concern for personal computer users when upgrading to a new version of an operating system, and may significantly affect this client’s sales performance. In a recent important release, this client needed to develop a software component and conduct extensive testing to ensure applications under the older version operating system would be compatible with the new version. It decided to appoint an independent service provider for this specific issue due to a tight schedule and budget concerns. The task required not only in-depth knowledge of both the old and new versions of this operating system, but also rich experience in software development and testing work.

Our Solutions.    We assembled a highly qualified and experienced development and testing team, and dispatched them to the client’s premises to work closely with its development personnel. During the four-month development process, our professionals designed various transition programs of the software component for over 80 types of applications, and automated over 70 tests covering approximately 160 Application Programming Interfaces, or APIs. Our understanding of the two versions of the operating system, know-how across development and testing processes, and outstanding communications and coordination capabilities enabled us to deliver the work on time, facilitating the client’s successful launch of the upgraded operating system.

Current Relationship with Client.    We were one of the first Chinese service providers to help this software company resolve such a technically challenging and strategically important issue. Since then, we have been involved in a wide range of R&D services for this client on over 100 projects. Currently, we are one of the largest Chinese service providers working with this software company in terms of revenues and number of dedicated professionals. Meanwhile, we have been appointed by this client for more technically challenging projects such as developing operating systems on various embedded devices.

Huawei (a leading Chinese telecommunications equipment manufacturer with over 61,000 employees)

Client’s Project Requirements.    In 2004, Huawei appointed us to develop label switch protocol management system, or LSPM, version 1.0, for network management of Internet communications. As Huawei’s customers, who are mainly telecommunications carriers, were in urgent need of this system, we were required to deliver LSPM version 1.0 within a tight timeframe.

Our Solutions.    We assembled a project team consisting of an experienced project manager and 10 professionals, each with a background in the telecommunications industry, to facilitate our completion of this project within the required deadline. Since LSPM was designed for the provision of an integrated platform for all network switch elements, our team devoted extensive efforts to making the system compatible with switch equipment manufactured by various vendors. Our LSPM version 1.0 also provides Huawei’s customers with a user-friendly interface to efficiently manage network communications and shorten their response time to telecommunication service subscribers. In addition, we adhered to high standards of quality control, risk management and progress control in performing our work for this project.

Current Relationship with Client.    Historically, Huawei was reluctant to outsource software development due to quality concerns. Recognizing the quality of our services for LSPM version 1.0, Huawei further engaged us to develop LSPM version 2.0 and version 3.0 under subsequently negotiated assignments, which had a project scale much larger than that of version 1.0. Currently, we are one of the major R&D service providers of Huawei.

Enterprise Solutions

We provide clients with a full spectrum of services in enterprise solutions, including enterprise resource planning, or ERP, customer relationship management, or CRM, supply chain management, enterprise application integration, or EAI, and system support and maintenance. We provide implementation and maintenance services

 

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for major enterprise resource planning systems, including SAP, Siebel, Peoplesoft, JD Edwards, Microsoft Dynamics and Oracle E-Business Suite. We provide comprehensive management and ongoing optimization of customer enterprise solutions. Our offerings, which are usually billed separately on a time-and-material basis, include:

 

   

packaged evaluation and selection;

 

   

packaged implementation;

 

   

customization;

 

   

regional rollout;

 

   

enhancement, maintenance and product support;

 

   

version upgrades; and

 

   

business intelligence/data warehouse, or BI/DW.

Our enterprise solutions are intended to help our clients focus on their core competencies and significantly reduce the clients’ expenses by taking advantage of our IT expertise. We focus on providing customized enterprise implementation that is both innovative and seamless, offering clients cost-effective solutions for consistent results.

The following case studies describe the enterprise solutions services we provide to two of our clients:

A Fortune 100 company in the wireless and broadband communications business

Client’s Project Requirements.    Facing intense competition from other industry players, the communications company was under pressure to improve the efficiency and effectiveness of its channel management. The Mobile Devices Business Unit of the communications company intended to introduce a system based on the Siebel platform with the following defined targets:

 

   

accurate sales forecast by model and retail shop;

 

   

operation performance evaluation by volume and profitability by retail shops; and

 

   

sales and competition analysis to outline promotion and incentive plan.

Our Solutions.    We have worked closely with the communications company’s other service providers on this project since February 2006. Our team actively participated in the full life cycle of Siebel implementation from business requirements analysis, system design analysis, system structuring, implementation, testing, release to production, post production support and post-production change requests and enhancements and operation. As of September 30, 2007, we had devoted over 250 man-months to this project. We performed extensive studies and interviews to better understand the client’s specific needs and designed solutions by tailoring the Siebel system to meet the client’s business needs and technical requirements. Since the launch of the system, the communications company has significantly improved its retail channel management.

Current Relationship with Client.    Following the operation of the above project, we continue to provide supporting services for the client’s system on an on-going basis under separately billed assignments. We are also responsible for the installation and maintenance of the system under various operating environments. Furthermore, this client chose us to be one of its preferred service providers in Siebel implementation.

