nine20fa-062308alt.htm
UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C.
20549
_______________________
FORM 20-F/A
UNDER
THE SECURITIES ACT OF
1933
_______________________
|
|_|
|
REGISTRATION
STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
|
|X|
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
fiscal year ended December 31,
2006.
Commission file number: 000-51025
|
|_|
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
|_|
|
SHELL
COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
Date of
event requiring this shell company report
___________________________.
For the transition period from
__________________ to ____________________.
Commission
file number ________________________________________________.
Ninetowns Internet Technology Group
Company Limited
|
(Exact name of Registrant as
specified in its charter)
|
Cayman Islands
(Jurisdiction of incorporation or
organization)
22nd Floor, No. 1
Tower
Majestic Towers, No. 20 Gong Ti East
Road
Chaoyang District Beijing
100020
The People’s Republic of China
telephone: (86 10)
6588-7788
facsimile: (86 10)
6588-2290
e-mail:
ir@ninetowns.com
(Address of principal executive
offices)
_______________________
SEC
1852 (12-05)
|
Persons who respond to the
collection of information contained in this form are not required to
respond unless the form displays a currently valid OMB control
number.
|
American
Depositary Shares,
each
representing one ordinary share, par value HK$0.025 per share
_______________________
Indicate
the number of outstanding shares of each of the Issuer’s class of capital or
common stock as of the close of the period covered by this Annual Report:
34,991,834 ordinary shares, par value HK$0.025 per share.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes
|_| No |X|
If this
report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.
Yes
|_| No |X|
Note –
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from
their obligations under those Sections.
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes
|X| No |_|
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act. (Check one):
Large
accelerated filer
|_| Accelerated
filer
|X| Non-accelerated
filer |_|
Indicate
by check mark which financial statement item the registrant has elected to
follow.
Item 17
|_| Item 18 |X|
If this
is an annual report, indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act).
Yes
|_| No |X|
EXPLANATORY
NOTE
This
Amendment No. 2 on Form 20-F/A, or Amendment No. 2, amends our annual report on
Form 20-F for the year ended December 31, 2006, or the Annual Report, filed with
the Securities and Exchange Commission on July 16, 2007. This
Amendment No. 2 includes the complete text of each item that was amended by
Amendment No. 1 on Form 20-F/A, or Amendment No.1, filed with the Securities and
Exchange Commission on July 17, 2007.
Except as
described above, this Amendment No. 2 does not revise or update the Annual
Report or Amendment No. 1 in any other way.
Item 3. Key
Information.
A. Selected
financial information and other data
The
following table shows selected consolidated financial information and other data
for our business. You should read the following information in conjunction with
Item 5 of this annual report, “Operating and Financial Review and Prospects.”
The statement of operations data and cash flow data for the years ended December
31, 2004, 2005 and 2006, and the balance sheet data as of December 31, 2005 and
2006, are derived from our audited consolidated financial statements and related
notes thereto, which are included in this annual report beginning on page F-1.
These audited consolidated financial statements and the related notes thereto
have been prepared in accordance with accounting principles generally accepted
in the United States, or U.S. GAAP.
The
statement of operations data for 2002 and 2003, and the balance sheet data as of
December 31, 2002 and 2003, are derived from our audited consolidated financial
statements which have not been included in this annual report.
In thousands, except per share,
per ADS and
|
|
For the year ended December
31,
|
|
|
|
|
operating data and
percentages
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statement of operations
data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Enterprise
software
|
|
RMB 93,375
|
|
|
RMB 113,791
|
|
|
RMB
188,720
|
|
|
RMB
203,488
|
|
|
RMB
116,833
|
|
|
US$
14,971
|
|
Software
development services
|
|
|
14,400
|
|
|
|
19,045
|
|
|
|
12,723
|
|
|
|
35,700
|
|
|
|
36,017
|
|
|
|
4,615
|
|
Computer
hardware sales
|
|
|
258
|
|
|
|
72
|
|
|
|
104
|
|
|
|
678
|
|
|
|
398
|
|
|
|
51
|
|
|
|
|
108,033
|
|
|
|
132,908
|
|
|
|
201,547
|
|
|
|
239,866
|
|
|
|
153,248
|
|
|
|
19,637
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Enterprise
software
|
|
|
(1,115 |
) |
|
|
(1,532 |
) |
|
|
(1,528 |
) |
|
|
(495 |
) |
|
|
-
|
|
|
|
-
|
|
Software
development services
|
|
|
(3,534 |
) |
|
|
(4,939 |
) |
|
|
(2,970 |
) |
|
|
(18,192 |
) |
|
|
(16,805 |
) |
|
|
(2,153 |
) |
Computer
hardware sales
|
|
|
(216 |
) |
|
|
(48 |
) |
|
|
(9 |
) |
|
|
(482 |
) |
|
|
(134 |
) |
|
|
(17 |
) |
|
|
|
(4,865 |
) |
|
|
(6,519 |
) |
|
|
(4,507 |
) |
|
|
(19,169 |
) |
|
|
(16,939 |
) |
|
|
(2,170 |
) |
Gross
profit
|
|
|
103,168
|
|
|
|
126,389
|
|
|
|
197,040
|
|
|
|
220,697
|
|
|
|
136,309
|
|
|
|
17,467
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
expenses
|
|
|
(13,604 |
) |
|
|
(13,674 |
) |
|
|
(15,977 |
) |
|
|
(25,752 |
) |
|
|
(13,604 |
) |
|
|
(1,743 |
) |
General
and administrative expenses
|
|
|
(12,195 |
) |
|
|
(56,911 |
) |
|
|
(36,572 |
) |
|
|
(49,538 |
) |
|
|
(65,928 |
) |
|
|
(8,448 |
) |
Research
and development expenses
|
|
|
(4,108 |
) |
|
|
(2,691 |
) |
|
|
(4,819 |
) |
|
|
(11,249 |
) |
|
|
(29,825 |
) |
|
|
(3,822 |
) |
Total
operating expenses
|
|
|
(29,907 |
) |
|
|
(73,276 |
) |
|
|
(57,368 |
) |
|
|
(86,539 |
) |
|
|
(109,357
|
) |
|
|
(14,013
|
) |
Government
subsidies |
|
|
458 |
|
|
|
211 |
|
|
|
1,340 |
|
|
|
447 |
|
|
|
705 |
|
|
|
90 |
|
Income
from operations
|
|
|
73,719
|
|
|
|
53,324
|
|
|
|
141,012
|
|
|
|
134,605
|
|
|
|
27,657
|
|
|
|
3,544
|
|
Interest
income
|
|
|
619
|
|
|
|
1,220
|
|
|
|
3,768
|
|
|
|
17,625
|
|
|
|
19,302
|
|
|
|
2,473
|
|
In thousands, except per share,
per ADS and
|
|
For the years ended December
31,
|
|
operating data and
percentages
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before provision for income taxes minority interests and equity in
earnings of an affilliate
|
|
RMB 74,338
|
|
|
RMB 54,544
|
|
|
RMB
144,780
|
|
|
RMB
152,230
|
|
|
RMB
46,959
|
|
|
US$
6,017
|
|
Provision
for income taxes
|
|
|
(2,061 |
) |
|
|
(4,116 |
) |
|
|
(1,823 |
) |
|
|
(626 |
) |
|
|
(1,031 |
) |
|
|
(132 |
) |
Income
before minority interest and equity in earnings of an
affiliate
|
|
|
72,277
|
|
|
|
50,428
|
|
|
|
142,957
|
|
|
|
151,604
|
|
|
|
45,928
|
|
|
|
5,885
|
|
Minority
interest
|
|
|
(7,299 |
) |
|
|
(9,239 |
) |
|
|
(9,006 |
) |
|
|
—
|
|
|
|
-
|
|
|
|
-
|
|
Equity
in earnings of an affiliate
|
|
|
79
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
-
|
|
|
|
-
|
|
Net
income
|
|
|
65,057
|
|
|
|
41,189
|
|
|
|
133,951
|
|
|
|
151,604
|
|
|
|
45,928
|
|
|
|
5,885
|
|
Net
income per share and ADS(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
2.96
|
|
|
|
1.82
|
|
|
|
4.96
|
|
|
|
4.39
|
|
|
|
1.32
|
|
|
|
0.17
|
|
Diluted
|
|
|
2.96
|
|
|
|
1.82
|
|
|
|
4.74
|
|
|
|
4.25
|
|
|
|
1.30
|
|
|
|
0.17
|
|
Cash flow
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
56,984
|
|
|
|
87,244
|
|
|
|
143,270
|
|
|
|
146,372
|
|
|
|
40,832 |
|
|
|
5,232 |
|
Depreciation
and amortization
|
|
|
1,126
|
|
|
|
874
|
|
|
|
2,120
|
|
|
|
5,293
|
|
|
|
9,137
|
|
|
|
1,171
|
|
Net
cash provided by (used in) investing activities
|
|
|
15,613
|
|
|
|
(39,629
|
) |
|
|
(179,405 |
) |
|
|
(110,851 |
) |
|
|
(176,483 |
) |
|
|
(22,614 |
) |
Net
cash provided by (used in) financing activities
|
|
|
(30,531 |
) |
|
|
70,250
|
|
|
|
565,597
|
|
|
|
2,044
|
|
|
|
6,328
|
|
|
|
811
|
|
|
|
As of December
31,
|
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance sheet
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
RMB 49,666
|
|
|
RMB167,531
|
|
|
RMB696,993
|
|
|
RMB731,474
|
|
|
RMB598,648
|
|
|
US$76,709
|
|
Trade
receivables, net of allowance for doubtful debts, from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
external
customers
|
|
|
28,179
|
|
|
|
31,096
|
|
|
|
43,913
|
|
|
|
45,996
|
|
|
|
43,142
|
|
|
|
5,528
|
|
related
parties
|
|
|
9,000
|
|
|
|
31,885
|
|
|
|
30,940
|
|
|
|
29,752
|
|
|
|
3,963
|
|
|
|
508
|
|
Term
deposits
|
|
|
24,832
|
|
|
|
65,664
|
|
|
|
150,913
|
|
|
|
207,000
|
|
|
|
307,209
|
|
|
|
39,365
|
|
Total
assets
|
|
|
133,287
|
|
|
|
323,975
|
|
|
|
1,222,182
|
|
|
|
1,345,773
|
|
|
|
1,365,289
|
|
|
|
174,945
|
|
Deferred
revenue
|
|
|
44,420
|
|
|
|
70,608
|
|
|
|
97,230
|
|
|
|
67,886
|
|
|
|
26,383
|
|
|
|
3,381
|
|
Total
liabilities
|
|
|
56,581
|
|
|
|
94,234
|
|
|
|
131,130
|
|
|
|
98,808
|
|
|
|
60,309
|
|
|
|
7,728
|
|
Mezzanine
equity
|
|
|
—
|
|
|
|
46,937
|
|
|
|
—
|
|
|
|
—
|
|
|
|
-
|
|
|
|
-
|
|
Total
shareholders’ equity
|
|
|
68,671
|
|
|
|
165,530
|
|
|
|
1,090,452
|
|
|
|
1,246,365
|
|
|
|
1,304,980
|
|
|
|
167,217
|
|
Number
of ordinary shares outstanding
|
|
|
—
|
|
|
|
22,780,000
|
|
|
|
34,391,834
|
|
|
|
34,991,834
|
|
|
|
34,991,834
|
|
|
|
34,991,834
|
|
|
For
the convenience of the reader, the RMB amounts are expressed in U.S.
dollars at the rate of RMB7.8041 to US$1.00, the noon buying rate in
effect on December 29, 2006 as quoted by the Federal Reserve Bank of New
York.
|
(2)
|
On
November 9, 2004, our shareholders approved a 4-for-1 share split. All
shares and per share data have been restated to give retroactive effect to
this share split. One ADS represents one ordinary
share.
|
Exchange rate
information
Our
business is primarily conducted in China and denominated in Renminbi. This
annual report contains translations of Renminbi amounts into U.S. dollars at a
specific rate solely for the convenience of the reader. The conversion of
Renminbi into U.S. dollars in this annual report is based on the noon buying
rate in The City of New York for cable transfers of Renminbi as certified for
customs purposes by the Federal Reserve Bank of New York. Unless otherwise
noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to
Renminbi in this annual report were made at a rate of RMB7.8041 to US$1.00, the
noon buying rate in effect as of December 29, 2006. We make no representation
that any Renminbi or U.S. dollar amounts could have been, or could be, converted
into U.S. dollars or Renminbi, as the case may be, at any particular rate, the
rates stated below, or at all. In addition, such translations should not be
construed to be the amounts that would have been reported under U.S. GAAP. The
PRC government imposes controls over its foreign currency reserves in part
through direct regulation of the conversion of Renminbi into foreign exchange
and through restrictions on foreign trade.
The
following table sets forth information concerning exchange rates between
Renminbi and U.S. dollars for the periods indicated. These rates are provided
solely for your convenience and are not necessarily the exchange rates that we
used in this annual report or will use in the preparation of our periodic
reports or any other information to be provided to you. The source of these
rates is the Federal Reserve Bank of New York.
|
|
Noon Buying
Rate
|
|
|
Period
End
|
Average (1)
|
Low
|
High
|
|
(RMB per
US$1.00)
|
2002
|
8.2800
|
8.2770
|
8.2800
|
8.2669
|
2003
|
8.2767
|
8.2771
|
8.2880
|
8.2765
|
2004
|
8.2765
|
8.2768
|
8.2774
|
8.2764
|
2005
|
8.0702
|
8.1940
|
8.0702
|
8.2765
|
2006
|
7.8041
|
7.9723
|
7.8041
|
8.0702
|
2007
|
|
|
|
|
January
|
7.7714
|
7.7876
|
7.7705
|
7.8127
|
February
|
7.7410
|
7.7502
|
7.7410
|
7.7632
|
March
|
7.7232
|
7.7369
|
7.7232
|
7.7454
|
April
|
7.7090
|
7.7247
|
7.7090
|
7.7345
|
May
|
7.6516
|
7.6773
|
7.6463
|
7.7065
|
June
|
7.6120
|
7.6333
|
7.6120
|
7.6680
|
July(2)
|
7.5690
|
7.5908
|
7.5660
|
7.6055
|
(1)
|
Annual
and monthly averages are calculated using the average of the daily rates
during the relevant period.
|
(2)
|
For
the period to and including July 12,
2007.
|
B. Capitalization
and indebtedness
Not
applicable.
C. Reasons
for the offer and use of proceeds
Not
applicable.
D. Risk
factors
Risks related to our
business
We currently generate substantially
all of our total net revenues from either PRC government agencies or in
connection with PRC government agency filings, and our failure to maintain a
continued working relationship with certain PRC government agencies and, in
particular, the PRC Inspections Administration, would result in the reduction or
loss of substantially all of our total net revenues.
Sales of
our enterprise software and software development services that are either used
by the State Administration for Quality Supervision and Inspection and
Quarantine of the PRC, or PRC Inspections Administration, or by Beijing iTowNet
Cyber Technology Ltd., or iTowNet, the operator of the PRC Inspections
Administration’s data exchange platforms and electronic processing systems, have
accounted for substantially all of our total net revenues. We expect that, in
the near future, we will continue to generate a substantial portion of our total
net revenues through sales of enterprise software and software development
services that will be used in connection with PRC Inspections Administration
filings. Net revenues from sales of enterprise software for PRC
Inspections Administration filings accounted for 93.6%, 84.8% and
76.2% of our total net revenues in 2004, 2005 and 2006, respectively. Net
revenues from software development services provided, directly or indirectly,
to the PRC Inspections Administration and iTowNet accounted for 5.7%,
11.7% and 10.7% of our total net revenues in 2004, 2005 and 2006,
respectively.
We cannot
assure you that we will be able to maintain our working relationship with the
PRC Inspections Administration or other PRC government agencies in connection
with new enterprise software or in relation to the continued use of our existing
enterprise software. If the PRC Inspections Administration ceases to cooperate
with us in researching and developing new enterprise software; ceases to use
the
electronic
infrastructure that we helped develop and build; reduces its spending on, or
commitment to, or ceases or slows down the implementation of, the digitization
of its processes for data collection and administration; encourages our
competitors or alternate means of data collection; or requires us to lower the
prices of our products and services; then our market position, revenues and
profitability would be materially and adversely affected. Furthermore, such a
change in our relationship with the PRC Inspections Administration could result
in the loss of what we perceive to be our first mover advantage in developing
software products compatible with the systems implemented by the PRC Inspections
Administration. The loss of such an advantage would result in slower growth
and/or reduced sales, which would require us to increase our research and
development and sales and marketing expenditures.
Our revenues would be adversely
affected if the PRC Inspections Administration, or any other government agency
to which our products relate, develops, endorses or adopts an alternative to our
enterprise software.
Our
business would be adversely affected if the PRC Inspections Administration, its
affiliated company iTowNet or any other government agency or affiliate to which
our products relate decides to develop its software and platform internally,
endorses software provided by others or permits filings to be made online
without independently produced software. In such case, we would not only face
enhanced competition, but our software products and services relating to the PRC
Inspections Administration, iTowNet or any such government agency or affiliate
could become obsolete, which would result in the reduction or loss of
substantially all of our revenues.
In August
2005, the PRC Inspections Administration selected our company as the winning
bidder in connection with the PRC Inspections Administration’s request for
proposals for the development of a software product that has certain basic
functionalities similar to those of iDeclare.CIQ and
iProcess.CIQ. The PRC Inspections Administration agreed to pay a
one-time fee of RMB3.3 million (US$423,000) to purchase the ownership of the
software product that we developed. In February 2006, the PRC
Inspections Administration commenced the distribution of the software products
that our company developed, free-of-charge to end-users. As certain
basic functionalities of the newly developed software products are similar to
those of iDeclare.CIQ and iProcess.CIQ, the provision of such software products
free-of-charge by the PRC Inspections Administration will likely have a material
adverse effect on our results of operations in the short-term and on our future
profitability. For example, we sold, together with our franchisees,
approximately 1,500 and 2,200 software packages of iDeclare.CIQ during the first
quarter of 2006 and 2007, respectively, which is significantly lower than the
approximately 8,000 software packages of iDeclare.CIQ sold by our company and
our former distributors and franchisees during the first quarter of
2005. In May 2007, the PRC Inspections Administration selected our
company as one of the winning bidders in connection with the PRC Inspections
Administration’s request for proposals for servicing the free import/export
e-filing software provided by the PRC Inspections Administration.
We are in the process of
diversifying our business focus to include other businesses in addition to the
sales of our enterprise software and the provision of software development
services. Our new potential business ventures and limited operating
history in such potential business ventures may make it difficult for you to
evaluate our business, and our limited resources may affect our ability to
manage the growth we expect to achieve.
We
generated substantially all of our total net revenues from the sales of our
enterprise software and the provision of software development services in
2006. Currently, we are in the process of expanding our business
focus from the development of software products and the provision of software
development services to other potential business ventures. We
anticipate that a material portion of our net revenue in
the
future will be derived from businesses that are not directly related to sales of
our enterprise software or the provision of software development
services.
We are
still in the process of evaluating and market-testing potential business
ventures, including potential investments in the business-to-business, or
B2B, industry in China. Accordingly, we have no operating history in
respect to such potential business ventures upon which you can evaluate our
business and prospects in such area. Furthermore, as part of our operation
expansion, we need to continue to develop and improve our staff training,
financial and management controls and our reporting systems and procedures. We
cannot assure you that we will be able to efficiently or effectively manage or
grow our operations, and any failure to do so may limit our future growth and
materially adversely our business, financial condition and results of
operations.
Our significant shareholders,
related parties and management personnel have potential conflicts of interest
with us, which may result in their taking corporate actions which you may not
believe to be in your best interests or in the best interests of our
company.
As of May
31, 2007, Shuang Wang, our Chief Executive Officer and a director of our
company, or Mr. Wang, and Min Dong, our Senior Vice President of Legal Affairs,
Administration and Human Resources and the spouse of Mr. Wang, or Ms. Dong,
beneficially own 17.99% of our ordinary shares. Mr. Wang and Ms. Dong will have
substantial influence over the management and policies of our company and the
outcome of most corporate actions. In addition, Mr. Yong Ping Duan, or Mr. Duan,
and Technology Pioneer Corp., or Technology Pioneer, beneficially own 13.26% and
8.77% of our American Depositary Shares, or ADSs, respectively. Mr.
Duan will have substantial influence over the outcome of most corporate
actions. As a result, Mr. Wang, Ms. Dong and Mr. Duan have the power
to take corporate actions which other shareholders may not believe are in their
best interests or in the best interests of our company. There can be no
assurance that Mr. Wang, Ms. Dong and Mr. Duan will not cause our company to
take such corporate actions.
Mr. Wang
and Ms. Dong beneficially own 100.0% of Ninetowns Import & Export e-Commerce
Co., Ltd., or Import & Export, which in turn owns a 49.0% equity interest in
iTowNet. iTowNet is 51.0% owned by the PRC Inspections Administration and is the
ultimate user of a substantial portion of all the software development services
we provide and operates the data exchange platforms that interface between
international trade enterprises using our enterprise software and the PRC
Inspections Administration’s internal electronic processing systems. iTowNet
receives a fee of RMB5 from the end-users for each submission made over its data
exchange platforms. Mr. Wang is a non-executive director and the vice-chairman
of the board of directors of iTowNet. Due to their ownership interest in iTowNet
and Mr. Wang’s position as a director of iTowNet, the interests of Mr. Wang and
Ms. Dong may also differ from those of our other shareholders.
Mr.
Xiaoguang Ren, who is our President, or Mr. Ren, is also a non-executive
director of iTowNet. Mr. Bolin Wu, who is our General Manager, Research and
Development and Chief Technology Officer, or Mr. Wu, is the sole supervisor of
iTowNet. As the supervisor of iTowNet, Mr. Wu is responsible for overseeing the
financial operations of iTowNet, the actions of its board of directors and
senior management and their compliance with relevant laws and iTowNet’s charter
documents.
We
derived RMB22.9 million, RMB17.3 million and nil, or 11.4%, 7.2% and nil of our
total net revenues in 2004, 2005 and 2006, respectively, from iTowNet, which is
our related party and a major customer for our software development
services.
In
addition, we derived RMB24.2 million and RMB16.4 million (US$2.1 million), or
10.1% and 10.7%, of our total net revenues in 2005 and 2006, respectively, from
eGrid Technology Ltd., or eGrid, (formerly
known as
Beijing Regard Technology Co., Ltd., or Beijing Regard), which is our related
party and another major customer for our software development services. We did
not derive any of our total net revenues in 2004 from eGrid. We derived RMB25.2
million, RMB47.5 million and RMB21.2 million (US$2.7 million), or 13.4%, 19.8%
and 13.9% of our total net revenues in 2004, 2005 and 2006, respectively, from
Shenzhen Ninetowns Enke Software Technology Co., Ltd., or Ninetowns Enke, which
is our related party and also one of our franchisees.
We cannot
assure you that our transactions with iTowNet, eGrid and Ninetowns Enke would
have occurred on their current terms, or at all, had these relationships not
existed; nor can there be any assurance as to the effect these relationships
will have on our future business dealings with iTowNet, eGrid and Ninetowns
Enke. See Item 7 of this annual report, “Major Shareholders and Related Party
Transactions — Related party transactions.”
Since a significant part of the
growth of our total net revenues in 2004, 2005 and 2006 was generated from
software development services, a decline in demand for those services or a
change in our relationship with the primary purchasers of those services may
result in a significant reduction in our total net revenues and our net revenues
from the provision of software development services.
We have
provided software development services to iTowNet since April 2002. In addition,
we provide software development services either directly, or indirectly as a
sub-contractor for eGrid, to iTowNet. See Item 7 of this annual report, “Major
Shareholders and Related Party Transactions — Related party transactions — eGrid
Technology Ltd.”. Net revenues from the provision of software development
services, either directly to iTowNet or indirectly to iTowNet through eGrid,
accounted for approximately 4.8%, 11.7% and 8.4% of our total net revenues, and
75.4%, 78.7% and 35.9% of our net revenues from the provision of software
development services, in 2004, 2005 and 2006, respectively. We intend to
continue to offer these services to iTowNet and eGrid, but if we are unable to
obtain additional software development contracts from iTowNet or from eGrid, we
may cease to provide software development services or experience a significant
reduction in our total net revenues and our net revenues from the provision of
software development services.
A significant portion of our total
net revenues are generated by our major customers, and the loss of all or part
of our net revenues from any of these customers would result in a decline in our
total net revenues and a significant increase in our sales and marketing
expenditures.
As of May
31, 2007, we have franchise agreements with our four franchisees including (i)
Beijing Ninetowns Zhi Fang Software Technology Co., Ltd., or Ninetowns Zhi Fang,
(ii) Beijing Ninetowns Xin He Software Technology Co., Ltd., or Ninetowns Xin
He, (iii) Guangzhou Ninetowns Wang Li Software Co., Ltd., or Ninetowns Wang Li,
and (iv) Ninetowns Enke, who as a result of their purchases of enterprise
software for distribution to end-users, are also four of our largest customers.
We currently do not have any distributor. Our net revenues from sales
of our enterprise software from Ninetowns Zhi Fang were RMB3.3
million and RMB10.0 million (US$1.3 million), which represented 6.5% of our
total net revenues for 2006. Our net revenues from sales of our
enterprise software from Ninetowns Xin He were RMB9.2 million (US$1.2 million),
which represented 6.0% of our total net revenues for 2006. Our net
revenues from sales of our enterprise software from Ninetowns Wang Li were
RMB0.5 million (US$61,000), which represented 0.3% of our total net revenues for
2006. Our net revenues from sales of our enterprise software from Ninetowns Enke
were RMB25.2million, RMB47.5 million and RMB21.2 million (US$2.7 million) or
13.4%, 19.8% and 13.9% of our total net revenues in 2004, 2005 and 2006,
respectively.
To our
knowledge, none of our franchisees are PRC government agencies.
eGrid and
iTowNet have been our two largest customers for software development services.
Our net revenues from the provision of software development and other services
to eGrid were RMB24.2 million and RMB16.4 million (US$2.1 million) or 10.0% and
10.7% of our total net revenues in 2005 and 2006, respectively. We did not
recognize any net revenues from the provision of software development and other
services to eGrid in 2004. Our net revenues from the provision of software
development services to iTowNet were RMB9.6 million, RMB4.1million and nil, or
4.8%, 1.7% and nil of our total net revenues, in 2004, 2005 and 2006,
respectively. To our knowledge, iTowNet and eGrid are not PRC government
agencies, but iTowNet is 51.0% owned by the PRC Inspections
Administration.
In the
event one or more of our customers discussed above discontinues their businesses
or their dealings with us, and we are unable to find an adequate replacement for
such customer in a timely manner, we would suffer a decline in total net
revenues and in turn would need to significantly increase our sales and
marketing expenditures.
Our billed receivables, which
include trade receivables from related parties, are significant and if customers
fail to pay amounts owed, our profitability and financial position could
decline.
As of
December 31, 2006, our billed receivables amounted to approximately RMB21.9
million (US$2.8 million), of which our trade receivables from related parties
amounted to RMB4.0 million (US$0.5 million). Our trade receivables as of
December 31, 2006 represented approximately 2.2% of our total current assets and
our billed receivables from related parties represented approximately 0.4% of
our total current assets. As of December 31, 2006, we had an allowance for
doubtful debts of approximately RMB1.1 million (US$0.1 million). If any of our
franchisees or any of our other customers fails to pay, or delays payment on,
all or part of these receivables, we would be required to make additional
allowances for doubtful debts and our profitability and financial position could
decline.
Our existing major shareholders have
substantial control over us and could delay or prevent a change in corporate
control, which could in turn reduce the market price of your
ADSs.
Our
executive officers, directors and shareholders with 5.0% or more shareholding of
our company and their affiliates beneficially own approximately 46.35% of our
outstanding ordinary shares. Such concentration of ownership might have the
effect of delaying or preventing a change in control of our company which could
in turn reduce the market price of our ADSs and the voting and other rights of
our other shareholders.
Our failure to market our customer
maintenance services to our existing users could impair our planned revenue
growth.
We offer
one year of customer maintenance services with our iDeclare.CIQ basic package,
and charge a fee of RMB1,500 per licensee for customer maintenance services each
year thereafter. However, until September 2003, we did not emphasize the
marketing of customer maintenance services because we were focused on building
our relationships with our users and we believed that not all of our users and
potential users were accustomed to being charged for this type of service. In
2006, we offered customer maintenance service contracts to approximately 29,000
users, so that approximately 23.8% of the total number of users due for a
maintenance contract renewal in 2006 paid for the renewal. In 2006,
we recognized approximately RMB41.5 million (US$5.3 million) from provision of
customer maintenance services.
Our
success in marketing customer maintenance services to our users depends in part
on whether users require software updates. Software updates can implement
modifications to forms, programs and information systems necessary to address
changes imposed by the PRC Inspections Administration.
Therefore,
the desirability and usefulness of our customer maintenance services is
dependent in part on changes occurring in government policies. If we fail to
market our customer maintenance services to, or to collect customer maintenance
service fees from, our users in the future, our planned revenue growth could be
impaired.
We currently depend on our
iDeclare.CIQ product for a substantial majority of our total net revenues and
our failure to develop or license additional enterprise software or a decline in
demand for iDeclare.CIQ could materially reduce our total net
revenues.
Sales of
iDeclare.CIQ accounted for approximately 87.1%, 79.3% and 70.4% of our total net
revenues in 2004, 2005 and 2006, respectively. Any decrease in the demand for or
price of iDeclare.CIQ, any increase in competition to iDeclare.CIQ, including
but not limited to as a result of the PRC Inspections Administration’s and
iTowNet’s endorsement of a comparable product, any failure by our company to
develop additional enterprise software, any significant shift in our marketing
efforts, any lasting or prolonged interruption that prevents our enterprise
software from delivering data to government entities due to system failures or
other factors, or any other adverse development specific to iDeclare.CIQ, could
materially reduce our total net revenues. In February 2006, the PRC Inspections
Administration commenced to promote and distribute a software product, which has
certain basic functionalities similar to our iDeclare.CIQ, free-of charge to
end-users. As a result of competition from such free software, our
sales of iDeclare.CIQ have declined and will likely continue to decline. For
example, we sold, together with our franchisees, approximately 1,500 and 2,200
software packages of iDeclare.CIQ during the first quarter of 2006 and 2007,
respectively, which is significantly lower than the approximately 8,000 software
packages of iDeclare.CIQ sold by our company and our former distributors and
franchisees during the first quarter of 2005. In the event such decline
continues, we expect to experience a significant decline in our total net
revenues.
Competition could reduce our profit
margins and revenues.
Companies
that have expertise in marketing and providing government-related software
products and services may begin to compete with us. There are companies that
provide software products and services similar to ours in many other countries.
In addition, there are companies in China that provide such products and
services to PRC government agencies other than the PRC Inspections
Administration. In particular, there are regional software providers in China
implementing systems for provincial branches of government agencies such as the
Customs General Administration of the PRC, or PRC Customs. Furthermore, we are
aware of one other software provider in China, Fujian Ronji Software Development
Co., Ltd., or Ronji, that provides enterprise software for PRC Inspections
Administration-related filings. We are also aware of several software developers
that provide software development services to our customers, in particular to
iTowNet. See Item 4 of this annual report, “Information on the Company —
Business overview — Competition.” There can be no assurance that other companies
will not allocate resources to pursue opportunities relating to the needs of
international trade enterprises making government filings in China.
Our
potential competitors may have greater marketing, programming, research and
development, capital and other resources than we do. These resources could
enable our potential competitors to take aggressive action to gain market share.
Additionally, we may face competition from the free software distributed by the
PRC Inspections Administration and from companies with established reputations
and political relationships with PRC government agencies. If we do not compete
effectively or if we experience any pricing pressure from our potential
competitors, we may experience loss of market share and reduced profit margins
and revenues.
Future acquisitions and investments
could divert our management’s attention, which may have an adverse effect on our
ability to manage our business and expose us to potential
risks.
Selective
acquisitions and investments in new businesses form part of our strategy to
further expand our business. In 2006 and 2007, we made investments in a leading
Chinese B2B trade facilitator and a leading Chinese B2B vertical search engine
operator, respectively. In May 2007, we launched our new B2B vertical
search platform, tootoo.com. We plan to utilize these investments in
combination with our existing software expertise to further increase our service
profile. If we are presented with additional opportunities, we may acquire
additional complementary companies, products or technologies, or invest in new
businesses. Future acquisitions and investments and the subsequent integration
of new companies, assets or business ventures would require significant time and
attention from our management. The diversion of our management’s attention to
integrate such acquisitions or investments and any difficulties encountered in
any integration process could have a material adverse effect on our ability to
manage our business and expose us to potential risks, including risks associated
with the integration of new operations, technologies and personnel, unforeseen
or hidden liabilities, the diversion of resources from our existing businesses
and technologies, the inability to generate sufficient revenues to offset the
costs and expenses of acquisitions and investments, and potential loss of, or
harm to, our relationships with employees, customers and suppliers.
Our business depends substantially
on the continuing efforts of our executive officers, and our business may be
severely disrupted if we lose their services.
Our
success depends substantially on the expertise and experience of our executive
officers, who have extensive skills in and knowledge about the international
trade industry and the software industry in China. They also have established
relationships with our major customers, our suppliers, government regulators and
our shareholders. We do not maintain key-man life insurance for any of our
executive officers. The loss of services of any or all of our executive officers
in the absence of suitable replacements could have a material adverse effect on
our operations and future profitability.
In
addition, if any of our executive officers joins a competitor or forms a
competing company, we may lose customers, suppliers, research and development
expertise and employees and our relationship with the PRC Inspections
Administration could be materially and adversely affected. Although all of our
executive officers have entered into service agreements with us which contain
confidentiality and non-competition provisions, it may be difficult to enforce
such provisions in China in light of uncertainties relating to China’s legal
system. See “— Risks related to doing business in China — The uncertain legal
environment in China could limit the legal protections available to you and
could adversely affect our ability to provide our products and services in
China.”
Our inability to attract and retain
experienced personnel may adversely affect our ability to create enterprise
software for international trade enterprises or provide software development
services to PRC government agencies.
Our
success depends on our ability to attract, retain, train and motivate highly
skilled employees, including experienced software engineers, technical personnel
and sales and marketing personnel, all of whom are in great demand in China. In
particular, we depend on software engineers who have expertise and experience in
creating enterprise software for international trade enterprises as well as
providing software development services to PRC government agencies. We may not
be able to attract or retain the key personnel that we will need to achieve our
business objectives. In addition, as we are still a relatively young company and
our business has grown rapidly since our establishment, at times our ability to
train and integrate new employees into our operations may not meet the growing
demands of our business. As the PRC economy continues to develop, demand for
personnel with the skills we require to create and
distribute
our enterprise software will increase, which could raise our costs or make it
impracticable for us to hire skilled or experienced personnel. Certain of our
senior software engineers, technical officers or staff members are not bound by
non-competition agreements and those who are not bound could decide to resign or
work for our competitors at any time without any contractual restriction. The
departure of any of these personnel could have a material adverse effect on our
ability to create enterprise software for international trade enterprises or
provide software development services to PRC government agencies.
If we
grant employee share options and other share-based compensation in the future,
our net income could be materially and adversely affected.
We
adopted the 2003 Plan in November 2003, and the Amended and Restated 2004 Plan
and the 2006 Share Incentive Plan in October 2005, or collectively, the
Plans. As of December 31, 2006, we had granted options under the
Plans with the right to purchase a total of 3,464,000 ordinary shares, of which
165,809 unexercised options had been returned to the pool of our ungranted
options as a result of resignation from employment by a few former
employees.
Until
December 31, 2005 we accounted for options granted to our directors and
employees in accordance with Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees,” or APB 25, and its related
interpretations, which require us to recognize compensation expenses for share
options we grant where the exercise price is less than the deemed fair value of
our ordinary shares on the date of the grant. However, the Financial Accounting
Standards Board, or FASB, has issued Statement No. 123 (Revised 2004),
“Share-Based Payments,” or SFAS 123R, which requires all companies to recognize,
as an expense, the fair value of share options and other share-based
compensation to employees at the beginning of the first annual or interim period
after June 15, 2005. As a result, beginning on January 1, 2006, we account for
compensation costs for certain share options using a fair-value based method and
recognize expenses in our consolidated statement of operations in accordance
with the relevant rules under U.S. GAAP, which may have a material and adverse
effect on our reported earnings. Moreover, the additional expenses associated
with share-based compensation may reduce the attractiveness of such incentive
plan to us. However, if we reduce the scope of the Plans, we may not be able to
attract and retain key personnel, as share options are an important employee
recruitment and retention tool. If we grant employee share options or other
share-based compensation in the future, our net income could be adversely
affected.
Without PRC government action, we
may not be able to introduce or enhance our enterprise software products, which
may restrict our ability to expand our business and
revenues.
Our
ability to offer enterprise software to international trade enterprises depends
on the ability of various PRC government agencies to accept electronic filings
from users of our enterprise software. This includes some PRC government
agencies permitting electronic filings for the first time and other PRC
government agencies which already permit some electronic filings allowing
additional types of filings to be made. Factors such as a government agency’s
budget, timing, decision-making process, ability to implement our enterprise
software, willingness of local offices to implement our enterprise software and
other factors beyond our control could constrain our ability to expand our
business or increase our revenues.
Our failure to adequately manage our
growth and expansion could result in a deterioration in our results of
operations and financial condition.
Our
historical growth has placed, and such growth and any further growth is likely
to continue to place, a significant strain on our managerial, operational,
financial and other resources. Our future success will depend, in part, upon the
ability of our senior management to manage our growth effectively. Such
effective management will require us to implement additional management
information systems, to
develop
further our operating, administrative, financial and accounting systems and
controls and to maintain close coordination among our software design, software
coding, accounting, finance, marketing, sales and operations organizations. Any
failure to implement or improve systems or controls to manage our growth and
expansion effectively could result in a deterioration in our results of
operations and financial condition.
We often commence work on software
development projects based on verbal agreements and if our customers do not pay
us for these services our working capital requirements and expenses may increase
without a corresponding increase in net revenues, which would adversely affect
our profitability.
As we
believe is consistent with the practice of other software development companies
in China engaged in government-related work, we often commence software
development projects based on oral commitments from our customers. We may accrue
substantial trade receivables in connection with such projects, because we
seldom receive pre-payment or progress payments during the project. As a result,
we may need to substantially increase our expenses without assurance that we
will be paid for our software development services. Furthermore, we may not
recognize any revenue from software development projects in any given period
because we recognize revenue from such services only when a contract has been
signed. If our customers do not pay us, or delay paying us, for our
software development services, our working capital requirements and expenses may
increase without a corresponding increase in net revenues, which would adversely
affect our profitability.
It may be difficult for us to
maintain our market position and brand recognition in a rapidly developing
market or in the face of competition, which could severely hamper our ability to
operate profitably.
We
believe that market position and brand recognition are critical to attracting
potential customers in the PRC market. In particular, we believe that our sales
through indirect channels such as our four franchisees rely significantly on our
reputation and brand recognition. However, there is no assurance that we can
retain our reputation or capitalize on our current leading market share,
reputation or brand recognition as our market develops and attracts new
competitors. Our failure to promote and enhance our brand name could result in
reduced sales or slower growth, each of which may require us to increase
spending on marketing or to increase fees to our franchisees, which could reduce
our profitability.
Programming errors or flaws in our
enterprise software or other product defects could decrease market acceptance of
our software, which would reduce our revenues and
profitability.
Software
as complex as our enterprise software frequently contains undetected defects
that may be identified at any point in the software’s life. There can be no
assurance that, despite repeated testing, defects will not occur in existing or
new software. Such defects could result in loss of or delay in receiving
revenues, loss of market share, failure to achieve market acceptance, diversion
of development resources, injury to our reputation or increased service and
warranty costs. Any of the above consequences could adversely impact our
business, results of operations and financial condition. Furthermore, our
software development services typically involve working with sophisticated
software, computing and networking systems. Our failure or inability to meet
customer expectations or project milestones in a timely manner could also result
in loss of revenues or delay in revenue recognition, loss of market share,
failure to achieve market acceptance, injury to reputation and increased costs.
Because our customers rely on our products and services for critical trade
transactions, any significant defects or errors in our products or services
might discourage our customers or potential customers from utilizing our
products and services or result in tort or warranty claims. We do not maintain
any insurance against
product
liability or legal claims. Any imposition of liability on us may adversely
affect our business and increase our costs, resulting in reduced revenues and
profitability.
We may not be able to adequately
protect our intellectual property rights and others may claim that we have
infringed on their intellectual property rights, which could cause us to be less
competitive, may expose us to litigation and may negatively impact our business,
results of operations and financial condition.
We rely
on a combination of copyrights, trademarks and other methods to protect our
intellectual property rights. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy or otherwise obtain and use our
technology. In addition, there can be no assurance that others will not
independently develop substantially equivalent intellectual property. We cannot
be certain that the steps we have taken will prevent misappropriations of our
technology. From time to time, we may have to resort to litigation or other
measures to try to enforce our intellectual property rights, which could result
in substantial costs and diversion of our resources. We may be unable to enforce
our intellectual property rights even through litigation or other measures,
particularly in China. See “— Risks related to doing business in China — The
uncertain legal environment in China could limit the legal protections available
to you and could adversely affect our ability to provide our products and
services in China.” In particular, we are aware of an online video game company
in China whose name is substantially similar to our name in Chinese. Although we
have registered our trademarks in China, we cannot assure you that such company
will not take actions against us for trademark infringement. We are in the
process of registering our trademark outside of China.
There can
be no assurance that infringement or other claims will not be asserted or
prosecuted against us in the future or that any past or future assertions or
prosecutions will not materially and adversely affect our business, results of
operations and financial condition. Any such claims, with or without merit,
could be time-consuming, result in costly litigation and diversion of technical
and management personnel or require us to develop non-infringing technology or
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to us, or at
all. In the event of a successful claim of infringement against us, our revenues
may decrease and our expenses to obtain or develop non-infringing technology or
to license the infringed or similar technology may increase. In addition, our
failure or inability to develop non-infringing technology or license the
infringed or similar technology on a timely basis may cause our business,
results of operations and financial condition to be negatively affected. See
Item 4 of this annual report, “Information on the Company — Business overview —
Intellectual property rights.”
We sold some of our enterprise
software before they were registered for sale with the Ministry of Information
Industry of the PRC, which could expose us to
penalties.
We sold
our iDeclare.CIQ basic package before it was registered for sale with the
Ministry of Information Industry of the PRC, a registration which is required of
all PRC software products. We obtained the registration certificate for
iDeclare.CIQ in September 2001, 14 months after sales commenced in July 2000 and
recorded net revenues from sales of enterprise software of approximately RMB12.6
million in the period prior to issuance of the registration certificate. Our PRC
counsel has advised us that the PRC regulations requiring the registration of
software prior to its public sale do not set out any specific penalties for the
sales of unregistered software products, except that PRC regulators may issue
warnings and public censures. Although we were not aware of any warning or
public censure related to our pre-registration sales issued by any government
entity as of the date of this annual report, our business may be adversely
affected if penalties are subsequently imposed by the Ministry of Information
Industry of the PRC.
Any reduction of our preferential
tax treatment as a PRC high and new technology enterprise could materially
reduce our net income.
All of
our principal PRC operating subsidiaries enjoy or are entitled to enjoy
preferential tax treatment in the form of reduced tax rates or tax holidays
provided by the PRC government or its local agencies or bureaus. Beijing New
Take Electronic Commerce Limited, or Beijing New Take; Beijing Ninetowns Times
Electronic Commerce Limited, or Ninetowns Times; Ninetowns Digital Technology
Limited, or Ninetowns Digital, currently benefit from a 15.0% preferential
enterprise income tax, or EIT, rate. Beijing Ninetowns Ports Software and
Technology Co., Ltd., or Ninetowns Ports, currently benefit from a 7.5%
preferential EIT rate. Shanghai New Take Digital Technology Co., Ltd., or
Shanghai New Take, currently benefit from a 16.5% preferential EIT rate. Beijing
Ninetowns Network and Software Co., Ltd., or Ninetowns Network, and Guangdong
Ninetowns Technology Co., Ltd., or Guangdong Ninetowns Technology, are currently
entitled to an exemption from EIT. Beijing Ronge Tongshang Network
Technology Limited, or Ronge Tongshang, which is our variable interest entity,
is currently entitled to a 15.0% preferential EIT rate. As a result of these
preferential tax treatments and the recognition of deferred tax assets for
deductible temporary differences, our effective income tax rate for 2006 was
2.2%. In addition, we also receive from the PRC government a 14.0% value added
tax, or VAT, refund on sales of certain registered software. We cannot assure
you that we will continue to enjoy this preferential tax treatment in the
future, either due to a change in the PRC government’s tax policies or because a
subsidiary or variable interest entity fails to satisfy the financial and
operational criteria necessary to maintain its eligibility for such preferential
tax treatment. Any reduction in our preferential tax treatment could materially
reduce our net income.
On March
16, 2007, the 2008 PRC Enterprise Income Tax Law was enacted. Under
the new law, effective on January 1, 2008, the PRC government will adopt an
uniform EIT rate of 25.0% for all enterprises (including foreign-invested
enterprises) and revoke the current tax exemption, reduction and preferential
treatments applicable to foreign-invested enterprises. However, the
preferential EIT rate of 15.0% for “high and new technology enterprises”
was strongly supported by the State and current preferential tax treatments for
foreign-invested high and new technology enterprises are expected to be
grandfathered for a period of five years following the effective date of the new
law. We believe that our PRC operating subsidiaries and variable
interest entity will continue to qualify as high and new technology
enterprises entitled to the 15.0% preferential EIT rate, and therefore we will
not be adversely affected by the new law. However, we cannot assure
you that we will continue to enjoy this preferential tax treatment in the
future, either due to a change in the PRC government’s tax policies or because a
subsidiary or variable interest entity fails to satisfy the financial and
operational criteria necessary to maintain its eligibility for such preferential
tax treatment. Any reduction in our preferential tax treatment could
materially reduce our net income. Additionally, because the PRC State
Council has not promulgated detailed rules for the 2008 PRC Tax Law, our
subsidiaries and variable interest entities may not qualify as “high and new
technology enterprises” and thus may not be entitled to a preferential EIT
rate of 15.0%. Instead, our subsidiaries and variable interest entities may be
subject to the standard EIT rate of 25.0% after the current preferential tax
treatment they enjoy expires. We will seek to apply for “high and new
technology enterprise” status for our subsidiaries and variable interest
entities once the detailed rules are made available to us. In
addition, under the 2008 PRC Enterprise Income Tax Law, enterprises established
under the laws of foreign countries or regions whose “de facto management
bodies” are located within the PRC are considered resident enterprises and will
generally be subject to the EIT at the rate of 25.0% on its global
income. However, the 2008 PRC Enterprise Income Tax Law does not
define the term “de facto management bodies.” Substantially all of
our management is currently located in the PRC and if they remain located in the
PRC after the effective date of the PRC Enterprise Income Tax Law, we may be
considered to be a resident enterprise and therefore may be subject to the EIT
at the rate of 25.0% on our global income in the PRC.
It is likely that we would be
considered a passive foreign investment company for 2006, which could lead to
additional taxes for U.S. holders of ADSs.
Special
U.S. federal income tax rules apply to U.S. holders of shares of a non-U.S.
corporation that is classified as a passive foreign investment company, or PFIC,
for U.S. federal income tax purposes. The determination of our PFIC status
principally depends upon the composition of our assets, including goodwill, and
the amount and nature of our income, from time to time. The amount of goodwill
will depend in part on the market value of our ADSs or ordinary shares, which
may be especially volatile in a technology-related enterprise. We have limited
control over these variables. Accordingly, there can be no assurance that we
would not be considered a PFIC for any taxable year.
It is
likely that we would be classified as a PFIC for 2006. As a result,
U.S. holders of shares may be subject to United States federal income tax
consequences that are less favorable than those that would apply if we were not
a PFIC.
For
example, gain from the sale of our shares may be ineligible for preferential
capital gains rates and may be subject to an interest charge. Please
see Item 5 of this annual report, “Additional Information – Taxation – United
States federal income taxation.”
Risks related to our
industry
Our industry is subject to rapid
changes in technology and our failure to develop and introduce new enterprise
software could reduce our market competitiveness and ability to generate
revenues.
Our
industry is characterized by rapid technological changes and evolving customer,
industry and government standards. Our future success will depend, to a large
extent, on our ability to keep pace with technological advances in a timely and
cost-effective manner by improving our existing enterprise software or
developing new enterprise software that addresses changing customer
requirements. Our development of new enterprise software or the enhancement of
our existing enterprise software will entail substantial investments in research
and development, which we expect to fund with our cash flow from operations and
our available cash. Nevertheless, there can be no assurance that our research
and development efforts will result in the successful introduction of new
enterprise software or the enhancement of our existing enterprise software, nor
that any of such new or enhanced enterprise software will be accepted by the
market. The emerging nature of our market and its rapid evolution will require
us to continually improve the performance, features and reliability of our
enterprise software particularly in response to changing market standards, and
require us to introduce enterprise software or make enhancements to existing
enterprise software as quickly as possible and prior to our competitors. The
success of our new enterprise software is dependent on several factors,
including differentiation of our enterprise software from products of our
competitors and market acceptance. There can be no assurance that we will be
successful in developing and marketing new enterprise software that responds to
competitive and technological developments and changing customer
needs.
Our
failure to develop and introduce new enterprise software successfully on a
timely basis or to achieve market acceptance could reduce our market
competitiveness and ability to generate net revenues. In addition, the
widespread adoption of new Internet, networking or telecommunication
technologies or standards or other technological changes could require
substantial expenditures by us to modify or adapt our products and services. To
the extent that a method other than submission by Internet is adopted to enable
trusted and secure communications with the PRC Inspections Administration and
other trade-related PRC government agencies, sales of our existing and planned
enterprise software products will be adversely affected and our enterprise
software could be rendered unmarketable or obsolete. Such
consequences
would have a negative impact on our business, results of operations and
financial condition.
Government policies, standards,
rules and regulations may force us to implement changes to our existing
enterprise software or change how we provide products and services to our
customers, which could increase our expenses and decrease our
profitability.
The
software industry is a new and rapidly evolving industry in China and the
regulatory environment has been and continues to be subject to uncertainty.
Although the PRC government adopted policies to encourage the development of the
PRC electronic government, or e-government, industry through the “Three
Digitizations Project,” there can be no assurance that policies and the
government’s standards, rules and regulations relating to the e-government
software industry, such as the Regulations for the Protection of Computer
Software, will not be implemented, interpreted or revised in a manner that may
force us to implement changes to our existing enterprise software or change how
we provide products and services to our customers, which could increase our
expenses and decrease our profitability. See Item 4 of this annual report,
“Information on the Company — Business overview — Regulation” for a discussion
of the laws and regulations that apply to our company. We cannot accurately
predict the circumstances that would cause the PRC government to implement,
interpret or revise its policies in such a manner. Nevertheless, the PRC
government could adopt measures to more closely regulate the use of the Internet
or the software industry in China in order to enhance the government’s control
over the Internet or over the content of software being distributed in
China.
For
example, we may be subject to potential liability for selling software that is
subsequently deemed to be illegal by the relevant PRC regulatory authorities for
having non-approved technology. These potential liabilities may include fines,
product confiscation and criminal sanctions. We cannot assure you that our
business, financial condition and results of operations will not be negatively
affected by the application of these regulations.