Adidas (a world leading sportswear and sports equipment manufacturer with over 26,000 employees)

Client’s Project Requirements.    Adidas, which we have served since 2006, needed assistance in implementing a system to handle and analyze data from the following sources:

 

   

thousands of franchised stores across China;

 

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a growing number of wholly-owned outlets; and

 

   

entities previously owned by Reebok which Adidas acquired.

In late 2006, Adidas appointed us to deliver a DW/BI solution to efficiently store, manage and utilize its business data.

Our Solutions.    In early 2007, we began developing a Cognos based DW/BI solution capable of helping Adidas to achieve its goal of improving its supply chain and financial management framework. We designed and implemented a DW/BI solution to extract data from Adidas’s SAP system, transfer such data to Microsoft Structured Query Language, or SQL, server pre-staging database, and load the data into a data warehouse in an expedient and cost effective manner. The team then generated standard reports and online analytical processing, or OLAP, to fulfill the demands of Adidas’s key users and data analysts. We conducted the requirement collection process by analyzing business processes and performing comprehensive tests to ensure that the system conformity and performance standards were met. Recently, we have also been requested to provide post-production support under separately billed assignments to ensure stable operation of the data warehouse and function as a helpdesk to support the ongoing changes in user data requirements.

Current Relationship with Client.    As our relationship with Adidas evolves, we have accumulated extensive knowledge of Adidas’s IT systems. We have successfully expanded our services to Adidas, such as phased data warehouse construction, Cognos reports/cube development, and post-production support. Our Adidas team is comprised approximately of ten engineers dedicated to working on various Adidas projects. As of September 30, 2007, the team had devoted over 60 man-months to data warehouse design, data integration from SAP, and BI platform construction for Adidas. We intend to continually leverage our understanding of Adidas and its IT systems to provide more support and solutions for this client in the future under separately billed assignments.

Application Development and Maintenance

We design, develop and implement software solutions to meet a variety of client requirements. We also provide maintenance services for large software systems, which may include modifications and enhancements to the system and product support. Unlike our R&D services that target research and development spending by technology product development companies, our ADM services target our clients’ other IT spending, which is generally controlled by their chief information officers. We perform application design, programming, testing and maintenance either in our delivery offices or at our clients’ sites. Our projects include new development and significant functional enhancements to existing software applications. We have developed expertise in mainframe, customer-server, Internet and mobile software technologies and on emerging platforms such as Windows series, Linux, Unix, IBM Mainframe and Symbian. Our major programming language tools include C/C++, Java/J2EE/J2ME, JSP and .NET.

We offer a wide spectrum of ADM services to our clients, designed to help them manage their IT outsourcing spending. The following case study describes the ADM services we provide to one of our clients:

NEC System (a subsidiary of NEC Corporation, a multinational technology company headquartered in Japan with operations in over 40 countries)

Client’s Project Requirements.    NEC System positions itself as a key supplier of application solutions to governments, telecommunications carriers and enterprises and has built up its core competencies in this sector. Facing intensive competition from other industry players, declining project prices and climbing labor costs, as well as customers’ constantly changing demands and increasing requests for customization, NEC System decided to outsource development work to lower-cost locations, such as China. However, NEC System has always had concerns about outsourcing, particularly in the following aspects:

 

   

quality assurance, which is critical for NEC System to serve its customers in Japan;

 

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on-time delivery; and

 

   

understanding the demands of end users.

Our Solutions.    Shanghai Solutions, which we acquired in 2007, built up a team to assist NEC System in 2002. Currently, we maintain a dedicated development team of over 100 engineers for NEC System. Our strict cost control, project management experience and economies of scale brought cost advantages to NEC System in the Japanese market. To meet the quality requirements of NEC System’s customers, we designed a set of development processes and a quality control system which meet NEC System’s own standards. We have also strengthened NEC System’s confidence in our quality control through stringent internal inspection and continual improvements. Through our real-time Web-based monitoring and communications system, we are able to control the work progress and better understand the demand and feedback from NEC System and its customers. In addition, our in-depth industry expertise has enabled NEC System to better serve its customers in a short timeframe.

Current Relationship with Client.    We set up a WEB Application System Development Center in Shanghai for NEC System with approximately 200 engineers, and have devoted over 100 man-months for NEC System’s projects every month. Our partnership with NEC System has enabled it to sustain a competitive position in the Japanese market. For instance, due to our delivery capability, NEC System won a project of 1,500 man-months from COREPLUS, lasting from 2004 to 2007.

In addition, NEC System is currently a minority shareholder of our subsidiary, Shanghai Solutions, which further solidifies the strategic partnership between NEC System and us.

Quality Assurance and Testing

Businesses rely on quality assurance and testing to reduce defects and enhance IT applications. As testing is relatively independent from the development process, many clients outsource testing to third-party service providers, which also mitigates conflicts of interest faced by their internal testing department and enhances the neutrality and accuracy of testing. Our testing services help clients successfully and cost-effectively realize their goals. Our advanced testing skills, cost-effective testing approaches, and proven testing methodologies help clients improve their hardware and software.