Furthermore,
China and the United States may afford different patent protection to software
programs. For example, there are jurisdictional variations in the enforcement of
patent rights in China because most patent infringement disputes are resolved by
courts at the municipal or provincial level or by local administrative
authorities for patent affairs, which may be subject to varying local economic
and political influences in rendering their decisions. By contrast, all patent
disputes in the United States are reviewable by a single federal circuit court,
which generally provides greater uniformity to the adjudication of patent
disputes. We cannot predict whether the PRC authorities would centralize the
enforcement or adjudication of patent rights in the future or how such
centralized enforcement or adjudication would affect our rights. If the PRC
authorities further de-centralize the regulation of the software industry, or
centralize its enforcement or adjudication policy in a way that is detrimental
to our company, we may be forced to implement changes to our existing enterprise
software or change how we provide products and services to our customers, which
could increase our expenses and decrease our profitability.
Risks related to doing business in
China
Adverse economic, political, social
or legal developments or a decrease in domestic demand in China could result in
a reduction in international trade activities involving China, which could in
turn reduce the demand for our products and services.
All of
our total net revenues have been, and are for the foreseeable future expected to
be, derived from the PRC market and substantially all of our operating assets
are located in China. Accordingly, our operating results and financial condition
are largely subject to economic, political, social and legal developments in
China as well as changes in the demand for our enterprise software and
software
development
services by international trade enterprises and PRC government agencies in
China. There can be no assurance that such developments will not adversely
affect our performance and profitability.
We cannot
predict the future direction of the economic reform measures that have been
adopted by the PRC government or the effects these measures may have on our
business, results of operations or financial position. Many laws and regulations
governing economic matters implemented by the PRC government are at an early
stage of development and their interpretation and enforcement involve more
uncertainties than in most countries belonging to the Organization for Economic
Cooperation and Development, or OECD. In addition, the PRC economy differs from
the economies of most countries belonging to the OECD. These differences
include:
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level
of government involvement in the
economy;
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level
of capital reinvestment;
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control
of foreign exchange;
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methods
of allocating resources; and
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balance
of payments position.
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As a
result of these differences, our business may not develop in the same way or at
the same rate as might be expected if the PRC economy were similar to those of
other OECD member countries.
In
addition, there can be no assurance that any growth in the PRC economy will be
steady or that any slowdown will not have a negative effect on our business;
that deflation will not reoccur in the PRC economy in the foreseeable future; or
that the level of international trade to and from China will not cease to grow
at historical rates or even decrease, which could negatively impact demand for
our enterprise software. Finally, our results of operations and financial
condition could be negatively affected by adverse changes in government monetary
policies, import/export polices and regulations, tax regulations or policies and
regulations affecting the software industry. In recent years, the PRC government
implemented a number of measures, such as raising bank reserves against deposit
rates, to place additional limitations on the ability of commercial banks to
make loans, in order to slow growth in certain segments of the PRC economy it
believed to be overheating. These actions, as well as future actions and
policies of the PRC government, could result in a reduction in international
trade activities involving China, which could in turn reduce the demand for our
products and services.
The uncertain legal environment in
China could limit the legal protections available to you and could adversely
affect our ability to provide our products and services in
China.
We
conduct our business entirely through our operating subsidiaries and variable
interest entities incorporated in China. Our subsidiaries are generally subject
to laws and regulations applicable to foreign investment in China and, in
particular, laws applicable to wholly foreign-owned enterprises. The PRC legal
system is a civil law system based on written statutes. Unlike common law
systems, it is a system in which decided legal cases have little precedential
value. In the late 1970s, the PRC government began to promulgate a comprehensive
system of laws and regulations governing economic matters. However, these laws,
regulations and legal requirements are relatively new and are evolving rapidly,
and their interpretation and
enforcement
involve uncertainties. These uncertainties could limit the legal protections
available to foreign investors and entities, including you and us, such as the
right of foreign-invested enterprises to hold licenses and permits such as
customs-related business licenses and permits, software licenses and licenses
and approvals necessary to provide services to government enterprises. As the
PRC legal system matures, changes in its legislation or interpretation of its
legislation may adversely affect our ability to provide our products and
services in China.
Landlords for some of our leased
properties may not possess valid title to their properties and we could be
forced to vacate such properties should their title be
challenged.
PRC law
requires that lessors of properties possess title certificates to the leased
properties. We currently have approximately eight leases for properties
that we use as employee housing or as our offices for technical support centers
in Guangdong Province for which the lessors cannot provide copies of the
required title certificates. If there are disputes over the ownership of any of
these leased properties for which the lessors do not possess title certificates,
our leases may be deemed invalid by the PRC courts and we may be forced to
vacate these properties.
The recurrence of SARS or avian
influenza may result in a reduction in business activity in and related to Asia,
which could have an adverse effect on our total net revenues, growth and
profits.
In early
2003, several economies in Asia, including Hong Kong and China, were affected by
the outbreak of Severe Acute Respiratory Syndrome, or SARS. Several confirmed or
suspected SARS cases were reported in early 2004 in Beijing and Anhui Province
in China. In addition, lethal outbreaks of avian influenza A (H5N1) infection
among poultry were reported by several countries in Asia, including China in
2005. In March 2007, a new fatal case of avian influenza was reported in Anhui
Province in China. If there is a recurrence of an outbreak of SARS or
avian influenza, it may adversely affect our total net revenues, growth and
profits. For instance, a recurrence of SARS, avian influenza or any other
epidemic may reduce the level of economic activity in affected areas and
negatively impact international trade activities involving China, which could
have a negative impact on our business. In addition, health or other government
regulations may require temporary closure of our offices, government offices or
the offices of our customers, which will severely disrupt our business
operations and have a material adverse effect on our total net revenues, growth
and profits.
Restrictions on currency exchange
may limit our ability to receive and use our revenues to, among other things,
pay dividends and make distributions.
Because
almost all of our future revenues will be in the form of Renminbi, any future
restrictions on currency exchanges may limit our ability to use revenues
generated in Renminbi to fund future business activities outside China or to
make dividend or other payments in U.S. dollars. There are significant
restrictions on the convertibility of the Renminbi, including the restriction
that foreign-invested enterprises may only buy, sell and/or remit foreign
currencies after providing valid commercial documents at banks authorized to
conduct foreign exchange business. In addition, conversion of Renminbi for
capital account items, including direct investment and loans, is subject to
approval of the State Administration of Foreign Exchange of the PRC, or SAFE,
and companies are required to open and maintain separate foreign exchange
accounts for capital account items. We cannot be certain that the PRC regulatory
authorities will not impose more stringent restrictions on the convertibility of
the Renminbi, especially with respect to foreign exchange
transactions.
The value of our ordinary shares and
our ADSs, and the value of your investment in our company, may decrease due to
changes in the foreign exchange rate between U.S. dollars and
Renminbi.
The value
of our ordinary shares and our ADSs will be affected by the foreign exchange
rate between U.S. dollars and Renminbi. For example, to the extent that we need
to convert U.S. dollars into Renminbi for our operational needs and if the
Renminbi appreciates against the U.S. dollar at that time, our financial
condition and the price of our ordinary shares and our ADSs may be adversely
affected. Conversely, if we decide to convert our Renminbi into U.S. dollars for
the purpose of declaring dividends on our ordinary shares or for other business
purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar
equivalent of our earnings from our subsidiaries and variable interest entities
in China would be reduced.
The value
of your investment in our ADSs may fluctuate with the foreign exchange rate
between the U.S. dollar and the Renminbi, because the value of our business is
largely denominated in Renminbi, while our ADSs will be traded in U.S.
dollars.
PRC regulations relating to offshore
investment activities by PRC residents may increase our administrative burden
and restrict our overseas and cross-border investment activity. If
our shareholders who are PRC residents fail to make any required applications
and filings under such regulations, we may be unable to distribute profits and
may become subject to liability under PRC law.
In
October 2005, SAFE issued the Notice on Issues Relating to the Administration of
Foreign Exchange in Fund – Raising and Return Investment Activities of Domestic
Residents Conducted via Offshore Special Purpose Companies, or Notice 75, which
took effect on November 1, 2005. Notice 75 supersedes prior SAFE
regulations promulgated in January and April of 2005. Notice 75
requires PRC residents to register with the relevant local SAFE branch in
connection with their establishment or control of an offshore entity established
for the purpose of overseas equity financing involving onshore assets or equity
interests held by them. The term “PRC residents” as used in Notice 75
includes PRC citizens as wells as other persons who habitually reside in the PRC
for economic benefit. Such PRC residents are required to complete
amended registrations with the relevant SAFE branch upon (i) injection of equity
interests or assets of an onshore enterprise into the offshore entity, (ii)
subsequent overseas equity financing by such offshore entity, or (iii) any
material change in the shareholding or capital of the offshore entity, such as
changes in share capital, share transfers and long-term equity or debt
investments, and providing security. PRC residents who have already
incorporated or gained control of offshore entities that made onshore
investments in the PRC before Notice 75 was promulgated was required to register
with the relevant local SAFE branch on or before March 31, 2006. In
addition, such PRC residents are required to repatriate into China all of their
dividend profits or capital gains from their shareholdings in the offshore
entity within 180 days of their receipt of such profits or gains.
The
registration and amendment procedures set forth by Notice 75 are prerequisites
for other approval and registration procedures necessary for capital inflow from
the offshore entity, such as inbound investment or shareholders loans, or
capital outflow to the offshore entity, such as the payment of profits or
dividends, liquidating distributions, equity sale proceeds or the return of
funds upon a capital reduction.
A number
of terms and provision in Notice 75 remain unclear. Because of uncertainty over
how Notice 75 will be interpreted and implemented, we cannot predict how it will
affect our business operations or future strategies. For example, our present
and prospective PRC subsidiaries' or variable interest entities' ability to
conduct foreign exchange activities, such as remitting dividends and
foreign-currency denominated borrowings, may be subject to compliance with
Notice 75 requirements by our PRC resident shareholders. Despite our efforts to
fully comply with the SAFE regulations, we cannot assure you that we will
obtain, or receive waivers
from, any
necessary approvals or not be found in violation of the SAFE regulations or any
other related foreign exchange regulations. In particular, we cannot assure you
that we will be able to cause all our present or prospective PRC resident
shareholders to comply with all SAFE regulations. A failure by our
PRC resident shareholders to comply with Notice 75 or our inability to secure
required approvals or registrations may subject us to fines or legal sanctions,
limit our subsidiaries' ability to make distributions or pay dividends, restrict
our overseas or cross-border investment activities or affect our ownership
structure, any of which could affect our business and prospects.
Risks related to our ADSs and
ordinary shares
Your ability to participate in any
future rights offerings may be limited, which may cause dilution to your
holdings.
We may
from time to time distribute rights to our shareholders, including rights to
acquire our securities. Under the deposit agreement, the depositary will not
offer you those rights unless the distribution to ADS holders of both the rights
and any related securities are either registered under the U.S. Securities Act
of 1933, as amended, or the Securities Act, or exempt from registration under
the Securities Act. We are under no obligation to file a registration statement
with respect to any such rights or securities or to cause such a registration
statement to be declared effective. Moreover, we may not be able to establish an
exemption from registration under the Securities Act. Accordingly, you may be
unable to participate in our rights offerings and may experience dilution in
your holdings.
The future sales by our directors,
officers and our current shareholders of a substantial number of our ordinary
shares could result in the supply of our ADSs in the public market exceeding
demand, which in turn could lower the market price of our
ADSs.
If our
shareholders sell substantial amounts of our ordinary shares or ADSs, including
those issued upon the exercise of outstanding options, in the public market, the
market price of our ADSs could fall. Such sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate. If any existing shareholder or
shareholders sell a substantial amount of ordinary shares, the supply of our
ADSs in the public market may exceed demand, which in turn could lower the
market price for our ADSs and thus the value of your investment could be
adversely affected.
The market price for our ADSs may be
volatile, and the value of your investment in our ADSs may
decrease.
The
market price for our ADSs may be highly volatile and subject to wide
fluctuations in response to the factors set forth elsewhere in this section, as
well as:
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actual
or anticipated fluctuations in our quarterly operating
results;
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actual
or anticipated fluctuations in the market price of Internet and
PRC-related companies;
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announcements
of new products or services by us or our
competitors;
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conditions
in the international trade industry;
and
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announcements
by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital
commitments.
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In
particular, the performance and fluctuation of the market prices of other PRC
technology companies that have listed their securities in the United States may
affect the trading and price volatility of our ADSs. Recently, a number of PRC
companies have listed their securities, or are preparing to list their
securities, in the United States. Some of these securities have experienced
significant volatility, including significant price declines in connection with
or in the periods following their initial public offerings. The trading
performances of these companies’ securities may affect the investor sentiment
towards PRC companies listed in the United States in general, which may impact
the trading performance of our ADSs. These broad market and industry factors may
significantly affect the market price and volatility of our ADSs.
You may not be able to exercise your
right to vote.
The SEC
generally exempts foreign private issuers such as our company from its proxy
solicitation requirements. As a holder of ADSs, you may instruct the depositary
of our ADSs to vote the ordinary shares underlying your ADSs, but only if we ask
the depositary to ask for your instructions. Otherwise, you will not be able to
exercise your right to vote unless you withdraw the ordinary shares. However,
you may not know about the meeting enough in advance to withdraw the shares. If
we ask for your instructions, the depositary will notify you of the upcoming
vote and arrange to deliver our voting materials to you. We cannot assure you
that you will receive the voting materials in time to ensure that you can
instruct the depositary to vote your ordinary shares. In addition, the
depositary and its agents are not responsible for failing to carry out voting
instructions or for the manner of carrying out voting instructions. This means
that you may not be able to exercise your right to vote and there may be nothing
you can do if the ordinary shares underlying your ADSs are not voted as you
request.
We and the depositary may amend the
deposit agreement at any time without your consent, and by doing so may change
your rights thereunder in a manner with which you
disagree.
We may
agree with the depositary to amend the deposit agreement without your consent
for any reason. If you continue to hold your ADRs after being notified of such
amendment, you will be deemed to have agreed to such amendment. In the event you
disagree with any such amendment, your only recourse may be to sell your
ADSs.
You may not receive distributions on
ordinary shares or any value for them if it is illegal or impractical to make
them available to you and these restrictions may reduce the value of your
ADSs.
The
depositary of our ADSs has agreed to pay to you the cash dividends or other
distributions it or the custodian receives on our ordinary shares or other
deposited securities after deducting its fees and expenses. However, the
depositary is not required to do so if it decides that it is unlawful or
impractical to make a distribution available to any holders of ADSs. We have no
obligation to register ADSs, ordinary shares, rights or other securities under
U.S. securities laws. We also have no obligation to take any other action to
permit the distribution of ADSs, ordinary shares, rights or anything else to
holders of ADSs. This means that you may not receive the distributions we make
on our ordinary shares or any value for them if it is illegal or impractical for
us to make them available to you. These restrictions may reduce the value of
your ADSs.
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 it expedient to do so 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 thinks 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.
We have
not adopted any policy regarding the closing of our books relating to our ADSs,
nor is there any provision under Cayman Islands or New York law, or the deposit
agreement, that would prevent the transferability of ADSs. Under the deposit
agreement, however, the depository may close its books for our ADR facility from
time to time at its discretion, which may prevent you from transferring your
ADSs when you wish to do so.
If our subsidiaries are restricted
from paying dividends and other distributions to us, our primary source of funds
would decrease.
We are a
holding company with no significant assets other than our equity interests in
our subsidiaries in China. As a result, we rely on dividends and other
distributions paid to us by our subsidiaries in China, including the funds
necessary to service any debt we may incur. If our subsidiaries incur debts on
their own behalf in the future, the instruments governing the debts may restrict
their ability to pay dividends or make other distributions to us, which in turn
would limit our ability to pay dividends on our ordinary shares. PRC regulations
permit payment of dividends only out of accumulated profits as determined in
accordance with PRC accounting standards and regulations. Our subsidiaries in
China are also required to set aside a portion of their after-tax profits
according to PRC accounting standards and regulations to fund certain reserve
funds that are not distributable as cash dividends.
Other
than restrictions imposed by PRC law as set forth under Item 8 of this annual
report, “Financial Information — Consolidated statements and other financial
information — Dividend policy,” and except as set forth below, our subsidiaries
in China are not currently subject to any restriction that would prevent them
from paying any dividend or any other form of distribution to us, but there can
be no assurance that PRC legal restrictions will not prevent the payment of
dividends or distributions in the future and deprive us of our primary source of
funds.
Relevant
PRC laws and regulations permit payments of dividends by our PRC subsidiaries
only out of their retained earnings, if any, as determined in accordance with
PRC accounting standards and regulations. In addition, the statutory general
reserve fund, which requires annual appropriations of 10% of net after-tax
income should be set aside prior to payment of any dividends. As a result of
these and other restrictions under PRC laws and regulations, our PRC
subsidiaries and affiliates are restricted in their ability to transfer a
portion of their net assets to us either in the form of dividends, loans or
advances, restricted portion amounted to approximately RMB522.5 million (US$67.0
million), or 40.0% of our total consolidated net assets as of December 31,
2006.
Even
though we currently do not require any such dividends, loans or advances from
our PRC subsidiaries, we may in the future require additional cash resources
from our PRC subsidiaries due to changes in business conditions, to fund future
acquisitions or developments, or merely to declare and pay dividends or
distributions to our shareholders, although we currently have no intention to do
so.
You may face difficulties in
protecting your interests, and our ability to protect our rights through the
U.S. federal courts may be limited, because we are incorporated under Cayman
Islands law.
Our
corporate affairs are governed by our amended and restated memorandum and
articles of association, the Companies Law, Cap. 22 (Law 3 of 1961, as
consolidated and revised) and the common law of the Cayman Islands. The rights
of shareholders to take action against the directors and actions by minority
shareholders are to a large extent governed by the common law of the Cayman
Islands. Cayman
Islands
law in this area may not be as established and may differ from provisions under
statutes or judicial precedent in existence in the United States. As a result,
our public shareholders may face different considerations in protecting their
interests in actions against our management, directors or our controlling
shareholder than would shareholders of a corporation incorporated in a
jurisdiction of the United States.
The
rights of shareholders and the responsibilities of management, members of the
board of directors and controlling shareholders under Cayman Islands law, such
as in the areas of fiduciary duties, are different from those applicable to a
company incorporated in a jurisdiction of the United States. For example, the
Cayman Islands courts are unlikely:
·
|
to
recognize or enforce against us judgments of courts of the United States
based on certain civil liability provisions of U.S. securities laws;
and
|
·
|
in
original actions brought in the Cayman Islands, to impose liabilities
against us based on certain civil liability provisions of U.S. securities
laws that are penal in nature.
|
As a
result, our public shareholders may have more difficulty in protecting their
interests in connection with actions taken by our management, members of our
board of directors or our controlling shareholder than they would as public
shareholders of a U.S. company.
Our ability to protect our rights
through the U.S. federal courts may be limited because we are incorporated under
Cayman Islands law.
Cayman
Islands companies may not have standing to initiate a derivative action in a
federal court of the United States. As a result, our ability to protect our
interests if we are harmed in a manner that would otherwise enable us to sue in
a United States federal court may be limited.
Your ability to bring an action
against us or against our directors and officers, or to enforce a judgment
against us or them, will be limited because we are incorporated in the Cayman
Islands, a substantial portion of our operations are in China and the majority
of our directors and officers reside outside of the United
States.
We are
incorporated in the Cayman Islands, and we conduct substantially all of our
operations through our operating subsidiaries and variable interest entities in
China. Most of our directors and officers reside outside of the United States
and substantially 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 action against us or against these individuals in the United States in the
event that you believe that your rights have been infringed under the U.S.
securities laws or otherwise. Even if you are successful in bringing an action
of this kind, the laws of the Cayman Islands and of China may render you unable
to enforce a judgment against our assets or the assets of our directors and
officers. For more information regarding the relevant laws of the Cayman Islands
and China, see Item 10 of this annual report, “Additional Information — Taxation
— United States federal income taxation — Enforceability of civil
liabilities.”
We may be at risk of securities
class action litigation.
In the
past, securities class action litigation has been brought against companies
following declines in the market price of their securities. If we are faced with
such litigation, it could result in substantial costs and a diversion of our
management’s attention and resources, which could have a material adverse effect
on our business, results of operation, financial condition and the trading price
of our ADSs.
We are required to implement
additional controls and procedures in finance and accounting systems in the
future to satisfy new reporting requirements. Failure to complete the required
assessment as to the adequacy of our internal control over financial reporting
or unavailability of an unqualified report as to the effectiveness of our
internal controls over financial reporting provided by our independent
registered public accounting firm could result in the loss of confidence in the
reliability of such controls, which may adversely affect the trading price of
our ADSs.
As a
public reporting company, we are required to comply with the Sarbanes-Oxley Act
of 2002 and the related rules and regulations of the Securities and Exchange
Commission, including expanded disclosures and accelerated reporting
requirements. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and
other requirements may increase our costs and require additional management
resources. We have recently been upgrading and implementing additional
controls and procedures in our finance and accounting systems and will
need to continue to do so as we grow our business and organization and to
satisfy new reporting requirements. If we are unable to complete the
required assessment as to the adequacy of our internal control over financial
reporting or if our independent registered public accounting firm qualifies its
report as to the effectiveness of our internal controls over financial
reporting, investors could lose confidence in the reliability of our internal
controls over financial reporting, which could adversely affect the trading
price of our ADSs.
Our
management has determined that our internal control over financial
reporting as at December 31, 2006 was effective. However, it is
possible that we or our independent registered public accounting firm may
identify other significant deficiencies or material weakness in future periods.
Such results could cause our investors to lose confidence in the
reliability of our internal controls over financial reporting, which could
adversely affect the trading price of our ADSs. Furthermore, we anticipate that
we will continue to incur increased costs and devote significant management
resources to comply with Section 404 of the Sarbanes-Oxley Act of
2002.
Item 4.
Information on the Company.
A. History
and development of the company
Our
predecessor, Ninetowns Technology, a “share cooperative enterprise” formed under
PRC law on March 22, 1995, focused on the research and development of software
related to the declaration process, in addition to selling computer hardware and
accessories. Through a series of restructuring transactions in 2000, Ixworth
Enterprises Limited, or Ixworth, a company incorporated in the British Virgin
Islands, acquired 90.0% of the equity interest of Ninetowns Technology. Such
90.0% equity interest acquired by Ixworth was held by New Take Limited, or New
Take, and Shielder Limited, or Shielder, both Hong Kong companies, through their
respective subsidiaries, Beijing New Take and Ninetowns Times. In September
2003, we issued 21,999,996 ordinary shares to Jitter Bug Holdings Limited, or
Jitter Bug, the parent company of Ixworth. Jitter Bug simultaneously transferred
100.0% of the equity interest in Ixworth to us. We were incorporated in the
Cayman Islands on February 8, 2002 as Ninetowns Digital World Trade Technology
Holdings Limited. We changed our name to “Ninetowns Digital World Trade One
Technology Holdings Limited” on June 11, 2002 and then to “Ninetowns Digital
World Trade Holdings Limited” on April 7, 2003. On June 30, 2004, we signed
definitive agreements to acquire the remaining 10.0% equity interest in Shanghai
New Take for a consideration of RMB50,000 from Import & Export. From August
to October 2004, we completed a series of reorganization transactions to acquire
from our shareholder Value Chain International Limited, or Value Chain, the
remaining 10.0% equity interest in Beijing New Take, Ninetowns Digital,
Ninetowns Times, Ninetowns Ports and Shanghai New Take, as well as a 70.0%
equity interest in Tsingdao Fujin, in exchange for 2,002,312 ordinary shares and
US$5,876,540 in cash. On November 8, 2006, Tsingdao Fujin terminated
its registration with the Qingdao Industry and
Commercial
Administrative Bureau, Shinan Branch. On November 9, 2004, we
effected a 4-for-1 split of our ordinary shares in preparation for our initial
public offering. On December 3, 2004, we listed our ADSs on the Nasdaq National
Market, under the symbol “NINE.” On December 8, 2004, we completed the initial
public offering of our ADSs, each of which represented one ordinary share.
Ixworth formed Beprecise Investments Limited, or Beprecise, a British Virgin
Islands Company, as a wholly-owned subsidiary in 2006. On October 19,
2006, our wholly-owned subsidiary, Beprecise, acquired a 16.25% interest in
Global Market Group Limited, or Global Market. On September 15, 2006,
we changed our name to “Ninetowns Internet Technology Group Company
Limited.” On April 27, 2007, our wholly-owned subsidiary, Ixworth,
acquired a 70% interest in Ample Spring Holdings Limited, or Ample
Spring, a company incorporated in the British Virgin Islands.
We
conduct our business in China through seven PRC subsidiaries, namely (i) Beijing
New Take, (ii) Ninetowns Digital, (iii) Ninetowns Times, (iv) Ninetowns
Ports, (v) Shanghai New Take, (vi) Guangdong Ninetowns Technology and (vii)
Ninetowns Network; two variable interest entities, namely (i) Ronghe Tongshang
and (ii) Beijing Baichuan Tongda Science and Technology Development Company
Ltd., or Baichuan, which we effectively control, through a series of contractual
agreements entered into in 2006 and 2007, respectively. For more
information, see Item 7 of this annual report “Major Shareholders and Related
Party Transactions – Related party transactions—Control over Ronghe Tongshang”
and “Major Shareholders and Related Party Transactions – Related party
transactions—Control over Baichuan.” Our principal executive offices are located
at 5th Floor, Union Plaza, 20 Chaowai Street, Chaoyang District, Beijing 100020,
People’s Republic of China. Our telephone number in China is (86 10) 6588-7788.
We have appointed CT Corporation System, 111 Eighth Avenue, New York, NY 10011,
as our agent for service of process in the United States.
Our
capital expenditures for 2004, 2005 and 2006, which totaled approximately
RMB51.5 million, RMB31.4 million and RMB75.9 million (US$9.7 million),
respectively, consisted primarily of purchases of property and equipment as well
as copyright for software, acquisition of interests in subsidiaries and other
investments. During 2004, 2005 and 2006, we paid deposits for the
acquisition of property and equipment in the amounts of RMB49.7 million, RMB23.4
million and RMB0.4 million (US$48,000), respectively. We anticipate
that we will incur capital expenditures in 2007 of approximately RMB30.0 million
(US$3.8 million) to purchase equipment and software products to support our new
software development projects and development of new potential business
ventures, approximately RMB65.0 million (US$8.3 million) to acquire office
premises and office furniture as part of our effort to reduce office rental
expenses in the future, and approximately RMB125 million (US$16.0 million) for
strategic acquisitions and investments. We expect to use our cash flow from
operations and our available cash to fund such capital expenditures (including
capital expenditures for development of new software products and functions) and
to execute our business strategy.
B. Business
overview
We are a
leading PRC software company that enables enterprises and trade-related PRC
government agencies to streamline the import/export process in China; we believe
we are a leader in our market based on revenues and market share. We achieve
this by leveraging our international trade expertise and our insight into the
needs and procedures of trade-related PRC government agencies. To date, we have
focused on providing enterprise software and related services for the completion
over the Internet of the declaration process. In order to secure our market
position, we assisted in designing and building, and continue to help maintain
and upgrade, the electronic systems of the PRC Inspections Administration that
enable our enterprise software to process electronic declarations over the
Internet. We have pioneered the implementation of enterprise software that
enables, among other things:
(i)
|
electronic
application to the PRC Inspections Administration for an Origin
Certificate;
|
(ii)
|
electronic
application to the PRC Inspections Administration for goods
inspection;
|
(iii)
|
electronic
transfer of various import/export documents between the local inspection
agency branch office where an international trade enterprise is located
and the branch office at the discharging port or station through which the
relevant goods are being imported into or exported from the PRC;
and
|
(iv)
|
electronic
transfer of documents from the PRC Inspections Administration to PRC
Customs.
|
Our
enterprise software products consists of standardized, easy-to-install
applications that simplify the declaration and approval process for
international trade enterprises. Our enterprise software automates and
facilitates the processing of the required import/export declarations and
approvals in a cost-efficient, user-friendly and legally-compliant manner over
the Internet, utilizing an electronic infrastructure we helped build that links
together numerous branch offices of the PRC Inspections
Administration.
Through
our software development services, we assist in the development and maintenance
of (i) the software systems used to process electronic filings by the PRC
Inspections Administration and iTowNet and (ii) the data exchange platforms
which serve as the interface between such systems and our enterprise software
users. The infrastructure used by the PRC Inspections Administration in the
declaration process was developed as a result of the collaborative efforts of
our company and the PRC Inspections Administration. We and the PRC Inspections
Administration used shared knowledge in connection with the implementation at
the PRC Inspections Administration of a PRC e-government initiative widely known
as the “Three Digitizations Project.” The “Three Digitizations Project” became
particularly active following China’s accession into the World Trade
Organization, or WTO, and seeks to enhance the transparency of the
administration and improve the internal organization and workflow management of
PRC government agencies. The PRC Inspections Administration infrastructure we
helped implement includes internal electronic processing systems and data
exchange platforms, operated by iTowNet, that interface between international
trade enterprises using our enterprise software and the PRC Inspections
Administration’s internal electronic processing system. We believe e-government
initiatives relating to import/export processes will continue to be an important
factor in PRC international trade as China becomes more fully integrated into
the WTO.
We
believe the market for our enterprise software is large and relatively
under-penetrated. The market for our enterprise software relating to the
declaration process consists of international trade enterprises in China.
According to the PRC Ministry of Commerce, there were approximately 609,276
foreign-invested companies registered to do business in China as of May 31,
2007, many of which engage in importing goods into and exporting goods from
China, as well as millions of PRC-based companies which do not have foreign
investment but which do engage in importing and exporting. Of these companies,
as of May 31, 2007, only approximately 150,000 engaged in
electronic import/export declaration processing. We believe approximately
134,000, or approximately 89.3%, of such users use our enterprise software to
complete the declaration process with the PRC Inspections
Administration.
In August
2005, the PRC Inspections Administration selected our company as the winning
bidder in connection with the PRC Inspections Administration’s request for
proposals for the development of a software product that has certain basic
functionalities similar to those of iDeclare.CIQ and
iProcess.CIQ. The PRC Inspections Administration agreed to pay a
one-time fee of RMB3.3 million (US$423,000) to purchase the ownership of the
software product that we developed. The development of such software product was
completed in December 2005 and the PRC Inspections Administration commenced to
distribute such software products free-of-charge to end-users in February 2006.
We believe that the distribution of free software products, while in the
long-term would further increase the number of e-filers and in turn increase
demand for our enterprise software services, would also have a significant
adverse
effect on
our business, our results of operations and profitability in the short-term. For
example, we sold, together with our franchisees, approximately 1,500 and 2,200
software packages of iDeclare.CIQ during the first quarter of 2006 and 2007,
respectively, which is significantly lower than the approximately 8,000 software
packages of iDeclare.CIQ sold by our company and our former distributors and
franchisees during the first quarter of 2005.
In 2006,
we derived 76.2% of our total net revenues from sales of enterprise software and
23.5% from software development services. Specifically, our enterprise software
recognized net revenues of RMB188.7 million, RMB203.5 million and RMB116.8
million (US$15.0 million) in 2004, 2005 and 2006, respectively. We believe there
were approximately 95,000, 122,000 and 130,000 licensees of our enterprise
software registered on their data exchange platforms as of December 31, 2004,
2005 and 2006, respectively.
We intend
to increase our revenues by leveraging and strengthening our market reputation,
enhancing value for our clients through broader product offerings and improved
customer maintenance services, expanding our client base through increased
marketing, maintaining our leadership in technical and industry knowledge and
pursuing selective strategic acquisitions and investments. However, given the
uncertain impact on our business resulting from the distribution of free
software products by the PRC Inspections Administration to end-users, we cannot
predict the growth in our revenues, if there are any at all.
Advantages of our enterprise software
products
Our
enterprise software primarily facilitates declaration processing in a
cost-efficient and user-friendly manner over the Internet, utilizing data
exchange platforms that we helped build. The key advantages of our products
are:
Ease of
deployment
Our
enterprise software consists of standardized programs that can be easily
installed onto most computers from a CD-ROM or through the Internet and be fully
operational in less than 30 minutes. Our enterprise software is broadly
applicable to all international trade enterprises seeking to complete the
declaration process electronically and does not require customization. We helped
build the PRC Inspections Administration’s internal electronic processing
systems and the data exchange platforms within the PRC Inspections
Administration offices. We have leveraged our experience and expertise with
these data exchange platforms, which interface between international trade
enterprises and the PRC Inspections Administration’s own internal electronic
processing systems, to design enterprise software with optimal compatibility
with the PRC Inspections Administration’s systems and internal requirements. We
intend to continue to help maintain and upgrade the data exchange platforms.
Given our knowledge of such data exchange platforms and our role in continuing
to maintain and upgrade such systems, we believe we are in a unique position to
provide enterprise software that is easy to deploy, fully integrated and
optimally compatible with the PRC Inspections Administration’s systems and
internal requirements.
Fast, efficient and accurate
transfers
Our
enterprise software eliminates the need for the manual preparation and
submission of paperwork in the declaration process and can reduce the time
required to complete the declaration process from approximately two or more days
to as quick as one hour. Our enterprise software enables nearly immediate
submission of electronic filings and notice of most submission errors, allowing
for fast and accurate submissions. In addition, demands on staff time are
reduced and the risk of delayed responses from the PRC Inspections
Administration due to delivery failures is minimized because transmissions
to
and
feedback from the PRC Inspections Administration are delivered electronically.
Furthermore, since data is submitted in electronic format, there is reduced risk
of error and delay related to the PRC Inspections Administration’s inability to
read or accurately copy required data. The electronic forms contained in our
enterprise software are regularly updated, ensuring that all required
information is submitted to the PRC Inspections Administration.
Reduction of costs associated with
declaration filings
We
believe our enterprise software significantly reduces the costs associated with
PRC Inspections Administration filings and that the increased efficiency and
accuracy derived from using our enterprise software results in reduced need for
staff to complete the declaration process. In addition, there is a reduction in
travel expenses traditionally associated with making declarations in person at
the PRC Inspections Administration. Furthermore, faster processing can result in
reduced transportation time for goods, which is particularly important for
perishable goods and reduces an importer’s or exporter’s working capital
allocated to inventory.
Convenience of filing anytime and
from anywhere over the Internet
Traditionally,
an international trade enterprise would send a representative to a PRC
Inspections Administration branch office in China during business hours to make
a declaration filing. The PRC Inspections Administration branch office would
then process and forward the documentation to the PRC Inspections Administration
branch office at the port or station through which the relevant goods were being
imported into or exported from China. Our enterprise software allows
international trade enterprises to make declaration filings with the PRC
Inspections Administration electronically over the Internet. Declarations can be
made at any time, whether the PRC Inspections Administration’s branch offices
are open for business or not, and from anywhere in the world through a computer
on which our enterprise software is installed and which is connected to the
Internet. In addition, our enterprise software and the electronic systems we
helped build allow the PRC Inspections Administration branch office processing
the electronic filing to electronically transmit various import/export documents
to the PRC Inspections Administration branch office at the relevant import or
export port or station. This system increases the efficiency and accuracy of
communications between the PRC Inspections Administration’s branch offices and
saves time and expense for the PRC Inspections Administration.
User-friendly
software
Our
user-friendly enterprise software simplifies the declaration process. Our users
benefit from an interface that requires very little training and is updated
regularly to reflect revisions to the regulations related to the declaration
process. Our enterprise software has auto-correction functions that
automatically detect errors and suggest corrections. We also offer additional
software functions that our users can purchase to expand their software
capabilities as their business requires.
Competitive
advantages
We
believe we have achieved the leading position in our industry, in part, by
establishing the competitive strengths described below:
First to market, setting the
industry standard
We
assisted in designing and building the electronic infrastructure used by the PRC
Inspections Administration to accept and process electronic declarations. We
believe our enterprise software for PRC Inspections Administration filings is
perceived by our customers and others to be the industry standard in our market
because:
·
|
we
helped build the PRC Inspections Administration’s system for accepting and
processing electronic declarations,
|
·
|
our
enterprise software is highly
reliable,
|
·
|
we
believe our enterprise software was the first made available for
electronic declaration processing with the PRC Inspections
Administration,
|
·
|
we
believe our enterprise software was the first product endorsed by the PRC
Inspections Administration for use in such declarations,
and
|
·
|
as
of May 31, 2007, our enterprise software is being used by approximately
89.3% of all filers making electronic PRC Inspections Administration
declarations.
|
Based on
the foregoing, we believe we are the leading provider of enterprise software to
international trade enterprises using the electronic declaration process in
China.
Proven ability to establish and
maintain collaborative relationships with the PRC Inspections
Administration
We
believe we were the first company to work with the PRC Inspections
Administration to develop enterprise software related to the declaration
process. As a result of our long-standing relationship with the PRC Inspections
Administration, we have developed a detailed understanding of the PRC
Inspections Administration’s and international trade enterprises’ declaration
processing and other trade-related requirements. Mr. Wang and Ms. Dong also
beneficially own a 49.0% equity interest in iTowNet, which is 51.0% owned by the
PRC Inspections Administration and operates the data exchange platforms that
interface between international trade enterprises using our enterprise software
and the PRC Inspections Administration’s internal electronic processing
system. We continue to work closely with the PRC Inspections
Administration to refine our enterprise software to reflect changes in the PRC
Inspections Administration’s information systems, procedures, rules and
regulations and to create new software functions to address additional aspects
of the declaration process. For more information regarding our relationship with
the PRC Inspections Administration. See Item 3D of this annual report, “Risk factors – Risks related to our
business – We currently generate substantially all of our total net revenues
from either PRC government agencies or in connection with PRC government agency
filings and approval procedures, and our failure to maintain a continued working
relationship with certain PRC government agencies and, in particular, the PRC
Inspections Administration, would result in the reduction or loss of
substantially all of our total net revenues.” We also believe that
our solid track record with the PRC Inspections Administration will assist us in
establishing collaborative relationships with other PRC government agencies,
such as PRC Customs.
Scalable, modular and secure
software
The data
exchange platform that we built for iTowNet is designed to effectively and
efficiently handle a large number of concurrent transactions for a large number
of users. We believe such scalability enables the PRC Inspections Administration
to adapt to the growing and changing PRC market at minimal cost. Our enterprise
software is designed to be modular, which allows our users to easily add
functions by installing additional software over the Internet with minimal cost
to us. Furthermore, all users must be
authenticated
as having a licensed copy of our enterprise software and as having a properly
registered account with the PRC Inspections Administration in order to conduct
electronic transactions over the PRC Inspections Administration’s data exchange
platforms, thus making it difficult to use pirated copies of our enterprise
software.
Strong market
reputation
We
believe we have earned a strong market reputation among international trade
enterprises in China for fast, user-friendly, efficient, cost-effective and
convenient declaration processing over the Internet, as well as for our customer
maintenance service. We believe that the endorsement of iDeclare.CIQ by the PRC
Inspections Administration and our significant market share have established us
as the market leader in our industry. iDeclare.CIQ has been recognized by
various PRC agencies and authorities for its quality.
Extensive distribution and support
network
Currently,
through our own distribution network and our franchisees, we maintain four
technical support centers, and also cooperate with our franchisees to jointly
maintain 43 technical support centers to reach most of the major
import/export cities in China. Through them, we provide coverage,
sales and marketing and customer maintenance services to most of the major
import/export cities in China.
Experienced management team with
strong product development capabilities
Our
management team has significant experience in the enterprise software business.
They have extensive knowledge of international trade enterprises, the
inner-workings of the PRC Inspections Administration and the rapidly changing
PRC trade-related regulations. In addition, our management has been recognized
for its expertise in the information technology industry in China. For example,
in March 2002, Mr. Shuang Wang was awarded the Traverse Cup Prize by Software
World Magazine jointly with a number of industry magazines in China for his
significant contributions to the information technology industry. In March 2003,
Mr. Wang was also recognized as one of the “2002 top ten leaders of the PRC
software industry in China” by Software World Magazine and China Central TV for
his significant contributions to the PRC software industry. We believe our
management team’s (i) close relationship with the PRC Inspections
Administration, (ii) deep and broad experience with PRC import/export processes,
(iii) knowledge of PRC import/export policies and business requirements and (iv)
strong product development capabilities provide us with the ability to develop
high-quality software to serve the needs of our markets.
Business strategy
Our
primary goal is to create long-term shareholder value and to become the leading
software company that enables enterprises and government agencies to streamline
their import/export processes in China. Our new B2B strategy
leverages our market intelligence in business-to-government, or B2G, trade
processing, by integrating B2B vertical search capabilities into our service
profile with pioneering vertical search technology. We believe China’s rapidly
growing import/export activities, continuous import/export policy changes and
evolving import/export filing requirements, coupled with the PRC government’s
initiative to streamline and use the Internet to carry out various government
operations, provide us with significant growth opportunities. We intend to use
our cash flow from operations and our available cash to pursue the following
strategies:
Leverage and strengthen our market
reputation by creating new products
We
believe that we have a strong market reputation for enabling international trade
enterprises to complete electronic declarations over the Internet efficiently
and cost effectively. We intend to expand this brand recognition for PRC
Inspections Administration-related products to other PRC trade-related
government agencies and trade-related third parties such as banks, insurers and
logistics providers. For example, we launched a new product series called
iProcess.CIQ in June 2005, which enables international trade enterprises and
their suppliers to submit product quality-related data to the PRC Inspections
Administration throughout the production process over the Internet. Such
information allows the PRC Inspections Administration to accelerate the approval
process and provide better monitoring support. We believe that building a strong
brand is an essential element of our sales and marketing strategy because brand
recognition allows us to grow our revenues rapidly without incurring significant
marketing costs.
Enhance value for existing clients
through broader product offerings and improved customer maintenance
services
We intend
to develop new functions for our existing products to enhance the interaction
between our users and the PRC Inspections Administration, other PRC
trade-related government agencies and related third parties. For example, we are
in the process of developing additional functions to further expand our existing
iDeclare.CIQ products, such as applications for permits to import used
equipment, paint, food and cosmetic products. In addition, we currently support
our existing users jointly with our four franchisees through four technical
support centers operated and maintained by us and 43 technical support
centers operated and maintained by our four franchisees located in most of the
major import/export cities in China.
Expand our client base through
increased marketing and broader product offerings
We intend
to grow our client base by expanding the use of our franchisees and our own
distribution network for marketing and front-line technical support throughout
China. In addition, we plan to upgrade all of our existing technical support
centers to full-service customer relations management centers. As a result, we
do not intend to engage new distributors in the near future. In addition, we
intend to develop new products which will appeal to international trade
enterprises that do not currently use our enterprise software.
Maintain leadership in technical and
industry knowledge
We intend
to continue to invest in our research and development efforts to enhance our
existing enterprise software and develop new products that will increase the
efficiency and cost-effectiveness of the declaration process and related
processes. In addition, we expect to continue to accumulate
import/export-related industry knowledge and technical expertise in order to
provide software for potential import/export-related processes. Both software
technology and the import/export regulatory environment in China are
continuously changing and we believe that continuous accumulation of both
technical and industry knowledge is crucial in providing the best software for
our customers.
Pursue selective strategic
acquisitions, investments, joint ventures or collaborative
arrangements
We expect
that our enterprise software user base will grow with the expected expansion of
the PRC export manufacturing sector and the increase in domestic demand for
imported goods. In response to this growth in our base of potential users, we
intend to pursue strategic acquisitions, investments, joint ventures or other
collaborative arrangements that complement our existing enterprise software. We
are
reviewing
selective investments in order to increase the scale of our business and
strengthen our position as a leading provider of enterprise software for
international trade enterprises.
In
connection with our pursuit of selective strategic acquisitions, on October 19,
2006, our indirect wholly-owned subsidiary, Beprecise, acquired a 16.25%
interest in Global Market for a consideration of US$5,000,000. Global
Market is a leading Chinese B2B trade facilitator headquartered in
Guangzhou. On April 27, 2007, Ixworth, our wholly-owned subsidiary,
acquired a 70% interest in Ample Spring, for a consideration of RMB210 million
(US$26.9 million). Ample Spring is a related party of Baichuan, a leading
Chinese B2B vertical search engine operator. In May 2007, our company
launched tootoo.com, our new B2B vertical search platform. By
leveraging our B2G expertise with these recent acquisitions and integrating
Baichuan's pioneering vertical search technology and supplier ranking system
with the in-depth quality validation process offered by our existing software
solutions, tootoo.com is positioned to become a leading B2B search and service
provider. We plan to continue to seek opportunities to cooperate with other B2B
platforms and technology to further increase our service profile.
Products and
services
In 2006,
we derived 76.2% of our total net revenues from sales of enterprise software and
23.5% of our total net revenues from provision of software development
services.
The
products and services we offered in 2006 included the following:
Enterprise
software
We have
five enterprise software products currently available commercially or in trial
version: (i) iDeclare.CIQ, (ii) iProcess.CIQ, (iii) User Message Agent, or
UMA, (iv) iMonitor.CGA and (v) iValue.
iDeclare.CIQ
series
Commercially
introduced in August 2000, the iDeclare.CIQ series of products enables
international trade enterprises to complete the declaration process
electronically over the Internet. We initially offered the iDeclare.CIQ basic
package, which included two separate software functions, for a one-time license
fee of RMB6,800, including one year of customer maintenance services. In
September 2001, we started to offer the current iDeclare.CIQ basic package,
which includes six separate software functions, for a one-time license fee of
RMB4,500, including one year of basic customer maintenance
services. In September 2006, we also developed Ninetowns Network
Quality Supervision Software v1.0, the newest version of software in the
iDeclare.CIQ series. We charge RMB1,500 for each additional year of
customer maintenance services, which includes a number of value-added services
in addition to the basic maintenance services. In 2004, 2005 and 2006, we
generated RMB175.5 million, RMB186.5 million and RMB107.9 million (US$13.8
million), respectively, of net revenues from sales of the iDeclare.CIQ basic
package and related customer maintenance services (including the per declaration
fees as described below), which represented a substantial portion of our net
revenues from sales of enterprise software in each of those
periods.
A limited
number of our iDeclare.CIQ users, substantially all of whom are located in
Guangdong Province, China, do not pay a one-time license fee or annual customer
maintenance service fees. Instead, such users pay a fee of RMB20 per declaration
filing made using iDeclare.CIQ. Net revenues from sales of enterprise software
included RMB24.1 million, RMB23.6 million and RMB21.9 million (US$2.8 million)
of such per-use fees, or 12.8%, 9.8% and 18.7% of our net revenues for sales of
enterprise software in 2004, 2005 and 2006, respectively.
We offer
trial versions of our new software functions to existing users until we
commercially launch such software functions. Once commercially launched, these
new software functions are not offered as part of the iDeclare.CIQ basic package
and a user must pay additional fees in order to use the new software
functions.
Our
iDeclare.CIQ product series users include a variety of international trade
enterprises operating in a wide range of businesses. They include the PRC branch
offices of multinational trading companies that might purchase multiple copies
of iDeclare.CIQ, as well as smaller PRC companies focused on niche businesses
that might buy only one copy of iDeclare.CIQ. We rely mainly on our franchisees
to sell our iDeclare.CIQ product series.
Our
iDeclare.CIQ product series allows users to submit encrypted applications to the
PRC Inspections Administration for examination, comment and approval over the
Internet. In addition, iDeclare.CIQ is capable of generating electronic
documents with information inter-linking ability to efficiently replicate
documents required for international trade transactions. Such documents include
invoices for export, packaging forms, bills, customs clearing forms and approval
forms for special goods. Additional software functions are designed for easy
installation and incorporation into the iDeclare.CIQ product series. When a
customer purchases and installs a new module, new tabs and folders appear in the
existing user interface, allowing customers to add new software functions while
maintaining a familiar and easy-to-use environment.
Currently,
the iDeclare.CIQ product series has three main applications: (i) Origin
Certificate processing, (ii) declaration processing and (iii) registration and
permit processing.
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The
Origin Certificate processing application allows users to apply for and
obtain over the Internet an Origin Certificate, which is a required
document showing the place of origin of goods imported or exported.
iDeclare.CIQ’s Origin Certificate processing application has five software
functions that allow an international trade enterprise to obtain Origin
Certificates. The different software functions relate to the import/export
regulations of different countries and can help an enterprise determine if
it qualifies for favorable tariffs between China and a second country. To
date, all five software functions have been included in the iDeclare.CIQ
product series.
|
·
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The
declaration processing application allows users to declare their imported
or exported goods for inspection by the PRC Inspections Administration,
which typically involves a general inspection of the goods, the packaging
material and the shipping container. To date, the declaration for
inspection of goods has been included in the iDeclare.CIQ product series.
A package inspection function and container inspection function are new
software functions available only in trial versions; we expect to charge
our users a fee to use each of these software functions when they are
launched commercially.
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·
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The
registration and permit processing application allows users to register
goods to be imported or exported and to apply for a permit for such
import/export transaction. This application is currently used when
animals, plants or related products are imported or exported. The
registration and permit processing application is a new function and is
only available in a trial version; we expect to charge our users a fee to
use this function when it is launched commercially. See Item 5 of this
annual report, “Operating and Financial Review and Prospects — Research
and development.”
|
Our
iDeclare.CIQ product series transmits all user submissions to the PRC
Inspections Administration electronically in an encrypted format over the data
exchange platforms operated by iTowNet. iTowNet receives a fee for each
submission made over its platforms. Once received by the PRC Inspections
Administration, such transmissions are examined and electronically approved or
returned to the user for revision.
The table
below sets forth the benefits of electronic filings, as compared to paper
filings:
Traditional paper-based filing
method
|
iDeclare.CIQ electronic filing
method
|
declaration
form filled manually
|
electronic
input minimizes mistakes arising from illegible
handwriting
|
declaration
form physically submitted to the PRC Inspections
Administration
|
submission
of electronic declaration form reduces cost and time
|
long
waiting time in the process of declaration
|
no
physical queue-up for submission required
|
incomplete
information or mistakes in declaration form cause delay, stress and
additional costs
|
built-in
error detection function helps prevent omissions and
mistakes
|
iProcess.CIQ
series
In June
2005, we launched iQS, one component of a new product series called
iProcess.CIQ, in certain major cities of the PRC including Ningbo, Qingdao,
Dalian, Hangzhou, Jinan, Tianjin and Shanghai. Our iProcess.CIQ product series
enables international trade enterprises and their suppliers to submit product
quality-related data to the PRC Inspections Administration throughout the
production process. In addition, Our iProcess.CIQ product series enables
manufacturers to submit production-related data over the Internet to the PRC
Inspections Administration regarding the nature and quality of the components
and materials being used by the manufacturers in creating their products. Such
information can be submitted prior to the manufacturers’ exporting their
products from the PRC. The PRC Inspections Administration may, but is not
required to, use such information to assess the products and determine whether
an inspection is necessary prior to such products being exported from the PRC. A
determination by the PRC Inspections Administration that an inspection is not
required will likely expedite the declaration process for such
products.
Furthermore,
users of our iDeclare.CIQ product series that have paid their annual maintenance
fees may share data between the iDeclare.CIQ and iProcess.CIQ product series.
This will not only reduce data input requirements for iDeclare.CIQ users, but
may also encourage existing iDeclare.CIQ product series users to pay their
annual maintenance fees.