We offer customized and automated testing practices according to clients’ business needs, including functional testing, globalization and localization testing, automation testing, performance testing, remote testing and test process consulting. Our testing engineers are well trained in several test management tools such as Performance Studio, WinRunner/LoadRunner and TestDirector.

The following case study describes the quality assurance and testing services we provide to one of our clients:

A Fortune 100 financial services company

Client’s Project Requirements. In 2006, a European subsidiary of the financial services company decided to adopt a new system to manage its banking businesses ranging from retail banking, credit cards to capital markets services. Due to the complexity of the project and its importance to our client’s business, rigorous tests must be conducted before the launch of this new system. The client required that the service provider have:

 

   

extensive experience in testing;

 

   

solid knowledge of financial services industry practice;

 

   

clear understanding of relevant local regulations; and

 

   

cost effective and timely delivery capabilities.

 

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Our Solutions. We set up a joint testing center with the client in 2003, where we established well-defined testing processes, methodologies and project management procedures for the client’s projects. For this specific testing project, we formulated a comprehensive testing plan together with the client’s software developers. We deployed, on short notice, a dedicated testing team of over 100 engineers. We participated in the testing work during each phase of the project, from system integration testing during system development to customer acceptance testing during implementation. The project is proceeding smoothly and is expected to be completed in 2008.

Current Relationship with Client. Our testing team dedicated to the client’s joint testing center had grown to approximately 165 engineers as of September 30, 2007. Since 2006, we have also been retained by the client’s Asia-Pacific research headquarters and other branches for various testing projects under separately billed assignments.

Globalization and Localization

We started our business in 1995 by offering globalization and localization services to help clients penetrate local markets. We also started our engagement for several of our key clients, such as IBM, by providing quality globalization and localization services. Our globalization and localization services consist of a multi-step process to create the specific language versions of our clients’ software and hardware, including software applications, printed documents, communications materials, website contents, desktop publishing, E-learning and training content. Our globalization and localization services are generally billed on a time-and-material basis. Our customized solutions include:

 

   

software and content localization;

 

   

localization engineering;

 

   

localization testing;

 

   

internationalization engineering; and

 

   

internationalization testing.

We provide these services to meet our clients’ cultural, linguistic, legal, technical and marketing requirements in a specific country or region. Currently, we provide high-quality globalization and localization services at significant cost savings and offer translation services into over 35 languages, including English, simplified Chinese, traditional Chinese, Japanese and Korean. Our superior project management capability enables us to maintain long-term relationships with our clients as they generally continue to work with us for upgraded versions or updates of existing products, under separately negotiated and billed contracts or SOWs entered into subsequently.

The following case studies describe the globalization and localization services we provide to two of our clients:

A Fortune 100 international information technology company

Client’s Project Requirements.    In 1998, the information technology company decided to release an upgraded version of its enterprise solution product which enables customers to better manage their infrastructure operations and IT processes, in the Asian market. The information technology company required that the upgraded enterprise solution product with all of its new features be translated into multi-linguistic versions, and all testing work be completed to ensure the stability and suitability of these versions. This project required not only globalization and localization expertise, but also deep understanding of the structure and features of the enterprise solution product. In addition, the information technology company targeted to release qualified local versions in Asia within a very short lead time.

Our Solutions.    As a major testing vendor for the enterprise solution product of this information technology company, we had accumulated in-depth knowledge and experience with respect to its enterprise solution product. We set up a team consisting of localization and testing experts to provide one-stop-shop services to the

 

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information technology company, from translation, desktop publishing in Simplified Chinese, English, Japanese, Korean and other languages, to localization testing and localization engineering. In particular, by leveraging our project management experience, we designated a senior project manager to control the working process, coordinate different service stages and plan an elaborate timetable in order to shorten the overall turnaround time. Within the planned budget, our localization services achieved quality delivery of the enterprise solution product localized versions in a timely manner.

Current Relationship with Client.    As one of this leading information technology company’s earliest localization vendors, we have maintained a long-term relationship with this client for its different product lines. We have approximately 45 dedicated professionals in the client’s localization team each year, providing localization, engineering, and translation verification testing services. In addition, we provide a full-spectrum of services, including quality assurance and testing, software development and enterprise solutions.

A Chinese subsidiary of one of the largest global enterprise software providers

Client’s Project Requirements.    The client believed that a truly global enterprise software company should have a presence in every country and decided to expand their business to Asia, especially China. In order to attract local Chinese customers and successfully penetrate the Chinese market, the client sought to develop Chinese versions of its products, including user interface applications, user manuals and related content.

Our Solutions.    We established a highly qualified in-house engineering team dedicated to the client’s localization project. Our team worked closely with engineers and business managers of the client to obtain first-hand information from end users, which helped us to better understand end users’ behavior patterns and provided us the basis to structure and customize user interface applications and improve user manuals. Following the completion of the user interface application construction, we also designed test plans and implemented the test cases/scenarios to monitor and ensure the functionality and compatibility of the localizations and customizations. We performed extensive analysis and were able to meet the following requirements of the client:

 

   

domain expertise and technical sophistication to handle complex enterprise applications;