In 2005
and 2006, we generated RMB3.3 million and RMB5.5 million (US$0.7 million),
respectively, of net revenues from sales of the iProcess.CIQ product
series.
UMA series
Commercially
launched in October 2003, the UMA series of enterprise software facilitates
effective and secure data transfers:
·
|
within
iTowNet’s data exchange platforms;
|
·
|
among
PRC Inspections Administration’s internal processing systems;
and
|
·
|
between
PRC government agencies.
|
We
entered into a product sales and service contract with iTowNet in October 2003.
Pursuant to such contract, we sold certain UMA software to iTowNet for a
one-time license fee of RMB50,000. We also charge RMB15,000 per licensee for
each year of customer maintenance services.
In 2005
and 2006, we recognized RMB13.5 million and RMB3.5 million (US$0.4 million),
respectively, in net revenues from sales of the UMA series of enterprise
software and related customer maintenance services. We currently do
not expect to have significant sales of the UMA series of enterprise software
and related services.
iMonitor.CGA
series
The
iMonitor.CGA series of software and hardware products was commercially
introduced in June 2004 and was designed to be installed at the customs clearing
gates of PRC Customs branch offices to allow inspection of goods-in-bond. The
purpose of an inspection of goods-in-bond is, among other things, to monitor and
inspect shipping containers to prevent such shipping containers from passing PRC
Customs without paying the required tariffs. We expect the price per system of
iMonitor.CGA, including software and certain hardware, for example cameras and
sensors, to range from RMB100,000 to RMB200,000, and we intend to charge an
annual maintenance fee after the first year of installation. We have not yet
determined the maintenance fee for iMonitor.CGA product series. The price per
system of iMonitor.CGA will be determined through negotiations with our
potential customers for such product, which we expect to be mainly trade-related
PRC government agencies. To date, we have not recognized any significant
revenues from the sale of iMonitor.CGA product series.
Our
iMonitor.CGA product series has two main applications: (i) data collection
through container number recognition, and (ii) gate inspection.
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|
The
container number recognition application allows PRC Customs to manage the
thousands of shipping containers that pass through China’s import/export
ports daily by using cameras to observe, identify and process
identification numbers painted on the exterior of shipping
containers.
|
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|
The
gate inspection application provides PRC Customs an entire suite of
applications, ranging from the container number recognition application
described above to the tracking of vehicles and containers. The gate
inspection application uses automatic sensors to electronically observe,
transmit, process and manage data such as vehicle driver identification,
vehicle license plate numbers, shipping container identification codes and
shipping container size and weight, as well as the movement of vehicles
and containers in the PRC Customs ports. The gate inspection application
also verifies the collected information against the information stated in
the relevant declaration documents.
|
Our
iMonitor.CGA series of products interfaces with PRC Customs’ multiple cameras
and sensors installed at import/export clearing gates to process the captured
images and output the results in an organized and easy-to-manage manner. The
main advantage of iMonitor.CGA product series is its automation of previously
manual inspection procedures which significantly reduces the staff costs and
time that it would take for information gathering, while increasing accuracy of
the information gathered.
iValue series
A trial
version of iValue product was introduced in March 2004. The purpose of the
iValue product series is to provide services that are complementary to a user’s
interaction with the PRC Inspections Administration and PRC Customs. Currently,
iValue product series has only one principal application: electronic bill
payment. This application allows users to electronically pay PRC Inspections
Administration- or PRC Customs-related fees over the Internet via a platform
that we operate. This trial product minimizes staff costs associated with
in-person payments and delays associated with payments by post. Electronic
payments are made as wire transfers directly from a payor’s bank account at a
participating bank. Funds are released upon receipt of wire instructions by the
participating bank through our iValue platform. As a result, we are not exposed
to the credit risk of the payor. The iValue product series
also allows integration of payment records into other software and
databases.
Since we
only introduced our iValue product in a trial version, we have not marketed the
iValue product to international trade enterprises and we have not yet determined
the pricing model for, or recognized any revenues from, this
product.
Software development
services
We
provide software development services to PRC government agencies, their related
entities and their third party service providers in order to enhance electronic
data exchange, processing and monitoring capabilities. Our software development
services consist of the design, development and maintenance of, and upgrades to:
(i) the internal software systems used by PRC government agencies and their
related entities to process electronic filings made with our enterprise
software, and (ii) the data exchange platforms which serve as the interface
between such systems and users of our enterprise software.
In 2003,
we provided software development services primarily to Beijing Regard in
connection with Beijing Regard’s contracts to provide software development
services for iTowNet. Under this arrangement, Beijing Regard designs software
for iTowNet and subcontracts the software coding work to us. We enter into all
contracts with iTowNet and eGrid on an arm’s length basis. See Item 7 of this
annual report, “Major Shareholders and Related Party Transactions — Related
party transactions.” On January 27, 2005, we entered into a software development
contract with the PRC Inspections Administration pursuant to which we contracted
to develop an internal Decision & Support System for the PRC Inspections
Administration for RMB5.6 million.
On
February 16, 2006 and February 28, 2006, we entered into two software
development contracts with the PRC Inspections Administration pursuant to which
we contracted to develop an electronic monitoring system and an “import and
export hygiene monitoring system” for the PRC Inspections Administration for
RMB3.3 million (US$423,000) and RMB1.6 million (US$205,000),
respectively.
We offer
our software development services on a fixed-fee basis. We often start work on
software development projects based on verbal agreements and do not receive
payment until the completion of a particular project. We believe such practice
is consistent with the general practice in the government-related software
development industry in China.
Technology
Our
enterprise software operates on a sophisticated data processing platform called
iCSP. iCSP is our proprietary Internet-based services management platform with
centralized data exchange capabilities that we have been developing since 1999.
Our iCSP platform allows our enterprise software to incorporate the utility and
power of the Internet. Our iCSP platform has two components. One component
supports Microsoft Windows clients and is a part of our enterprise software. The
other component supports a variety of Microsoft, UNIX and Linux servers and is a
part of the software that we assisted in developing for iTowNet. We used
development tools such as Microsoft.Net and Sun Java2EE to develop our iCSP
platform.
The iCSP
platform is a modular, scalable and secure client/server architecture, which
suits the rapidly changing demands of enterprise users. The basic software
architecture of the iCSP platform allows for (i) dynamic application management
for enterprise users, (ii) seamless data exchange among multiple
enterprises and government agencies and (iii) automatic data
synchronization.
At the
core platform level, the service management system provides various basic system
functions, such as downloading of applications, authentication of user licenses
and performance of routine system maintenance. The architecture separates data
exchange (oDex), data synchronization (oCox) and application logic (oAfx) into
different units to maintain flexibility and scalability.
oDex is
the data exchange system which supports common data exchange protocols such as
EDI, x.12, EBXML and RossetaNet. oDex converts document formats and processes
documents based on pre-determined programming rules.
oCox is
the data synchronization system which replicates data across different users,
systems and institutions.
oAfx is
the application library system which contains the various enterprise software
functions.
The iCSP
platform also has a comprehensive security system which performs security
auditing and management to maintain data security and integrity.
Products under
development
We
usually have numerous new software products and features in development. The
process of researching and developing software products and features typically
involves steps to: (i) work with the relevant PRC government agency to identify
needs and parameters; (ii) begin research and development; (iii) test product or
function feasibility; (iv) establish product launch plan and timetable with the
PRC government agency; and (v) launch the product or function. The following are
examples of new enterprise software and enhancements to our existing products
which are currently under development:
Additional iValue
modules
We are
currently developing additional functions to complement iValue to process status
enquiries for a user’s PRC Inspections Administration filings and to allow for
enrollment in online courses, such as customs declarer
examinations. We cannot predict if or when such efforts will be
completed.
iDeclare.CGA
Series
Similar
to the PRC Inspections Administration, PRC Customs has a standardized set of
forms used by international trade enterprises and we plan to work with PRC
Customs to develop enterprise software that will facilitate electronic filings
of such forms. We intend for this enterprise software to enable electronic
filings of customs, manifest, bill of lading, export goods receipt and other
declarations. In addition, we also plan to work with PRC local tax authorities
to develop a product to facilitate electronic filings of tax and ATA Carnet
declarations, which are international customs documents that permit duty-free
and tax-free temporary import of goods for up to one year. Research and
development work on the iDeclare.CGA product series commenced in the second
quarter of 2004; we cannot predict if or when such efforts will be
completed.
Production and hardware
design
The
principal steps involved in production of our enterprise software are
duplicating CDs, printing boxes and related materials such as user manuals, and
assembling and shipping our final products. We have production arrangements with
several outside contractors under which they provide all necessary outsourced
production services related to our enterprise software. We produce enterprise
software packages on an as-necessary basis and keep only a small inventory in
our headquarters in Beijing. Currently we also distribute some of our enterprise
software packages through the Internet. We have designed the configuration of
some data-gathering hardware, for example cameras, for use with the iMonitor.CGA
product series although customers may also use their own hardware. The hardware
we design is produced by third party vendors.
Seasonality
There is
no particular seasonal fluctuation in our sales except that net revenues from
sales of our enterprise software in the first quarter are typically lower than
in other quarters. This is primarily due to decreased business activities
throughout China before, during and after the week-long Chinese New Year
holidays, which occur in January or February each year. In addition, net
revenues from software development services are typically higher in the third
and fourth quarters of each year because our software development contracts are
usually signed during that time. However, we cannot predict when our software
development contracts will be signed in the future, or if they will be signed at
all.
Our
future revenues and results of operations may fluctuate significantly due to a
combination of factors, including:
·
|
acceptance
of our products and services in
China;
|
·
|
the
strength of our relationships with the PRC Inspections Administration, PRC
Customs and other PRC government
agencies;
|
·
|
our
ability to attract and retain
users;
|
·
|
our
ability to develop new software products and
services;
|
·
|
PRC
government regulation of software sales and development;
and
|
·
|
general
economic conditions in China.
|
Quality
We are
committed to delivering enterprise software and services of consistently
superior quality to our customers. We believe our commitment to quality and our
total quality management system are key elements to our operation as a leading
provider of enterprise software to international trade enterprises and
trade-related PRC government agencies.
On August
3, 2004, we were awarded the ISO 9001:2000 Quality Management System Recognition
Certificate. ISO 9001:2000 is a worldwide quality management system
certification program regarding management system standards administered by the
International Organization for Standardization. Our enterprise software has also
been endorsed by the PRC Inspections Administration for electronic customs
declaration.
Sales and
marketing
We have
implemented our sales and marketing initiative in three phases. In the first
phase, we relied mainly on direct sales of new software products to
international trade enterprises. In the second phase, we used authorized
distributors to reach additional international trade enterprises. We are
currently implementing the third phase of our sales and marketing initiative by
helping third parties establish franchisee to sell our software products. Our
intention is to continue to use a focused strategy designed to further enhance
our brand name and acquire new customers by recruiting franchisees, who will use
the “Ninetowns” brand name in the sales and marketing of our enterprise
software.
Direct sales and
marketing
We
re-defined our regional markets and changed our business model from direct sales
to a regional franchise model.
As of
December 31, 2006, we had a sales and marketing force consisting of
approximately 130 people, serving mainly the southern regions of China. Our
sales and marketing representatives also perform customer maintenance
services.
The
market operations center at our principal executive offices in Beijing is
responsible for national marketing policies, strategies and budgets. The market
operations center is divided into two departments: the corporate communication
department and the market operations department.
The
corporate communication department is responsible for brand promotion, package
design and marketing functions. The market operations department is responsible
for the collection of marketing intelligence. In addition to the corporate
communication department and the market operations department, we also have
salespersons in our own four technical support centers. The salespersons in
such centers are responsible for regional marketing strategies, including
(i) organizing promotional conferences in which existing and potential
clients are introduced to our products, and (ii) participating in national and
regional trade shows. On the local level, our salespersons promote our
enterprise software products mainly by holding seminars for international trade
enterprises, making telephone calls to potential customers and sending
promotional materials by mail.
Our
annual sales targets are set by our general manager of sales and marketing
according to regional sales plans and are reviewed quarterly. We have an
incentive-based sales scheme whereby salespersons are rewarded based on
achievement of sales targets.
Sales by authorized
distributors
We had
previously contracted with distributors to undertake marketing, distribution and
service activities in certain provinces in China where we do not have any
offices or where our customer maintenance service capabilities are insufficient
to serve and support our international trade enterprise clients. However, it is
our current strategy to develop our distribution and technical support network
through franchisees. As of December 31, 2005, the distribution agreements with
our two former authorized distributors, Panyu Chengchang Trade Development Co.,
Ltd., or Panyu Chengchang, and Shanghai Tomorrow Technology Development Co.,
Ltd., or Tomorrow Technology, expired and we chose not to renew them due to our
plans to develop our franchisee network. We currently do not have any
distributor.
For 2004,
2005 and 2006, net revenues from sales of enterprise software we recognized from
our former authorized distributors amounted to approximately RMB77.0 million,
RMB71.4 million and RMB17.0 million (US$2.2 million), respectively.
Sales by our
franchisee
It is our
current strategy to expand our franchisee network to undertake marketing,
distribution and service activities using the “Ninetowns” brand name. As of
December 31, 2006, we have four franchisees, Ninetowns Enke, Ninetowns Zhi Fang,
Ninetowns Xin He and Ninetowns Wang Li. Our franchise agreement with
Ninetowns Enke was entered into in February 2004. Pursuant to the franchise
agreement, Ninetowns Enke agreed to a minimum sales commitment of RMB50.0
million for the two
years
ended February 14, 2006 and a sales discount of RMB1,000 per each iDeclare.CIQ
basic package purchased from our company. In addition, Ninetowns Enke also
agreed to act as our sales agent to sell after sales maintenance services for
our enterprise software to our customers. On April 22, 2004, we agreed with
Ninetowns Enke to amend the franchise agreement to revise certain pricing terms.
This agreement has a two-year term and contains minimum sales
commitments. On May 12, 2006, we entered into a new franchise
agreement with Ninetowns Enke for our iDeclare.CIQ basic package. This agreement
has a two-year term and does not contain any minimum sales
commitment. Our franchise agreements with Ninetowns Zhi Fang were
entered into in May 2005 for two of our software products, iQs under the
iProcess.CIQ series and our iDeclare.CIQ basic package. Each of these
franchise agreements has a two-year term and does not contain any minimum sales
commitment. In January 2006, we engaged Ninetowns Xin He, as a new
franchisee. The franchise agreement with Ninetowns Xin He has a two-year term
and does not contain any minimum sales commitment. In October 2006, we entered
into a franchise agreement with our newest franchisee, Ninetowns Wang Li for our
iDeclare.CIQ basic package. This agreement has a two-year term and
does not contain minimum sales commitments. In December 2006, we
entered into new franchise agreements with Ninetowns Enke, Ninetowns Xin He,
Ninetowns Zhi Fang and Ninetowns Wang Li for our new software version under the
iDeclare.CIQ series, Ninetowns Network Quality Supervision Software v1.0
software, each for two-year terms and without minimum sales
commitments. Our franchisees provide customer maintenance services to
our enterprise software users. We intend to focus on establishing new franchisee
arrangements in the future.
For 2004,
2005 and 2006, net revenues from the sale of enterprise software generated by
our franchisee amounted to approximately RMB25.2 million, RMB50.8 million and
RMB40.9 million (US$5.2 million), respectively.
Customers
In 2006,
our customers for sales of enterprise software include our two former
distributors, and our franchisees, and international trade enterprises that we
sell our software to directly. Our users are engaged in a wide variety of import
and export activities in China. For 2004, 2005 and 2006, our five largest
enterprise software customers, which consisted primarily of our former
distributors and franchisees, accounted for approximately 56.0%, 60.1% and
49.1%, respectively, of our net revenues from sales of enterprise
software.
Our
customers for software development services include the PRC Inspections
Administration, iTowNet, eGrid and other third party customers. We did not
recognize any net revenues from provision of software development services until
2002. iTowNet and eGrid accounted for substantially all of our net revenues for
provision of software development services in 2004 and 2005. In 2006,
net revenues from provision of software development services to iTownet and
eGrid accounted for approximately 35.9% of our total software development
revenue.
Customer maintenance
services
We
believe our ability to provide customer maintenance services is one of the key
factors to building user loyalty. We offer one year of free customer maintenance
services with our iDeclare.CIQ basic package, and charge a fee of RMB1,500 for
customer maintenance services each year thereafter.
The
customer maintenance services we provide in connection with our software
products generally include:
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help-desk
support via telephone, facsimile or
e-mail;
|
·
|
site
visits to carry out maintenance
procedures;
|
·
|
training
for new updates of our enterprise software;
and
|
·
|
automatic
updates of software relating to changes in codes associated with goods,
countries and regions and changes to import/export
regulations.
|
Our
franchisees also provide customer maintenance services, including help-desk
support via telephone or e-mail, site visits for maintenance procedures and
software training.
We also
provide customer maintenance services to purchasers of our iMonitor.CGA product
series. Such customer maintenance services generally include routine inspections
of the system, system and software updates, on-site technical support and
maintenance services, consultation services through a toll free phone-line,
company website or direct hotline and training of our customer’s staff. We also
provide various customer maintenance services to our software development
services clients.
Each of
our technical support centers functions as a call center that responds to calls
from customers located in the surrounding areas. As of December 31, 2004, 2005
and 2006, we had 360, 454 and 128 customer service and technical support
employees, respectively.
Competition
We
believe there are only two enterprise software products, namely our iDeclare.CIQ
product series and “Easy Inspection” offered by Ronji, that have been endorsed
by the PRC Inspections Administration. We are not aware of any other products or
services which compete with our enterprise software. Therefore, we believe we
only have one competitor engaged in providing enterprise software to
international trade enterprises for transactions with the PRC Inspections
Administration. In addition, we face competition from the PRC
Inspections Administration’s free software product.
We
compete with several software developers in bidding for software development
projects. In particular, we compete against eGrid, which is a related party of
our company and one of our major customers in our software development business,
to provide software development services to iTowNet.
Many
other companies may in the future provide software and development services of
the type we offer. Companies that have expertise in marketing and providing
technical services to government entities may begin to compete with us by
further developing their services and increasing their focus on this aspect of
their business. There are companies which provide e-government services and
enterprise software similar to ours in many other countries. In addition, there
are other companies in China which are focusing on providing such services to
government agencies in China; in particular, regional providers attempting to
implement systems for provincial branches of government agencies such as PRC
Customs. Furthermore, there can be no assurance that software, hardware or other
companies unrelated to us will not allocate resources to pursue opportunities
relating to the needs of international trade enterprises making government
filings in China.
We
believe that the principal factors upon which we compete are:
·
|
reputation
in the market;
|
·
|
understanding
of the needs of PRC international trade-related government agencies, such
as the PRC Inspections Administration, as well as endorsements from such
agencies;
|
·
|
the
quality of our products and
services;
|
·
|
responsiveness
to the needs of users;
|
·
|
installed
base of international trade enterprise
customers;
|
·
|
cost-effectiveness;
and
|
We
believe that we compete favorably with respect to the above-listed
factors.
Intellectual property
rights
We rely
on a combination of nondisclosure, confidentiality and other contractual
arrangements with the PRC Inspections Administration, certain of our directors,
employees and customers, as well as PRC privacy and trade secret laws, to
protect and limit the distribution of the proprietary software and processes we
have developed in connection with our products and services.
As of
December 31, 2006, we had registered 38 software copyrights and three trademarks
in China. Although we have no registered trademarks outside China, we are in the
process of registering certain of our trademarks in the United States and Hong
Kong.
If we
fail to adequately protect our intellectual property rights or proprietary
technology or if we become involved in litigation relating to our intellectual
property rights or proprietary technology, our business could be harmed. Any
actions we take may not be adequate to protect our rights and other companies
may develop technologies that are similar or superior to our proprietary
technology.
Although
we believe that our products and services do not infringe on the intellectual
property rights of others and that we have all rights needed to use the
intellectual property employed in our business, it is possible that we could in
the future become subject to claims alleging infringement of third party
intellectual property rights. Any such claims could subject us to costly
litigation and may require us to pay damages and develop non-infringing
intellectual property or acquire licenses to the intellectual property that is
the subject of the alleged infringement.
We are
aware of an online video games company in China whose Chinese name is
substantially similar to ours and which may therefore infringe on our
trademark.
New Business
We are
currently in the process of exploring potential opportunities related to
international trade. We commenced market research in the first quarter of 2006
and we are currently evaluating various business models and experimenting with
new products. We cannot predict if or when any of such efforts will be
completed.
However,
we have pursued selective strategic acquisitions. On October 19,
2006, our indirect wholly-owned subsidiary, Beprecise, acquired a 16.25%
interest in Global Market, a leading Chinese B2B trade facilitator headquartered
in Guangzhou. On April 27, 2007, Ixworth, our wholly-owned
subsidiary, acquired a 70% interest in Ample Spring, a related party of
Baichuan, a leading Chinese B2B vertical search engine operator. In
May 2007, our company launched tootoo.com, our new B2B vertical search
platform. By leveraging our B2G expertise with these recent
acquisitions and integrating Baichuan's pioneering vertical search technology
and supplier ranking system with the in-depth quality validation process offered
by our existing software solutions, tootoo.com is positioned to become a leading
B2B
search
and service provider. We plan to continue to seek opportunities to cooperate
with other B2B platforms and technology to further increase our service
profile.
Regulation
Political, legal, economic and social
considerations in China
Since
1979, many laws and regulations dealing with economic matters with respect to
general foreign investment have been promulgated in China. In 1982, the PRC
National People’s Congress amended the PRC Constitution to authorize foreign
investments and guarantee the “lawful rights and interests” of foreign investors
in China. In 2004, the PRC Constitution was further amended to recognize the
right to private property for all PRC citizens. Subsequent legislation has
enhanced significantly the protection afforded to foreign and domestic investors
and allowed more active control of investors over their private enterprises in
China. In the last two decades, the PRC government has introduced substantial
economic and legal reforms. However, the legal system of the PRC is still
underdeveloped when compared to the systems of the advanced western nations. The
implementation and interpretation of existing laws may therefore be
uncertain.
Foreign investment
policies
According
to the Foreign Investment Industry Policy Guidelines promulgated on March 4,
2002, as amended on November 30, 2004, foreign investors are encouraged to
invest in the development and manufacturing of software products. No
restrictions or prohibition is currently imposed on the foreign ownership of
businesses engaged in the development and production of software products in
China.
New regulation relating to the
administration of an office
In April
2006, State Administration of Industry and Commerce, Ministry of Commerce, State
General Custom and SAFE jointly promulgated “Implementation Opinion on Certain
Issues about Application of Laws on Administration of Approval and Registration
for Companies with Foreign Investment”, or the Opinion. According to the
Opinion, the registration for companies with foreign investment apply to
companies registered under the PRC Company Law, as amended on October 27, 2005
and effective on January 1, 2006, and the Regulations on Administration of
Companies, amended on December 18, 2005, except otherwise stipulated by the laws
and regulations specifically governing companies with foreign investment.
According to the Opinion, the registration of offices established by companies
with foreign investment is required to cease. The Opinion also provides that the
procedures of variation or renewal for the offices that have been registered
will not be carried out. Once the operating term of an office expires, the
procedure of “cancellation of registration” will be implemented. If necessary,
such company can choose to establish a branch office.
In the
opinion of our PRC counsel, Commerce & Finance Law Offices, the ownership
structures, businesses and operations of our subsidiaries and variable interest
entities in China comply with all existing PRC laws, rules and regulations. In
addition, our PRC counsel has confirmed that no consent, approval or license,
other than those already obtained, is required for such ownership structures,
businesses and operations in order for us to comply with existing PRC laws rules
and regulations.
Regulation of the software
industry
Software
copyright
The State
Council of the PRC, or the State Council, promulgated the Regulations for the
Protection of Computer Software, or the Software Protection Regulations, on
December 20, 2001, and such regulations became effective on January 1, 2002. The
Software Protection Regulations were promulgated, among other things, to protect
the copyright of computer software in China. According to the Software
Protection Regulations, computer software that is independently developed and
exists in a physical form will be protected. However, such protection does not
apply to any ideas, mathematical concepts, processing and operation methods used
in the development of software products.
Under the
Software Protection Regulations, PRC citizens, legal persons and organizations
enjoy copyright protection for computer software they develop, regardless of
whether the software has been published. In addition, foreigners or any person
without a nationality enjoy copyright protection of computer software they
develop, if such computer software was first distributed in China.
Under the
Software Protection Regulations, software copyright holders enjoy the rights of
publication, authorship, modification, duplication, issuance, lease,
transmission on the information network, translation, licensing and transfer.
The software copyright comes into being on the day of completion of its
development. In the case of software developed by legal persons and other
organizations, the protection period is 50 years and ends on the thirty-first
day of December of the fiftieth year from the date the software product was
first published. However, the Software Protection Regulations will not protect
the software if it has never been published within 50 years since the completion
of development. A written license contract is required to license the right to
use the software copyright and a written assignment contract is required for
transfer of any software copyright.
Enforcement
actions available under the Software Protection Regulations against
infringements of copyright include, among other things, cessation of the
infringement, elimination of the effects, apology, compensation for losses and
other civil responsibilities. Disputes regarding infringements of software
copyright can be mediated. In addition, the parties may apply for arbitration in
accordance with the arbitration provision set forth in the copyright contract or
the arbitration agreement otherwise entered into between or among the parties.
If the parties do not have an arbitration agreement, they can resolve the
dispute through the PRC courts.
Software copyright
registration
Pursuant
to the Copyright Law of the PRC, or the Copyright Law, which was adopted at the
15th Meeting of the Standing Committee of the Seventh National People’s Congress
on September 7, 1990 and effective from June 1, 1991, works including computer
software developed by PRC citizens, legal persons or other entities without
legal personality, whether published or not, are protected under the Copyright
Law. On February 20, 2002, the State Copyright Administration of the PRC
promulgated the Measures Concerning Registration of Computer Software Copyright
Procedures, or the Registration Procedures, to implement the Regulations for the
Protection of Computer Software and to promote the development of China’s
software industry. The Registration Procedures apply to the registration of
software copyrights and software copyright exclusive licensing contracts and
assignment contracts. The registrant of a software copyright will be the
copyright owner and the natural person, legal person or other organization in
whom the software copyright becomes vested through succession, assignment or
inheritance.
Pursuant
to the Registration Procedures, the software to be registered must (i) have been
independently developed or (ii) significantly improve in its function or
performance after modification from the original software, with the permission
of the original copyright owner. If the software being registered is developed
by more than one person, the copyright owners may nominate one person to handle
the copyright registration process on behalf of the other copyright owners. If
the copyright owners fail to reach an
agreement
with respect to the registration, any of the copyright owners may apply for
registration but the names of the other copyright owners must be recorded on the
application.
The
parties to a software copyright assignment contract or exclusive licensing
contract may apply to the Copyright Protection Center of the PRC, or CPC, for
registration of such contracts. In registering a contract, the following
materials must be submitted: (1) a completed contract registration form; (2) a
copy of the contract; and (3) the applicant’s identification
documents.
The CPC
will complete its examination of an accepted application within 60 days of the
date of acceptance. If an application complies with the requirements of the
Software Protection Regulations and the Registration Procedures, a registration
will be granted, a corresponding registration certificate will be issued and the
registration will be publicly announced.
Software products
registration
On
October 27, 2000, the Ministry of Information Industry of the PRC, or the MII,
issued the Measures Concerning Software Products Administration, to regulate and
administer software products and promote the development of the software
Industry in China. Pursuant to the Measures Concerning Software Products
Administration, all software products operated or sold in China must be duly
registered with the relevant authorities.
To
produce software products in China, the software production units should meet
certain requirements, such as the possession of (i) enterprise legal person
status and a scope of operations which includes the computer software business;
(ii) a fixed production site; (iii) conditions and technologies for producing
software products; and (iv) quality control measures and capabilities for the
production of software products. Software developers or producers are allowed to
sell their registered software products independently or through agents, or by
way of licensing. If the software products are sold through a distribution
agent, there must be a contract between the software developer and the agent,
and between the agent and its sub-agents, if any, specifying the distribution
rights, distribution territory and distribution term as well as the technical
services to be provided by the distribution agent. The MII and other relevant
departments may carry out supervision and inspection over the development,
production, operation and import/export activities of software products in
China.
Policies to encourage the
development of software and integrated circuit
industries
On June
24, 2000, the State Council issued Certain Policies to Encourage the Development
of Software and Integrated Circuit Industries, or the Policies, to encourage the
development of the software and integrated circuit industries in China and to
enhance the international competitiveness of the PRC information technology
industry. The Policies encourage the development of the software and integrated
circuit industries in China through various methods, including:
(i)
|
encouraging
investment in the software industry and providing or assisting software
enterprises to raise capital
overseas;
|
(ii)
|
providing
tax incentives, including a tax rebate for taxpayers who sell
self-developed software products, before 2010, the amount of the 17.0%
statutory value added tax that exceeds 3.0%, will be refunded immediately
when paid. There is a full exemption from the PRC enterprise income tax
for two years starting from the first profit-making year of operations and
a 50.0%-relief from the PRC enterprise income tax for the following three
years for recognized newly established enterprises that are engaged in the
software industry. The software enterprises of particular importance
pursuant to the state stipulations, which do not enjoy any tax exemption
benefit in a
|
|
given
year, will be subject to a reduced enterprise income tax rate of 10.0% in
that year. Moreover, software enterprises that import certain equipment
for the development of their self-developed software, with limited
exemptions, are also entitled to the exemption of import related
value-added tax;
|
(iii)
|
providing
government support, such as government funding in the development of
software technology;
|
(iv)
|
providing
preferential treatment, such as credit facilities with low interest rates
to enterprises that export software
products;
|
(v)
|
taking
various strategies to ensure the software industry has sufficient
expertise; and
|
(vi)
|
implementing
measures to enhance intellectual property protection in
China.
|
Regulation of foreign exchange and
dividend distribution
Foreign
exchange
The
principal regulations governing foreign exchange in China are the Foreign
Exchange Control Rules (1996), as amended. On June 20, 1996, the People’s Bank
of China promulgated the Administration Rules of Settlement, Sale and Payment of
Foreign Exchange, or the FX Administration Rules, which became effective on July
1, 1996.
Under the
FX Administration Rules, Renminbi is generally freely convertible for trade and
service-related foreign exchange transactions, but not for foreign direct
investment, foreign loans or issuance of securities outside China unless the
prior approval of SAFE is obtained.
Pursuant
to the FX Administration Rules, foreign investment enterprises in China
generally may purchase foreign exchange without the approval or review of SAFE
for trade and service-related foreign exchange transactions by providing
commercial documents evidencing these transactions. They may also retain foreign
exchange, subject to a cap approved by SAFE, under current account items.
However, the relevant PRC government authorities may limit or eliminate the
ability of foreign investment enterprises to purchase and retain foreign
currencies in the future. Foreign investment enterprises are permitted to
distribute their profits or dividends in foreign currencies out of their foreign
exchange accounts or exchange Renminbi for foreign currencies through banks
authorized to conduct foreign exchange business.
Dividend
distribution
The
principal PRC regulations governing the distribution of dividends by our wholly
foreign-owned enterprises are (i) The Wholly Foreign-Owned Enterprise Law
(1986), as amended in 2000; and (ii) Implementation Regulations under the Wholly
Foreign-Owned Enterprise Law (2001).
Under
these regulations, wholly foreign-owned enterprises in China may only pay
dividends out of their accumulated profits, if any, determined in accordance
with PRC accounting standards and regulations. In addition, a wholly
foreign-owned enterprise in China is required to set aside at least 10.0% of its
after-tax income each year, if any, to fund a reserve fund until the accumulated
reserve amounts to 50.0% of its registered capital. It is also required to set
aside funds for the employee bonus and welfare fund from its after-tax income
each year at percentages determined at its sole discretion. These reserves are
not distributable as cash dividends.
Restricted net
assets
Relevant
PRC laws and regulations permit payments of dividends by our PRC subsidiaries
only out of their retained earnings, if any, as determined in accordance with
PRC accounting standards and regulations. In addition, the statutory general
reserve fund, which requires annual appropriations of 10% of net after-tax
income should be set aside prior to payment of any dividends. As a result of
these and other restrictions under PRC laws and regulations, our PRC subsidiary
and affiliate are restricted in their ability to transfer a portion of their net
assets to us either in the form of dividends, loans or advances, restricted
portion amounted to approximately RMB522.5 million (US$67.0 million), or 40.0%
of our total consolidated net assets as of December 31, 2006.
Even
though we currently do not require any such dividends, loans or advances from
our PRC subsidiaries, we may in the future require additional cash resources
from our PRC subsidiaries due to changes in business conditions, to fund future
acquisitions or developments, or merely to declare and pay dividends or
distributions to our shareholders, although we currently have no intention to do
so.
Regulation of the import/export
industry
The State Administration for Quality
Supervision and Inspection and Quarantine of the PRC
In April
2001, the PRC Inspections Administration was established by combining the former
State Import and Export Commodity Inspection Quarantine Bureau of the PRC and
the State Quality and Technique Supervision Bureau of the PRC, which oversees
the inspection work of import and export commodities for the PRC in accordance
with the institutional reform plan of the State Council. The PRC Inspections
Administration, which is primarily an administrative and law enforcement
institution governing, among others, the health quarantine of imported and
exported animals and plants, the inspection, appraisal, certification and
supervision of imported and exported commodities, has the following
responsibilities, among others:
•
|
executing
the inspection and quarantine, appraising and supervising of import and
export commodities;
|
•
|
implementing
the quarantine and supervision for the import and export of animals and
plants and the inspection, supervision and administration of the sanitary
and food quality;
|
•
|
administering
health registrations of import and export food products and their
production units and external registration for export enterprises;
administering the import and export inspection and quarantine marks,
import safety licenses, and export quality licenses; and implementing the
import and export-related quality authentication and
accreditation;
|
•
|
administering
the issuance of Origin Certificates for commodities and the general
certificates of origin;
|
•
|
formulating
the development plan of technologies for commodity inspection and
quarantine; and
|
•
|
developing
international cooperation and technology exchanges related to commodity
inspection and quarantine and carrying out the implementation work
relating to technological barriers to trade, as
stipulated.
|
Customs General Administration of the
PRC
PRC
Customs, General Administration is the highest authority for supervising and
administering the customs points for entering into and departing from the PRC
and is responsible for customs administration throughout the
nation.
The PRC
Customs Law is intended to protect PRC sovereignty and interests and to
strengthen the administration of customs supervision. In accordance with the PRC
Customs Law, PRC Customs, General Administration has primary responsibility
for:
•
|
supervising
the entering into and departing from the PRC of transportation tools,
goods, luggage, postal items and other
articles;
|
•
|
collecting
customs duties and other taxes and
fees;
|
•
|
investigating
and suppressing smuggling; and
|
•
|
preparing
customs statistics and conducting other customs
affairs.
|
Import/ Export license
system
The
import and export license system is an important administrative measure in the
international trade regulations of the PRC. Since the early 1990’s, the PRC
government has gradually relaxed its control over import activities including
abandoning or reducing the range of import licenses, import quotas and import
control. Since 1998, the PRC government has removed its control of import
licenses and export quotas over a wide range of commodities which previously
required import licenses. On December 10, 2001, the State Council issued the
Regulations of the People’s Republic of China on Administration of Import and
Export, or the Regulations, which apply to the import of goods into China and
the export of goods from China, to standardize administration of import and
export of goods and to promote the development of foreign trade in China.
Pursuant to the Regulations, goods for importation are divided into three
categories: (i) prohibited for imports, (ii) restricted for imports, and (iii)
free for imports. The lists of prohibited and restricted imports is formulated
by the State Council department responsible for foreign trade and economic
cooperation after consulting other relevant State Council departments.
Restricted imports are further divided into quota-controlled imports,
license-controlled imports and tariff- and quota-controlled imports. Import
quotas are distributed to quota applicants annually based on specific criteria.
Import licenses are issued on a case-by-case basis. Exported goods are also
divided into prohibited exports, restricted exports and free exports. The lists
of prohibited and restricted exports is formulated by the State Council
department responsible for foreign trade and economic cooperation after
consulting other relevant State Council departments. Restricted exports are
further divided into quota-controlled exports and license-controlled exports.
Export quotas are distributed annually and may be distributed through direct
allocation, invitation of bids or other methods. Export licenses are issued on a
case-by-case basis. Under certain circumstances, the relevant State Council
departments may take certain temporary measures to restrict or prohibit certain
imports.
Administrative provisions on the
Origin Certificate
All
exporters may apply for origin certificates in respect of the products to be
exported out of China. In compliance with the Implementation Rules of the Place
of Origin for Export Goods of the PRC issued on April
1, 1992, which became effective on May 1, 1992, and the Provisions for the
Issuance of the Origin Certificate for Export Goods of the PRC (Trial
Implementation), which became effective on January 1, 1996, and to strengthen
the administration of the issuance of Origin Certificates, the Ministry of
Foreign
Trade and
Economic Cooperation, currently known as the Ministry of Commerce, promulgated
the Administrative Provisions of the PRC on Origin Certificate on March 8, 1996,
or the Administrative Provisions. The Administrative Provisions are aimed at
facilitating the implementation of a national EDI project by the Ministry of
Commerce. The Ministry of Commerce made use of the recommended standard form of
the Origin Certificate issued by the then State Technology Supervision
Administration of the PRC on July 1, 1996, to standardize and regulate the
administration, subscription, printing, transportation, record-keeping,
issuance, calculation and examination of the Origin Certificate, thus minimizing
or eliminating the occurrence of forged or fake Origin Certificates. The new
standard form of the Origin Certificate bears a uniform serial
number.
Commodity quality inspection and
quarantine inspection
Commodity quality
inspection
The Law
on the People’s Republic of China on Import and Export Commodity Inspection
adopted by the Standing Committee of the Seventh National People’s Congress on
February 21, 1989, which became effective on August 1, 1989, as amended on April
28, 2002, provides that all imported and exported commodities included in a
published inspection list must be inspected in accordance with the relevant
compulsory inspection standards or other standards specified by the state
inspection authorities prior to export out of China or use or sale in China for
imported goods. On October 23, 1992, the State Import and Export Commodities
Inspection Bureau, with the approval of the State Council, promulgated the
Implementing Provisions for Law of the People’s Republic of China on Import and
Export Commodity Inspection, which stipulates particular requirements for the
import and export commodity inspection.
Quarantine
inspection
The
Standing Committee of the PRC National People’s Congress adopted the Import
& Export Animals and Plants Quarantine Law on April 1, 1992, which provides
the legal basis for the quarantine inspection of animals, plants and other
products and the containers and packaging materials used for transporting or
packing these items. On December 2, 1996, the State Council issued Implementing
Regulations for the Import & Export Animals and Plants Quarantine Law which
provides detailed procedures for quarantine inspection of animals, plants and
other products. The PRC Inspections Administration is currently responsible for
carrying out import and export commodity inspections.
C. Organizational
structure
We
conduct substantially all of our business through seven PRC subsidiaries and two
variable interest entities in China. The following diagram illustrates our
subsidiaries, their country of incorporation and the proportion of our ownership
of each as of May 31, 2007.
For
details of the above subsidiaries and variable interest entities, see “— History
and development of the company.”
D. Property
and equipment
Our
principal executive offices occupy a total of approximately 3,170 square
meters on the 5th, 12th, 14th and 17th floors of Union Plaza, 20 Chaowai Street
and the 20th floor of the Fan Li Building, 22 Chowai Street, Chaoyang District,
Beijing 100020 PRC. In addition, we occupy a representative office of
approximately 200 square meters at Suites 1705-6, 17/F, Two Chinachem
Exchange Square, 338 King’s Road, North Point, Hong Kong. As of May 31, 2007, we have
one premise which we own and we have also leased 9 premises in the
following cities and municipalities to serve as technical support centers and
quarters for our technical support staff:
Location
|
Office
space
(in square
meters)
|
Number of
employees
|
Guangdong
Province
|
|
|
Dongguan
|
921.69
|
44
|
Guangzhou
|
120.85
|
60
|
Beijing
|
551.65
|
37
|
Shanghai
|
139.00
|
12
|
Total
|
1,733.19
|
153
|
During
2005, we transferred a number of technical support centers to our franchisees in
an effort to reduce the number of technical support centers that we operate on
our own. We currently support our existing users jointly with our
four franchisees through four technical support centers operated and
maintained by us and 43 technical support centers operated and maintained
by our four franchisees located in most of the major import/export cities in
China.
Ninetowns
Ports acquired, subject to the receipt of the necessary title certificates, four
residential units in the Sing Sun Building in Guangzhou, with aggregate space of
approximately 355 square meters and uses such premises as employee housing for
our employees in Guangzhou. During 2006, Ninetowns Ports acquired two
commercial units as offices with aggregate space of approximately 340.61 square
meters.
Ninetowns
Times owns two commercial units in the Qingdao Bai Sing Building in Qingdao,
with aggregate space of approximately 384 square meters and uses such commercial
units as offices. Ninetowns Times also acquired, subject to the receipt of the
necessary title certificates, an eight-storey building in Fengtai, with
aggregate space of approximately 2,206.59 square meters and uses such
building as a call center for our technical support services and also as a
research and development center.
Ninetowns
Ports also acquired four floors and the naming right of a building in
Beijing. See Item 7 of this annual report, “Major Shareholders and
Related Party Transactions — Related party transactions — Transaction with Mr.
Ko Jin Heng.”
Insurance
The
insurance industry in China is still at an early stage of development. We are
not required to maintain business liability insurance, and, to our knowledge,
other software companies in China do not maintain such insurance. As a result,
we do not have business liability insurance coverage, but we do maintain vehicle
liability insurance. Moreover, while business disruption insurance is available,
we have determined that the risks of disruption and the cost of insurance are
such that we do not require it at this time. Any business disruption, litigation
or natural disaster might therefore result in substantial costs and diversion of
our resources.
We do not
maintain key-man life insurance for any member of senior management. We maintain
directors and officers insurance for our directors and members of senior
management.
Item 5.
Operating and Financial Review and Prospects.
Overview
We are a
leading PRC software company that enables enterprises and trade-related PRC
government agencies to streamline the import/export process in China; we believe
we are a leader in our market based on revenues and market share. We achieve
this by leveraging our international trade expertise and our insight into the
needs and procedures of certain trade-related PRC government agencies. To date,
we have focused on providing enterprise software and related customer
maintenance services for the completion over the Internet of the declaration
process. In order to secure our market position, we assisted in designing and
building, and continue to maintain and upgrade, the electronic systems of the
PRC Inspections Administration, that enable our enterprise software to process
electronic declarations over the Internet.
We
generated total net revenues of RMB201.5 million, RMB239.9 million and RMB153.2
million (US$19.6 million) in 2004, 2005 and 2006, respectively. The decrease in
our total net revenues was due to the PRC Inspections Administration’s free
distribution of products that are similar to our iDeclare.CIQ product
series. Our net income in 2004 was RMB134.0 million increasing to
RMB151.6 million in 2005. Our net income in 2006 was RMB45.9 million
(US$5.9 million) representing a 69.7% decrease from 2005. We believe
there were approximately 95,000, 122,000 and 130,000 licensees of our enterprise
software registered to effect electronic import/export processing with the PRC
Inspections Administration as of December 31, 2004, 2005 and 2006,
respectively.
The major
factors affecting our results of operations and financial condition
include:
Focus on sales of enterprise
software and software development services
Our
predecessor, Ninetowns Technology, was formed in 1995 to focus on the research
and development of software related to the declaration process, in addition to
selling computer hardware and accessories. During the first several years of our
operations, our net revenues from computer hardware sales constituted almost all
of our total net revenues and provided the necessary funding for our development
of software related to the declaration process. As we developed, we engaged in
three main lines of business: (i) sales of enterprise software and related
customer maintenance services, (ii) provision of software development services,
and (iii) sales of computer hardware and accessories. Since 2001, we have
shifted our business focus from sales of computer hardware and accessories to
sales of enterprise software and related customer maintenance services and
provision of software development services. Sales of computer hardware and
accessories accounted for an insignificant percentage of our total net revenues
in 2006 and are expected to be a negligible part of our business in the
future. We intend to continue deploying our resources on sales of
enterprise software and related customer maintenance services and provision of
software development services that enable enterprises and trade-related PRC
government agencies to streamline the import/export process in
China.
Growth of the import/export industry
in China
Our
financial results have been, and we expect them to continue to be, affected by
the growth of the import/export industry in China. According to Global Insight,
the total value of import/export transactions in China reached approximately
US$1.7 trillion in 2006, up from approximately US$1.2 trillion in
2004 and approximately US$1.4 million in 2005. As a result of China’s accession
into the WTO in 2001, tariffs imposed by China on all imported goods are
expected to be reduced and PRC-imposed import quotas and permit requirements are
expected to be gradually eliminated. We believe the combination of a
rapidly
growing
PRC economy and China’s accession to the WTO will accelerate the growth of the
import/export industry in China, and as a result create additional demand for
our products and services.
Increase in number of potential
users
The
number of users of our enterprise software has increased significantly since we
first launched our iDeclare.CIQ software products in August 2000. This increase
is partially attributable to the increasing number of PRC international trade
enterprises and partially attributable to the increasing demand from such
enterprises for more efficient import/export processing methods. We expect an
increase in the number of PRC international trade enterprises as the PRC economy
continues to expand. We believe this in turn will increase demand for our
enterprise software and related customer maintenance services and software
development services, as international trade enterprises seek an efficient means
of completing the declaration process.
In August
2005, the PRC Inspections Administration selected our company as the winning
bidder in connection with the PRC Inspections Administration’s request for
proposals for the development of a software product that has certain basic
functionalities similar to those of iDeclare.CIQ and iProcess.CIQ product
series. The PRC Inspections Administration agreed to pay a one-time
fee of RMB3.3 million (US$423,000) to purchase the ownership of the software
product that we developed. In February 2006, the PRC Inspections Administration
commenced to distribute such software products free-of-charge to
end-users. We believe that the distribution of free software
products, while in the long run will likely increase the number of e-filers and
hence increase demand for our enterprise software services, would have a
significant adverse effect on our total net revenue, our results of operations
and profitability in the short-term. For example, we sold, together with our
franchisees, approximately 1,500 and 2,200 software packages of iDeclare.CIQ
during the first quarter of 2006 and 2007, respectively, which is significantly
lower than the approximately 8,000 software packages of iDeclare.CIQ sold by our
company and our former distributors and franchisees during the first quarter of
2005. In May 2007, the PRC Inspections Administration selected our
company as one of the winning bidders in connection with the PRC Inspections
Administration’s request for proposals for servicing the free import/export
e-filing software provided by the PRC Inspections Administration.
Expanding our user base through
franchisees
We
believe our user base has substantial growth potential due to the high number of
international trade enterprises that possess import/export rights in China.
According to the PRC Ministry of Commerce, there were approximately 609,276
foreign-invested companies registered to do business in China as of May 31,
2007. In addition, there are numerous PRC-based companies that possess
import/export rights. A key component of our growth strategy is to secure new
customers through the efforts of our franchisees and we intend to engage
additional franchisees to expand our marketing and distribution network.
Currently, we have engaged four franchisees to undertake marketing, distribution
and service activities in China.
Description of revenues, cost items
and trade receivables
We
primarily operate in three lines of business: (i) sales of enterprise software,
(ii) software development services, and (iii) sales of computer hardware and
accessories. Currently, our total net revenues are primarily derived from our
sales of enterprise software. Our net revenues from sales of computer hardware
and accessories constituted less than 0.3% of our total net revenues for
2006. In May 2007, we launched tootoo.com, our new B2B vertical
search platform.
Total net
revenues
Currently,
we generate total net revenues primarily from (i) sales of enterprise software
products and fees from customer maintenance services, (ii) fees from software
development services, and (iii) sales of computer hardware and
accessories.
We
derived RMB51.7 million, RMB89.1million and RMB37.6 million (US$4.8 million), or
25.6%, 37.1% and 24.6% of our total net revenues in 2004, 2005 and 2006,
respectively, from our related parties iTowNet and eGrid, which are two of our
major customers for software development services, and Ninetowns Enke, which is
one of our franchisees.
Our total
net revenues are net of business tax and VAT, but include VAT refunds as
discussed below. Our sales of enterprise software products and computer hardware
and accessories are generally subject to a VAT of 17.0%. Our fees charged for
software development services and customer maintenance service for enterprise
software products are generally subject to a 5.0% business tax. Pursuant to the
laws and regulations of the PRC, three of our subsidiaries in China are entitled
to a refund of the 14.0% VAT for certain self-developed software products. We
recognize the VAT refunds at the same time we recognize net revenues from sales
of enterprise software. VAT refunds are included in our net revenues from sales
of enterprise software. In 2006, we recognized RMB10.5 million (US$1.3 million) in
VAT refunds. We cannot predict how much our net revenues from sales of our
enterprise software or software development services will increase in the
future, or if they will increase at all.
Enterprise software. Our net
revenues from enterprise software are derived primarily from sales of our
iDeclare.CIQ basic package and related customer maintenance service fees. We
charge users of our iDeclare.CIQ product series a license fee of RMB4,500
per software package, which includes a one-year basic customer maintenance
service period. We also charge RMB1,500 for each additional year of customer
maintenance services, which includes a number of value-added services in
addition to the basic maintenance services. We charge users of
iProcess.CIQ product series on the same terms as those for iDeclare.CIQ product
series. Enterprise software revenues and fees from customer maintenance services
are recognized ratably over a 12-month period. Enterprise software revenues
received or receivable but not yet recognized are accounted for as deferred
revenue on our balance sheets. Deferred revenue is reduced proportionately as
enterprise software revenues are recognized ratably over the 12-month
period.
In
addition to direct sales, we also sold our enterprise software to our former
distributors and franchisees for further sale to users. As of December 31, 2005,
the distribution agreements with our former distributors, Panyu Chengchang and
Tomorrow Technology, expired and we chose not to renew them due to our efforts
to develop our franchisee network. In May 2005, January 2006 and
October 2006, we engaged three new franchisees and we currently have four
franchisees. Our per-unit license fee for enterprise software
products charged to our former distributors and franchisees is based on our
negotiated sales arrangement with the former distributor or franchisee, and is
less than the RMB4,500 per-unit license fee we receive from direct sales. We
also sell iDeclare.CIQ products on a fee-per-declaration filing basis to a
limited number of users, substantially all of whom are located in Guangdong
Province, China. Our ability to grow our net revenues from sales of enterprise
software will depend on (i) the rate of increase in the number of new users of
such product, (ii) the market’s acceptance of our planned new software products,
(iii) the success of our plans to engage additional franchisees, and (iv) our
increased efforts in marketing our customer maintenance services to our users.
It is currently unclear how the distribution of free enterprise software by the
PRC Inspections Administration affects our ability to grow our net revenues from
sales of enterprise software.
Notwithstanding
that we intend to charge for such maintenance services, we believe our users and
potential customers are not accustomed to being charged for this type of service
and it is unclear to us
how many
of our users will pay for such maintenance services. In 2006, we collected
customer maintenance service fees from approximately 29,000 users, representing
approximately 23.8% of our users due to renew their maintenance
service. We intend to continue to increase our marketing and
collection efforts with respect to these customer maintenance service fees. We
expect our profit margin from sales of enterprise software to decrease if the
VAT refund is eliminated or reduced by the PRC tax authorities. We expect net
revenues from per declaration filing fees to increase with our increased sales
of enterprise software, but to remain stable as a percentage of our total net
revenues.
Software development
services. Our net revenues from software development services are derived
primarily from contracts related to PRC government agency software development
projects, such as our services for the PRC Inspections Administration and the
data exchange platforms operated by iTowNet, which is our related party, and our
services for eGrid, which is also our related party. As we believe is consistent
with the practice of other software development companies in China engaged in
government-related work, we often commence work on software development projects
based on oral commitments from our customer and sign the contract after the
commencement of work. Once a contract has been signed, we begin recognizing net
revenues from these projects based on the percentage-of-completion method, in
which revenue recognition is based on the man-hours spent and the costs invested
in the project. Billing is generally done periodically in accordance with
predetermined milestones as established by the contract. We expect net revenues
from software development services to increase as we are engaged by additional
PRC government agencies, such as PRC Customs, to perform such services, but we
cannot predict how much such revenues will grow in the future, or if they will
grow at all.
Computer hardware
sales. Although we derived significant net revenues from
computer hardware sales in the past, we expect net revenues from this business
to represent an insignificant portion of our total net revenues in the
future.
Cost of
revenues
Our cost
of revenues consists principally of costs related to sales of our enterprise
software and our provision of software development services.
Enterprise software. Our
enterprise software consists of standardized software, the production of which
involves minimal cost. We have production arrangements with several outside
contractors, under which they produce the compact discs that contain our
software and charge us a fee for such services. We package such compact discs
with compact disc holders and ship the packages from our Beijing headquarters to
our branch offices, former distributors and franchisees. As a result, the cost
of revenues for sales of enterprise software consists mainly of outsourcing
costs to those outside contractors and costs associated with packaging and
shipping of software. Currently, we also distribute our enterprise software
products through the Internet. We expect our cost of revenues from sales of
enterprise software to increase as a percentage of our total net revenues
because we will be required to recognize additional cost of revenues after we
commercially introduce our iMonitor.CGA product series, since the costs
associated with our iMonitor.CGA product series as a percentage of net revenues
from sales of enterprise software are higher than the costs associated with our
iDeclare.CIQ product series.
Software development
services. Our cost of software development services is comprised mainly
of personnel expenses, office rental expenses and other expenses directly
related to our provision of software development services. We record cost of
revenues for software development services on a percentage-of-completion method
by reference to the man-hours incurred and estimated total project hours. We
expect our cost of revenues related to software development services to increase
as a percentage of our net revenues from software development services as a
result of the requirement for more advanced technologies in new projects. As
such, we expect our overall cost of revenues from software development services
to increase as we perform more software development services.
Computer hardware sales. Our
cost of revenues from computer hardware sales is minimal because (i) we do not
manufacture these products, but source them from third party manufacturers, (ii)
we maintain minimal inventories of computer hardware and accessories, and (iii)
we have a very low volume of sales in this line of business.
Gross profit
margin
Our gross
profit margin is primarily affected by our net revenues from sales of enterprise
software and the cost of revenues for our software development services. For the
purpose of calculating our gross profits, costs that are not otherwise
specifically allocated are allocated to our costs associated with (i) sales of
enterprise software, (ii) software development services, and (iii) sales of
computer hardware and accessories, in proportion to the gross profits from these
lines of business prior to the allocation of such common costs. We expect our
enterprise software gross profit margin to decrease with our expected increase
in iMonitor.CGA sales because the costs associated with iMonitor.CGA, as a
percentage of net revenues from sales of enterprise software, are higher than
the costs associated with our iDeclare.CIQ product series. We expect our
software development services gross profit margin to decrease as we invest in
more advanced technologies in new software development projects. We do not
expect our computer hardware line of business to impact our gross profit as we
continue to shift our business focus to our other lines of
business.
Operating
expenses
Our
operating expenses consist of (i) selling expenses, (ii) general and
administrative expenses and (iii) research and development
expenses. We do not allocate operating expenses to individual lines
of business when making decisions about allocation of resources or assessing the
performance of our lines of business. Effective January 1, 2006, the
Company adopted SFAS 123R which supercedes APB 25 and recognized stock-based
compensation cost on a straight-line basis over the requisite service period,
which is the vesting method.
Selling expenses. Selling
expenses consist primarily of sales, marketing and personnel expenses, customer
service expenses, associated rental expenses, marketing and advertising expenses
and travel and entertainment expenses for our sales and marketing staff. We
expense all selling expenses as they are incurred. As we engage additional
franchisees to expand our marketing and distribution network, we expect to
significantly decrease the number of our sales and marketing
staff. This, after netting off the effect of the increase in our
stock-based compensation expenses, resulted in a significant decrease in our
selling expenses for 2006. We expect to expand our marketing and
advertising campaigns to compete with the free software distributed by the PRC
Inspections Administration and we intend to increase incentive payments to
salespersons to promote our enterprise platform products. In
addition, if we decide to engage in a new line of business, we expect to
increase the number of our sales and marketing staff to promote that business.
As a result of the above, we generally expect a gradual increase in our selling
expenses.
General and administrative
expenses. General and administrative expenses consist primarily of
personnel expenses, office rental expenses, general office expenses, travel and
entertainment expenses, professional fees and allowance for doubtful debts. We
expense all general and administrative expenses as they are incurred. In 2006,
we incurred substantially higher general and administrative expenses than in
earlier years (excluding the impact of stock-based compensation charge of
RMB35.0 million in 2003) as a result of increases in (i) professional fees
incurred related to our status as a public company and our acquisition and
investment activities, (ii) depreciation and amortization charges on fixed
assets and intangible assets, (iii) increase in stock-based compensation
expenses and (iv) increase in the number of employees due to our expansion into
the B2B business. We expect our general and administrative expenses
to increase continuously in 2007.
Research and development
expenses. Research and development expenses consist primarily of research
and development personnel expenses and associated rental expenses. We expense
research and development expenses as they are incurred. In addition, because
technological feasibility for our software products ordinarily occurs right
before such products are commercially launched and because costs incurred
between technological feasibility and commercial launch are immaterial, such
costs are expensed as incurred. We expect our research and development expenses
to increase as a result of (i) our investment in the research and development of
new enterprise platform products, (ii) an increase in the number of research and
development personnel, (iii) an increase in stock-based compensation expenses,
(iv) an expected increase in our potential new business ventures and (v) our
investment in software licenses for development tools to increase the
productivity of our overall research and development efforts.
As a
result of the cumulative effect of the factors described above, we expect in the
future our total operating expenses will increase.
Taxation
Under the
current laws of the Cayman Islands our company is not subject to tax on its
income or capital gains. In addition, payment of dividends by us is not subject
to withholding tax in the Cayman Islands.
PRC enterprise income tax.
Our PRC operating subsidiaries and variable interest entities are subject to PRC
EIT on their taxable income. Pursuant to PRC tax laws, EIT is generally assessed
at the rate of 33.0% of taxable income.
Beijing
New Take, Ninetowns Times and Ninetowns Digital are afforded favorable tax
treatment and are only subject to a 15.0% EIT, Shanghai New Take and Ninetowns
Ports are also afforded favorable tax treatment. Shanghai New Take was exempt
from EIT from January 1, 2003 to December 31, 2004 and is subject to a 16.5% EIT
from January 1, 2005 to December 31, 2007. Ninetowns Ports was exempt from EIT
from August 1, 2003 to December 31, 2005 and is subject to a 7.5% EIT for the
period from January 1, 2006 to December 31, 2008. Guangdong Ninetowns
Technology is entitled to an exemption from EIT from January 1, 2006 to December
31, 2007. Ninetowns Network is entitled to an exemption from EIT from January 1,
2006 to December 31, 2008. Ronghe Tongshang is currently subject
to a 15.0% EIT.
Ninetowns Digital,
Beijing New Take, Ninetowns Times, Ninetowns Ports, Ninetowns Network and Ronge
Tongshang have qualified as “new and high technology enterprises” and have been
granted preferential EIT rates based on such status. Shanghai New Take has also
been granted preferential EIT rates based on its status as a software company.
Relevant PRC government authorities specify certain financial and operational
criteria for a company to comply with in order to maintain its status as a new
and high technology enterprise.
Baichman
is currently subject to a 33.0% EIT.
PRC business tax. Our PRC
operating subsidiaries are also subject to PRC business tax. We primarily pay
business tax on our net revenues generated from software development services
and customer maintenance services. Our PRC operating subsidiaries and variable
interest entities generally pay a 5.0% business tax on our
net
revenues
derived from software development services and customer maintenance services and
this business tax is deducted from our total net revenues.
Value-added tax. Our PRC
operating subsidiaries are also generally subject to a 17.0% VAT on sales of
computer hardware and accessories and our enterprise software products. Pursuant
to PRC tax regulations, Ninetowns Times, Ninetowns Digital and Ninetowns
Ports are entitled to a 14.0% VAT refund on sales of certain registered
self-developed software products. Our net revenues from sales of such enterprise
software include VAT refunds in the amount of RMB17.4 million, RMB19.8 million
and RMB10.5 million (US$1.3 million) in 2004, 2005 and 2006,
respectively.
Upon
expiration of these preferential EIT rates and VAT refunds, we will consider
available options, if any, in accordance with applicable law, that would enable
us to qualify for further tax incentives.
Trade
receivables
Our trade
receivables from external customers and trade receivables from related parties
consist primarily of amounts due from our franchisees for enterprise software
delivered to them and amounts billed but not paid and amounts unbilled for our
software development services. Our trade receivables balance due from related
parties was RMB4.0 million (US$0.5 million) as of December
31, 2006.
Critical accounting
policies
The
methods, estimates and judgments we use in applying our accounting policies have
a significant impact on the results we report in our consolidated financial
statements. Some of our accounting policies require us to make difficult and
subjective judgments, often as a result of the need to make estimates of matters
that are inherently uncertain. We have summarized below our accounting policies
that we believe are both important to the portrayal of our financial results and
involve the need to make estimates about the effect of matters that are
inherently uncertain.
Revenue
recognition
We
account for the sales of our enterprise software in accordance with American
Institute of Certified Public Accountants, or AICPA, Statement of Position (SOP)
97-2, “Software Revenue Recognition.” The application of SOP 97-2 requires
judgment, including whether a software arrangement includes multiple elements,
and if so, whether vendor-specific objective evidence, or VSOE, of fair value
exists for those elements. Our customers receive certain elements of our
enterprise software over a period of time, including post-delivery repair and
enterprise software maintenance, training, telephone support and nonspecific
enhancements of the software on a when-and-if-available basis. As no fair value
of these elements can be assessed reliably, we recognize such revenues ratably
over the contract period of the software arrangement, which is usually 12
months. Changes to the elements in a software arrangement, the ability to
identify VSOE for those elements, and the fair value of the respective elements
could all materially impact the amount of earned and unearned revenue.
Enterprise software revenues received or receivable but not yet recognized are
accounted for as deferred revenue on our balance sheet. Deferred revenue is
reduced proportionately as enterprise software revenues are recognized ratably
over the 12-month period.
As we
believe is consistent with the practice of other software development companies
in China engaged in government-related work, we often commence work on software
development projects based on oral commitments from our customer and sign the
contract after the commencement of work. Once a contract has been signed, we
begin recognizing revenues from these projects based on the
percentage-of-completion of the contracts, in which revenue recognition is based
on the actual hours spent and the
estimated
costs to complete the projects. Billing is generally done periodically in
accordance with predetermined milestones as established by the contract. The
determination of percentage-of-completion with reference to actual hours spent
and the estimated costs to complete the projects requires significant
judgment.
Stock-based
compensation
Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R,
using the modified prospective transition method. Under this method, share-based
compensation expense recognized beginning January 1, 2006 includes: (a)
compensation expense for all share-based compensation awards granted prior to,
but not yet vested as of January 1, 2006, based on the fair market value as of
the grant date, measured in accordance with Statement of Financial
Accounting Standards No. 123, “Accounting for Stock-Based Compensation” issued
by FASB and (b) compensation expense for all share-based compensation awards
granted on or subsequent to January 1, 2006, based on grant-date fair value
estimated in accordance with the provisions of SFAS 123R. We recognize
share-based compensation costs on a straight-line basis over the requisite
service period which is generally the vesting period. For share-based
compensation awards that were granted before we became a public company and are
not yet vested, the fair value is measured using the minimum value method and we
continue to report these options under APB 25. For options vested
prior to January 1, 2006, we accounted for share-based compensation plans in
accordance with APB 25.
We
recorded a compensation charge of RMB10.3 million for the options granted to our
employees under our 2004 Plan. As we
have not granted options to our employees under the 2006 Share Incentive Plan,
we do not have compensation charges that are associated with the 2006 Share
Incentive Plan to record.
Trade
receivables
We
perform ongoing credit evaluations of our customers and adjust credit limits
based on payment history and the customer’s current credit-worthiness, as
determined by our review of their current credit information. We extended three
months of credit to our former distributors and franchisees pursuant
to
our
distribution and franchise agreements. However, it took on average five to six
months for our former distributors and franchisees, who are also our major
customers, to settle their debts to us. Therefore, in some fiscal periods, our
trade receivables increased, and may increase in the future, to an amount which
is approximately equal to our total net revenues for such period. We
continuously monitor collections and payments from our customers and
maintain
allowances for doubtful accounts for estimated losses resulting from the
inability of its customers to make the required payments and use the
specific identification method to record such allowances.
We
typically write-off billed receivables that are over 360 days outstanding.
While such credit losses have historically been within our expectations and the
provisions established, we cannot guarantee that we will continue to experience
the same credit loss rates that we have had in the past. The billed
receivables from Ninetowns Enke, iTowNet and eGrid, which are our customers that
are related to us, were approximately 18.1% of our total billed receivables
as of December 31, 2006. The billed receivables from our customers and
franchisees, which are unrelated to us, were approximately 81.9% of our total
billed receivables as of December 31, 2006. Since our billed receivables are
concentrated in a relatively small number of customers, a significant change in
the liquidity or financial position of any one of these customers could have a
material adverse impact on the collectibility of our billed receivables and our
future operating results.
Goodwill
Goodwill
represents the excess of the purchase price over the fair value of the
identifiable assets and liabilities acquired. Goodwill is tested for
impairment annually or more frequently if events or changes in circumstances
indicate that it might be impaired. We completed a two-step goodwill
impairment test for 2004, 2005 and 2006. The first step compares the
fair values 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 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. Based on the Company’s
assessment, there was no impairment of goodwill for the years ended December 31,
2004, 2005 and 2006.
A. Operating
results
The
following table sets forth the results of our operations expressed as a
percentage of our total net revenues for the periods indicated. Our historical
operating results are not necessarily indicative of the results for any future
period.
|
Year ended
December
31,
|
|
2004
|
2005
|
2006
|
|
|
|
|
Total
net revenues:
|
|
|
|
Enterprise
software
|
93.6%
|
84.8%
|
76.2%
|
Software
development
services
|
6.3
|
14.9
|
23.5
|
Computer
hardware
sales
|
0.1
|
0.3
|
0.3
|
Cost
of revenues:
|
|
|
|
Enterprise
software
|
0.7
|
0.2
|
-
|
Software
development
services
|
1.5
|
7.6
|
11.0
|
Computer
hardware
sales
|
–
|
0.2
|
0.1
|
Gross
profit
|
97.8
|
92.0
|
88.9
|
|
Year Ended
December
31,
|
|
2004
|
2005
|
2006
|
|
|
|
|
Operating
expenses:
|
|
|
|
Selling
expenses
|
7.9
|
10.7
|
8.9
|
General
and administrative expenses
|
18.2
|
20.6
|
43.0
|
Research
and development expenses
|
2.4
|
4.7
|
19.5
|
Total
operating expenses |
28.5
|
36
|
71.4
|
Government
subsidies
|
0.6
|
0.2
|
0.5
|
Income
from
operations
|
69.9
|
56.2
|
18.0
|
|
|
|
|
Interest
income
|
|
|
|
Income
before provision for income taxes and minority
interest
|
71.8
|
63.5
|
30.6
|
Provision
for income
taxes
|
0.9
|
0.3
|
0.6
|
Income
before minority
interests
|
70.9
|
63.2
|
30.0
|
Minority
interests
|
4.4
|
–
|
|
Net
income
|
66.5%
|
63.2%
|
30.0%
|
2006 compared to
2005
Total net
revenues
We
generated total net revenues of RMB153.2 million (US$19.6 million) in 2006, a
decrease of 36.1% over our total net revenues of RMB239.9 million in 2005. This
revenue decrease was principally the result of the PRC Inspections
Administration’s free distribution of products that are similar to
our iDeclare product series.
Enterprise software. Net
revenues from sales of our enterprise software decreased by 42.6% to RMB116.8
million (US$15.0 million) in 2006 from RMB203.5 million in 2005, primarily as a
result of the PRC Inspections Administration’s free distribution of products
that are similar to our iDeclare product series. The availability of
a free software product that has similar functions as iDeclare caused our sales
of our iDeclare product series to decline significantly. In 2006, we
signed customer maintenance service contracts with approximately 29,000 users
whose customer maintenance service contracts were due for renewal in
2006. We recognized net revenues of RMB43.4 million (US$5.6 million)
from provision of customer maintenance services in 2006. Of our net revenues
from sales of enterprise software, RMB23.6 million and RMB21.9 million (US$2.8
million) were from per declaration filing fees in 2005 and 2006, respectively,
representing a year-on-year decrease of 7.2%. As of December 31, 2006, we
believe there were approximately 130,000 licensees of our enterprise software
registered to effect electronic import/export processing over the data exchange
platforms of iTowNet, an increase of 6.6% from approximately 122,000 of such
licensees as of December 31, 2005.
Software development
services. Net revenues from our software development services increased
by 0.9% from RMB35.7 million in 2005 to RMB36.0 million (US$4.6
million) in 2006. In 2006, we did not enter into as many software
development contracts as compared to 2005, but we completed some project
milestones and recognized revenue for software development contracts signed in
2005.
Computer hardware sales. Net
revenues from computer hardware sales comprised less than 0.3% of our total net
revenues as we gradually exited this line of business.
Cost of
revenues
Enterprise software. Cost of
revenues from sales of enterprise software decreased by 100% to nil in 2006 as
compared to RMB495,000 in 2005. Since iDeclare is now generally distributed
through the Internet, we
incurred
minimal outsourcing costs to outside contractors and costs associated with
packaging and shipping of software.
Software development
services. Cost of revenues from software development services decreased
to RMB16.8 million (US$2.2 million) in 2006 from RMB18.2 million in 2005,
primarily as a result of fewer number of software development service contracts
signed in 2006. As of December 31, 2006, the Company did not have
capitalized costs related to such projects which represents a decrease of 100%
over the prior year’s balance of RMB153,000 as of December 31,
2005.
Computer hardware sales. Cost
of revenues from computer hardware sales was insignificant in 2006.
Gross profit
margin
Enterprise software. Gross
profit margin for sales of enterprise software in 2006 was 100% compared to
99.8% in 2005 primarily because iDeclare is now generally distributed through
the Internet and we incurred minimal outsourcing costs to outside contractors
and costs associated with packaging and shipping of software.
Software development
services. Gross profit margin for software development services in 2006
remained relatively stable at 53.3% compared to 49.0% in 2005.
Computer hardware sales.
Gross profit margin for computer hardware sales increased to 66.3% in 2006 from
28.9% in 2005, primarily due to decreased sales of lower-margin products such as
desktop computers.
Operating
expenses
Operating
expenses increased by 26.4% to RMB109.4 million (US$14.0 million) in 2006 from
RMB86.5 million in 2005, primarily as a result of our efforts to expand our
business through new business models, additional staff, increase in stock-based
compensation costs and increased research and development.
Selling expenses
Selling
expenses decreased by 47.2% to RMB13.6 million (US$1.7 million) in 2006 from
RMB25.7 million in 2005, primarily due to our change in business model from
direct sales to franchise sales.
General and administrative
expenses
General
and administrative expenses increased by 33.1% to RMB65.9 million (US$8.4
million) in 2006 from RMB49.5 million in 2005, primarily due to increases in (i)
professional fees incurred in relation to our acquisition and investment
activities and compliance requirements applicable to us as a public company
in the United States, (ii) depreciation and amortization charges on
fixed assets and intangible assets, (iii) stock-based compensation costs and
(iv) general personnel expenses, office expenses, communication expenses,
traveling expenses and insurance expenses, in each case associated with the
increase in the scale of our operations.
Research and development
expenses
Research
and development expenses increased significantly by 165.1% to RMB29.8 million
(US$3.8 million) in 2006 from RMB11.2 million in 2005, primarily due to an
increase in (i) stock-based compensation costs and (ii) staff costs related to
the research and development of our new products primarily related to our new
B2B business.
Government
subsidies
We received government subsidies of RMB705,000
(US$90,000) in 2006, which represented an increase of 57.8% from RMB
477,000 in 2005, primarily attributable to the receipt of government subsidies
for research and development of an electronic platform from the Committee of
Zhongguancun Science Park.
Interest
income
Interest
income increased to RMB19.3 million (US$2.5 million) in 2006 from RMB17.6
million in 2005, primarily due an increase in the amount of our term
deposits.
Income
taxes
Income
taxes increased by 64.7% to RMB1.0 million (US$132,000) in 2006 from RMB626,000
in 2005, as Ninetowns Ports, who is one of our major operating subsidiaries and
was exempt from EIT from August 1, 2003 to December 31, 2005, became subject to
a 7.5% EIT starting from January 1, 2006.
Net
income
Net income decreased
significantly by 69.7% to RMB45.9 million (US$5.9 million) in 2006 from RMB151.6
million in 2005 as a result of the cumulative effect of the factors described
above.
2005 compared to
2004
Total net
revenues
We
generated total net revenues of RMB239.9 million in 2005, an increase of 19.0%
over our total net revenues of RMB201.5 million in 2004. This revenue growth was
principally the result of the expansion of both of our enterprise software
business and software development business and the recognition of net revenues
from sales of enterprise software that were made in 2004.
Enterprise software. Net
revenues from sales of our enterprise software increased by 7.8% to RMB203.5
million in 2005 from RMB188.7 million in 2004, primarily as a result of an
increase in the number of users of our enterprise software, which is partially
attributable to the increasing number of international trade enterprises
operating in China and also attributable to the increasing demand for more
efficient import/export processing methods. The increase in our net revenues
from enterprise software is also attributable to the increase in the number of
customer maintenance service contracts sold to our existing users. In 2005, we
signed customer maintenance service contracts with approximately 44,600 users
whose customer maintenance service contracts were due for renewal in 2005. We
recognized net revenues of RMB33.2 million from provision of customer
maintenance services in 2005. Of our net revenues from sales of enterprise
software, RMB24.1 million and RMB23.6 million were from per declaration filing
fees in 2004 and 2005, respectively, representing a year-on-year decrease of
2.1%. As of December 31, 2005, we believe there were approximately 122,000
licensees of our enterprise software registered to effect electronic
import/export processing over the data exchange platforms of iTowNet, an
increase of 28.4% from approximately 95,000 of such licensees as of December 31,
2004.
Software development
services. Net revenues from our software development services increased
significantly to RMB35.7 million in 2005 from RMB12.7 million in 2004. This
increase is attributable to the fact that a number of software development
projects were initiated in 2004 based on oral commitments from our customers but
contracts for such projects were not signed until 2005, and therefore net
revenues were not recognized until 2005.
Computer hardware sales. Net
revenues from computer hardware sales comprised less than 1.0% of our total net
revenues as we gradually exited this line of business.
Cost of
revenues
Enterprise software. Cost of
revenues from sales of enterprise software decreased by 67.6% to RMB495,000 in
2005 as compared to RMB1.5 million in 2004, due to the effects of more stringent
cost controls.
Software development
services. Cost of revenues from software development services increased
significantly to RMB18.2 million in 2005 from RMB3.0 million in 2004, primarily
as a result of our work on software development projects in 2004 based on oral
commitments from our customers but contracts for such projects were not signed
until 2005, and therefore the cost for such projects were not recognized until
2005. As of December 31, 2005, the Company has capitalized costs related to such
projects totaling RMB153,000 which represents a significant decrease from the
prior year’s balance of RMB6.7 million as of December 31, 2004.
Computer hardware sales. Cost
of revenues from computer hardware sales was insignificant in 2005.
Gross profit
margin
Enterprise software. Gross
profit margin for sales of enterprise software in 2005 remained stable at 99.8%
compared to 99.2% in 2004 primarily because our costs of producing our
enterprise software are relatively low and did not change between the periods
presented.
Software development
services. Gross profit margin for software development services in 2005
decreased to 49.0% compared to 76.7% in 2004, which is mainly attributable to an
increase in software development personnel expenses.
Computer hardware sales.
Gross profit margin for computer hardware sales decreased to 28.9% in 2005 from
91.3% in 2004, primarily due to increased sales of lower-margin products such as
desktop computers.
Operating
expenses
Operating
expenses increased by 50.8% to RMB86.5 million in 2005 from RMB57.4 million in
2004, primarily as a result of our efforts to expand our business through
increased sales, additional staff and increased research and
development.
Selling expenses
Selling
expenses increased by 61.2% to RMB25.7 million in 2005 from RMB16.0 million in
2004, primarily due to an increase in advertising, office, rental, staff and
travel expenses related to increased sales and the expansion of our distribution
network.
General and administrative
expenses
General
and administrative expenses increased by 35.5% to RMB49.5 million in 2005 from
RMB36.6 million in 2004, primarily due to increases in (i) professional fees
incurred in relation to compliance requirements applicable to us as a public
company in the United States, (ii) depreciation and amortization
charges on fixed assets and intangible assets and (iii) general personnel
expenses, office expenses, communication expenses, traveling expenses and
insurance expenses, in each case associated with the increase in the scale of
our operations.
Research and development
expenses
Research
and development expenses increased by 133.4% to RMB11.2 million in 2005 from
RMB4.8 million in 2004, primarily due to an increase in staff costs related to
the research and development of our new products such as a PRC Customs
declaration filing system and an electronic payment system.
Government
subsidies
Government subsidies decreased by 66.6% to RMB447,000 in
2005 from RMB1.3 million in 2004. This was attributable to our receipt of a
RMB1.0 million government subsidy for research and development work from the
Electronic Information Industry Fund of the Ministry of Information Industry of
the PRC in 2004. We did not receive such subsidy in
2005.
Interest
income
Interest
income increased by significantly to RMB17.6 million in 2005 from RMB3.8 million
in 2004, primarily due to interest income derived from our net proceeds from our
initial public offering in December 2004.
Income
taxes
Income
taxes decreased by 65.7% to RMB626,000 in 2005 from RMB1.8 million in 2004,
primarily due to the increasing operations of Ninetowns Ports, which was exempt
from enterprise income tax in 2005.
Net
income
Net income increased by 13.2% to
RMB151.6 million in 2005 from RMB134.0 million in 2004 as a result of the
cumulative effect of the factors described above.
Inflation
Inflation
and deflation in China did not have a material impact on our results of
operations in the past three years. According to the National Bureau of
Statistics of China, China’s overall national inflation rate, as represented by
the change in the Consumer Price Index in China, was 3.9%, 1.8% and 1.5% in
2004, 2005 and 2006, respectively.
Foreign
currency risk
Substantially
all of our revenues and expenses are denominated in Renminbi, but a certain
amount of our cash is kept in U.S. dollars and Hong Kong dollars in reputable
financial institutions in Hong Kong and the United States. Although
we believe that in general, our exposure to foreign exchange risks should be
limited, our cash flows and revenues will be affected by the foreign exchange
rate between U.S. dollars and Renminbi. For example, if we decide to convert our
Renminbi into U.S. dollars for the purpose of declaring dividends on our
ordinary shares or for other business purposes and the U.S. dollar appreciates
against the Renminbi, the U.S. dollar equivalent of our earnings from our
subsidiaries in China would be reduced. In addition, our cash flows and revenues
may also be affected by the foreign exchange rate between Renminbi and Hong Kong
dollars or U.S. dollars and Hong Kong dollars, as we have certain operating
expenses related to our representative office in Hong Kong that are denominated
in Hong Kong dollars.
We have
experienced minimal foreign exchange gains and losses to date. We do not engage
in any hedging activities, and we may in the future experience economic loss as
a result of any foreign currency exchange rate fluctuations.
B. Liquidity
and capital resources
Our
primary sources of liquidity have been net cash provided by operating
activities. We had no outstanding debt as of December 31, 2006. The
following table sets forth the summary of our cash flows for the periods
indicated:
|
|
For the years ended December
31,
|
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
|
(in
millions)
|
|
Net
cash provided by operating activities
|
|
RMB 87.2
|
|
|
RMB 143.3
|
|
|
RMB 146.4
|
|
|
RMB 40.8
|
|
|
US$ 5.2
|
|
Net
cash used in investing
activities
|
|
|
(39.6 |
) |
|
|
(179.4 |
) |
|
|
(110.9 |
) |
|
|
(176.5 |
) |
|
(22.6)
|
|
Net
cash provided by financing activities
|
|
|
70.2
|
|
|
|
565.6
|
|
|
|
2.0
|
|
|
|
6.3
|
|
|
|
0.8
|
|
Net
increase / (decrease) in cash and cash equivalents
|
|
|
117.8
|
|
|
|
529.5
|
|
|
|
(34.5 |
) |
|
|
(132.8 |
) |
|
|
(17.0 |
) |
Cash
and cash equivalents, beginning of year
|
|
|
49.7
|
|
|
|
167.5
|
|
|
|
697.0
|
|
|
|
731.5
|
|
|
|
93.7
|
|
Cash
and cash equivalents, end of year
|
|
RMB 167.5
|
|
|
RMB 697.0
|
|
|
RMB731.5
|
|
|
RMB598.6
|
|
|
US$76.7
|
|
Substantially
all of our operations are in China. The ability of our PRC operating
subsidiaries to convert Renminbi into U.S. dollars and transfer such U.S.
dollars to us is subject to PRC foreign exchange regulations, including the
restriction that foreign invested enterprises may only buy, sell and/or remit
foreign currencies at banks in the PRC authorized to conduct foreign exchange
business after providing valid commercial documents.
Cash flow from operating
activities
We
provided cash from operating activities of RMB40.8 milion (US$5.2 million) in
2006. This was primarily attributable to our cash receipts from sales
of enterprise software and software development services. We provided
cash in operating activities of RMB146.4 million in 2005. This was primarily
attributable to our cash receipts from sales of enterprise software and software
development services. We generated cash from operating activities of
RMB143.3 million in 2004. This was primarily attributable to our cash receipts
from sales of enterprise and software development services.
Cash flow from investing
activities
Cash used
in investing activities was RMB176.5 million (US$22.6) million in
2006. This was primarily attributable to our purchase of property and
equipment for our new B2B business and our investment in Global Market, our
purchase of intangible assets and increase of term deposits.
Cash used
in investing activities was RMB110.9 million in 2005. This was
primarily attributable to a deposit payment for the acquisition of an additional
floor of the building under construction in Beijing, our purchases of property
and equipment and an increase in our term deposits. Investing activities used
cash of RMB179.4 million in 2004. This was primarily attributable to our
purchase of three floors and the naming rights of a building under construction
in Beijing, computer equipment, furniture, fixtures and office equipment, the
acquisition of minority interests in our subsidiaries and increase of term
deposits, offset by the repayment of loans by Import &
Export.
Cash flow from financing
activities
Financing
activities generated cash of RMB6.3 million (US$0.8 million), in
2006. This was comprised primarily of employee’s exercise of their
vested share options. Financing activities provided cash of RMB2.0
million in 2005. This was comprised primarily of receipt of proceeds on exercise
of stock options by our employees offset by our repayment of outstanding
advances from shareholders. Financing activities provided cash of RMB565.6
million in 2004. This was comprised primarily of the net proceeds from our
initial public offering in December 2004 of RMB531.4 million and approximately
US$3.0 million of escrowed net proceeds from our capital-raising activities in
2003, which we received from escrow in September 2004, offset by our repayment
of loans to Jitter Bug.
Capital
resources
Our
primary source of liquidity is cash flow from operating activities. Our cash and
cash equivalents primarily consist of cash on hand and bank deposits. As of
December 31, 2006, we had RMB598.6 million (US$76.7 million) in cash and cash
equivalents. In addition, as of December 31, 2006, we had invested RMB307.2
million (US$39.4 million) in term deposits, which are payable at varying
maturities from three to six months.
We
believe that our available cash and cash equivalents and cash provided by
operating activities will be sufficient to meet our capital needs for at least
the next 12 months. Except for our net cash provided by operating activities, we
currently have no plans to seek additional sources of liquidity in the near
future. However, we cannot assure you that our business or operations will not
change in a manner that would consume our available capital resources more
rapidly than anticipated, especially as we continue to evaluate other investment
and acquisition opportunities. As of December 31, 2006, we had no lines of
credit or other credit facilities.
Capital
expenditures
For
details of our capital expenditures, see Item 4 of this annual report,
“Information on the Company – History and development of the
company.”
C. Research
and development
Our
research and development department works continuously to develop new software
products as well as new software functions with additional import/export related
applications to complement our existing enterprise software, thereby enhancing
value for our users. Our research and development department is divided into the
following three sub-departments:
·
|
Business development
department— our business development department is responsible for
business strategies and research to identify users’ needs in order to
formulate new product designs.
|
·
|
Systems development
department— our systems development department is responsible for
product development in accordance with the designs proposed by the
business development department, as well as software testing and quality
control.
|
·
|
Project management
department— our project management department is responsible for
the allocation of staff and resources, employee training, product analysis
and the registration of new software products with the relevant PRC
government authorities.
|
In the
past, we have developed products and services both independently and through
cooperation with a variety of database providers, enterprise resource planners,
decision support statistical consultants, software integration providers and
others. Although we intend to continue to work closely with outside third
parties in product development efforts, we expect the core technology and
know-how for future enhancements to our existing and new products will be
developed internally and may be supplemented by technology licensed from third
parties. See Item 3 of this annual report, “Key Information — Risk factors —
Risks related to our business — We may not be able to adequately protect our
intellectual property rights and others may claim that we have infringed on
their intellectual property rights, which could cause us to be less competitive,
may expose us to litigation and may negatively impact our business, results of
operations and financial condition.” We have not granted any ownership interest
in any of our products to any party that has worked with us in our product
development efforts. In the past, we shared ownership in a foreign trade
business system software with Jingjiang A-Bin Software Workshop, or A-Bin, and a
declaration software system that is not a part of our iDeclare.CIQ product
series, with Beijing Regard. We are not selling either software and, to our
knowledge, neither A-Bin nor Beijing Regard is currently selling such
software.
As of
December 31, 2006, we had 424 employees dedicated to research and development,
22 of whom have master’s degrees and two of whom have Ph.D. degrees. Most of our
research and development efforts are located in our principal executive offices
in Beijing and in our research and development center in Fengtai.
Our
expenses for research and development activities totaled RMB4.8 million in 2004,
RMB11.2 million in 2005 and RMB29.8 million (US$3.8 million) in
2006.
We
believe that timely development of new and enhanced products and services is
necessary for us to remain competitive in the marketplace. Accordingly, we
intend to continue recruiting and hiring research and development personnel and
to make other investments in research and development. We are in the process of
establishing two additional research and development centers, one in the eastern
region of China and one in the southern region of China, and we expect those
research and development centers to be fully functional by the middle of
2008.
D. Trend
information
Other
than as disclosed elsewhere in this annual report, we are not aware of any
trends, uncertainties, demands, commitments or events for the period from
January 1, 2006 to December 31, 2006 that are reasonably likely to have a
material effect on our net revenues, income, profitability, liquidity or capital
resources, or that caused the disclosed financial information to be not
necessarily indicative of future operating results or financial
conditions.
E. Off-balance
sheet arrangements
In
September 2006, we entered into a subscription agreement with Global Market to
subscribe 1,940,000 Series A preferred shares, which represents 16.25% of the
fully diluted equity interest in Global Market on an if-converted basis, for a
cash consideration of US$5.0 million. The subscription agreement
contains certain put and call options. The call option gives us a
right to acquire a variable number of Global Market's ordinary shares at a
nominal price of US$1.00 in the event Global Market's earnings fall below a
predetermined level or to receive cash if additional earnings requirements are
not met. The put option gives Global Market a right to repurchase up
to 285,000 issued ordinary shares from us at a nominal price of US$1.00 when
Global Market's earnings are above a predetermined level. These put
and call options are accounted for as embedded derivatives and because they are
not clearly and closely related to the Series A preferred share agreement, they
should be bifurcated and marked to market on each balance sheet
date. These embedded derivatives are bundled together and reported as
a single, compound embedded derivative instrument. As of December 31,
2006, the fair value of this bundled derivative instrument was not material
because we have only had our investment in Global Market for a short period of
time and Global Market’s projected operating results are expected to be within a
reasonable range that will not cause a significant change in our investment
value.
We do not
have other derivative financial instruments, off-balance sheet guarantees,
interest rate swap transactions or foreign currency forward contracts, and we do
not engage in trading activities involving non-exchange traded
contracts.
F. Contractual
obligations
We have
entered into leasing arrangements relating to our office premises and technical
support centers. Our contractual obligations regarding these lease arrangements
generally consist of rental payments and other charges that are due and payable
on a monthly basis during the term of the relevant lease. In general, our
lessors have the right to terminate the lease agreements and repossess the
leased premises if we fail to make the prescribed payments for two consecutive
months, or the expiration of a reasonable period after service of notice for
non-payment of rent by the lessors. The following sets forth our commitments
under these leases as of December 31, 2006:
|
(in
thousands)
|
Less
than one
year
|
RMB1,959
|
1-3
years
|
155
|
3-5
years
|
—
|
More
than 5
years
|
—
|
Total
|
RMB2,114
|
As of
December 31, 2006, we had no purchase obligations or long-term commitments other
than the lease obligations described above.
G. Recently issued accounting
pronouncements
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments-an amendment of FASB Statements No. 133 and 140.” SFAS No.
155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities”, to permit fair value re-measurement for any hybrid financial
instrument with an embedded derivative that otherwise would require bifurcation,
provided that the whole instrument is accounted for on a fair value basis. SFAS
No. 155 amends SFAS No. 140, “Accounting for the Impairment or Disposal of
Long-Lived Assets”, to allow a qualifying special-purpose entity to hold a
derivative financial instrument that pertains to a beneficial interest other
than another derivative financial instrument. SFAS No. 155 applies to all
financial instruments acquired or issued after the beginning of an entity’s
first fiscal year that begins after September 15, 2006, with earlier application
allowed. The Company does not expect the adoption of SFAS No. 155 to have a
material impact on its consolidated results of operations and financial
condition.
In June
2006, the FASB ratified the provisions of the Emerging Issue Task Force Issue
No. 06-3 “How Sales Taxes Collected from Customers and Remitted to Governmental
Authorities Should Be Presented in the Income Statement” (“EITF 06-3”), which
requires the Company to disclose how it accounts for taxes imposed on and
concurrent with a specific revenue-producing transaction. EITF 06-3 will be
effective for the Company starting January 1, 2007. The Company does not believe
that the application of EITF 06-03 will have a material effect on its financial
position, cash flow and results of operations
In July
2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes — an
Interpretation of FASB Statement No. 109” which clarifies the accounting for
uncertainty in tax positions. This Interpretation requires that the Company
recognize and disclose in its financial statements the impact of a tax position
if that position is more likely than not of being sustained on audit, based on
the technical merits of the position. The provisions of FIN 48 became effective
for the Company on January 1, 2007, with the cumulative effect of the change in
accounting principle, if any, recorded as an adjustment to opening retained
earnings. The Company is currently evaluating the impact of adopting FIN 48 and
its impact on its consolidated financial position, results of operations, and
cash flows.
In
September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" which
defines fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. SFAS No.157 applies under other
accounting pronouncements that require or permit fair value measurements and
accordingly does not require any new fair value measurements. SFAS No.157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The Company is
currently evaluating whether the adoption of SFAS No. 157 will have a material
effect on its consolidated results of operations and financial
position.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities, Including an amendment of FASB
Statement No. 115". SFAS No. 159 provides companies with an option to
report selected financial assets and liabilities at fair value. SFAS No.
159 requires companies to provide additional information that will help
investors and other users of financial statements to more easily understand the
effect of the company's choice to use fair value on its earnings. It also
requires entities to display the fair value of those assets and liabilities for
which the Company has chosen to use fair value on the face of the balance
sheet. SFAS No. 159 is effective as of the beginning of an entity's first
fiscal year beginning after November 15, 2007. The Company is currently
evaluating whether the adoption of SFAS No. 159 will have a material effect on
its consolidated results of operations and financial position.
Item
7. Major Shareholders and Related Party
Transactions.
A. Major
shareholders
For the
details of our major shareholders, please refer to Item 6. “Directors, Senior
Management and Employees – Share Ownership.”
In April
2006, Mr. Kin Fai Ng transferred 3,831,301 ordinary shares of our company to Mr.
Wang.
B. Related
party transactions
Overview
Ninetowns
Technology, our predecessor, commenced business in 1995 as a vendor of computer
hardware and accessories with a view to using the proceeds from the sale of such
products to fund research and development of enterprise software. We also used
the sale of computer hardware and accessories to develop relationships with PRC
government agencies, such as the PRC Inspections Administration, that were
actively pursuing the digitization of government processes. By late 2000, our
research and development efforts resulted in the commercial launch of our first
enterprise software, the iDeclare.CIQ basic package.
From 2000
to 2002, we underwent a transitional period in which we completed a number of
transactions with certain parties related to our company. This resulted in a
corporate reorganization in line with our current business strategy, which is to
be a scalable enterprise platform products provider enabling international trade
enterprises and trade-related PRC government agencies to streamline the
import/export process in China. These transactions included a number of sales
and purchases of equity interests in Import & Export, which holds a 49.0%
interest in iTowNet, the company that currently operates the data exchange
platforms of the PRC Inspections Administration. Also during this time, each of
our company and our affiliated company sold one shell company to our former
employees. Our former employees used these shell companies to (i) form our
franchisee and (ii) establish one of our major customers and competitors for
software development services.
All of
these transactions were accounted for as acquisitions or dispositions and
resulted in minimal gain or loss to our company. By the end of 2002, we
completed our transitional period and emerged as a company that was engaged
primarily in the development and sale of enterprise software and related
software development services.
You
should note in particular that, as described more fully below some of our
officers, directors and related parties are members of the boards of directors
or shareholders of companies with which we have important business
relationships.
You
should be aware of the relationships and transactions described herein, and that
there can be no assurance as to the effect of such relationships and
transactions on our company and its business. Our amended and restated articles
of association require that all future transactions between our company and our
related parties be approved by our audit committee.
Transactions with Mr. Wang and Ms.
Dong
Mr. Wang
is a director of Import & Export, which is 100.0% beneficially owned by Mr.
Wang and Ms. Dong. Import & Export in turn owns a 49.0% equity interest in
iTowNet, which is 51.0% owned by the PRC Inspections Administration. iTowNet is
the ultimate user of substantially all the software development services we
provide and operates the data exchange platforms that interface between
international trade enterprises using our enterprise software and the PRC
Inspections Administration’s internal electronic processing system. iTowNet
receives a fee of RMB5 for each submission made over its platforms.
Pursuant
to a right of first refusal agreement dated as of November 2, 2004, among Import
& Export, Mr. Wang, Ms. Dong and our company, Import & Export has agreed
to sell its 49.0% interest in iTowNet to our company if, at any time while we
are required to submit reports to the SEC, Import & Export is allowed to
sell such interest to us under relevant PRC law and policy. Our right of first
refusal is subject to the
statutory
right of first refusal of the PRC Inspections Administration to purchase such
interest. If we exercise our right of first refusal, we have agreed to purchase
the 49.0% interest in iTowNet at a purchase price of US$25.0 million, plus a
compounded interest rate of 5.0% per year for each year that Import & Export
held the 49.0% interest since August 23, 2001, but deducting any dividend or
distribution that Import & Export had previously received or receives in the
future from iTowNet. Our audit committee has approved the right of first refusal
agreement and will need to approve the exercise of the purchase right granted
under the Right of First Refusal Agreement. Based on current PRC laws and
practice, and the stated policy of the PRC Inspections Administration, we do not
believe the exercise of the purchase right is probable.
Ms.
Dong’s sister, Li Dong, was a shareholder and director of Beijing Regard, a
company which was our significant customer for software development services in
2003 and competes with us for the provision of software development services to
iTowNet and the PRC Inspections Administration. Li Dong currently does not own
any interest in eGrid and is not a director or officer of eGrid.
Beijing iTowNet Cyber Technology
Ltd.
iTowNet
was established on August 23, 2001 and is currently the operator of the PRC
Inspections Administration’s data exchange platforms. iTowNet, a limited
liability company organized under the laws of the PRC, is currently 51.0% owned
by the PRC Inspections Administration and 49.0% owned by Import & Export.
Import & Export is currently 72.18% owned by Yadi Yangguang and 27.82% owned
by Mr. Wang. Mr. Wang is a non-executive director and the vice-chairman of the
board of directors of iTowNet. As the supervisor of iTowNet, Mr. Wu is
responsible for overseeing the financial operations of iTowNet, the actions of
its board of directors and senior management and their compliance with relevant
laws and iTowNet’s charter documents.
We
provide, directly and indirectly, software development services to iTowNet to
maintain, improve and upgrade the data exchange platforms that we assisted them
in building. We charge iTowNet, or their service providers such as eGrid, fees
for such services at negotiated rates, which are based on our estimated costs
plus certain mark-ups.
Under our
software development contracts with iTowNet and eGrid, we typically agree to
provide, among other services, design, installation, implementation and
maintenance of software systems for iTowNet. We also typically provide one-year
of free customer maintenance services commencing from the completion date of the
project. Users of iDeclare.CIQ submit electronic declarations to the PRC
Inspections Administration over the data exchange platforms of iTowNet. iTowNet
receives a fee of RMB5 for each submission made over its platforms, including
submissions made using our enterprise software.
In 2006,
we did not recognize revenues from the provision of software development
services to iTowNet.
eGrid Technology Ltd. (formerly
Beijing Regard Technology Co., Ltd.)
Upon
commencement of operations in 2003, eGrid was owned by our former employees:
73.75% by Shen Sun, 18.75% by Hongmei Tian, who also owns 18.75% of Ninetowns
Enke, 5.0% by Lin Wen and 2.5% by Limin Guo. Since 2003, we have entered into
several software development contracts with eGrid in connection with software
development services for iTowNet. Under these contracts, eGrid designed and
implemented software required by iTowNet and then sub-contracted with us for the
coding of the software under these contracts. In 2005, through a
series of reorganization steps, eGrid was re-named and became 100% beneficially
owned by Zhonghai Xu, who is also one of our former employees and also one of
the owners of Ninetowns Xin He.
On March
31, 2005, we entered into a software development contract with eGrid, pursuant
to which we contracted to develop an “export electronic monitoring project
(Phase I).” On June 28, 2005, we also entered into two software
development contracts with eGrid pursuant to which we contracted to develop a
“waste import electronic monitoring system” and an “electronic business
integrated service platform”. eGrid agreed to pay us RMB3.0 million and RMB7.0
million, respectively, for the services provided under those contracts. On
August 29, 2005, we entered into a software development contract with eGrid
pursuant to which we contracted to develop an “export electronic monitoring
project (Phase 2)”.
We
recognized net revenues of approximately RMB12.9 (US$1.7 million) from sales of
our software development services to eGrid in 2006.
Shenzhen Ninetowns Enke Software
Technology Co., Ltd.
(formerly Shenzhen Jinwangge Software
Co., Ltd.)
In late
2003, we decided to implement a franchise program to expand our sales
distribution network and Jing Shao and Hongmei Tian, one of our former
employees, expressed an interest in establishing such a franchisee relationship
with us. In order to do so, they needed to establish a technology company in
China, which is burdensome, requires substantial paperwork and often involves a
long waiting period. Yadi Yangguang, together with the other shareholders of
Jinwangge, agreed to sell 100.0% of the equity interest in Jinwangge to Jing
Shao and Hongmei Tian in July 2003 for an aggregate consideration of RMB8.0
million. The transfer of such interests was completed in February
2004.
In
September 2003, we entered into a franchise agreement with Jinwangge for the
distribution of iDeclare.CIQ in the southern region of China. This agreement has
a two-year term, contains minimum sales commitments and is renewable upon mutual
agreement of the parties within 120 days of expiration. We sell our enterprise
software to Jinwangge at a discount pursuant to a negotiated formula. On
February 10, 2004, Jinwangge was re-named “Shenzhen Ninetowns Enke Software
Technology Co., Ltd.” and was then 81.25% owned by Jing Shao and 18.75% owned by
Hongmei Tian. We entered into a franchise agreement with Ninetowns Enke on
February 14, 2004 on terms substantially identical to the terms in the franchise
agreement with Jinwangge. Pursuant to the franchise agreement, Ninetowns Enke
agreed to a minimum sales commitment of RMB50.0 million for the two years ending
February 14, 2006 and a sales discount of RMB1,000 per each iDeclare.CIQ package
purchased from our company. In addition, Ninetowns Enke also agreed to act as
our sales agent for our enterprise software after sales maintenance services and
a sales discount of RMB750 per each maintenance contract sold to customer. On
April 22, 2004, we agreed with Ninetowns Enke to amend the franchise agreement
to revise certain pricing terms.
In
September 2005, Hongmei Tian transferred her interest in Ninetowns Enke to Su
Tianjian, also one of our former employees, and Ninetowns Enke is currently
81.25% owned by Jing Shao and 18.75% owned by Su Tianjian. On May 12, 2006, we
entered into a new franchise agreement with Ninetowns Enke for iDeclare.CIQ.
This agreement has a two-year term and does not contain any minimum sales
commitment.
We
recognized net revenues of approximately RMB21.2 million (US$2.7 million) from
sales of our software products to Ninetowns Enke in 2006.
Transaction with Mr. Ko Jin
Heng
Mr. Ko
Jin Heng, one of the directors of Jitter Bug, is also a director and the vice
chairman of Beijing Heng Fu Plaza Development Co. Ltd, or Beijing Heng Fu.
Jitter Bug was our principal shareholder until December 1, 2005. Beijing Heng Fu
received a refundable deposit of RMB28.0 million (US$3.4 million) from Ninetowns
Ports after entering into a Provisional Sale and Purchase Agreement on June 15,
2004 with Ninetowns Ports and received the remainder of RMB19.3 million (US$2.3
million) on September 14, 2004. After making such payments, Ninetowns Ports
acquired the naming rights of a building in Beijing which is being constructed
by Beijing Heng Fu. Pursuant to certain sale and purchase agreements dated July
30, 2004, Ninetowns Ports acquired from Beijing Heng Fu, subject to the receipt
of the necessary title certificates, three floors of such building. The purchase
price for the three floors was approximately 25.0% below its fair market value,
as determined by an independent third party. In March 2005, Ninetowns Ports also
entered into a sale and purchase agreement with Beijing Heng Fu pursuant to
which Ninetowns Ports acquired from Beijing Heng Fu, subject to the receipt of
the necessary title certificates, an additional floor in such building for the
purchase price of approximately RMB18.6 million (US$2.2 million). Construction
of the building was completed at the end of 2006. We expect to move
into the building by the end of 2007.
Control over Ronghe
Tongshang
In March
2006, Mr. Wang, Mr. Ren and Ms. Dong established Ronghe Tongshang. We
entered into a series of contractual agreements with Ronghe Tongshang and its
current shareholders that provide us with effective control over Ronghe
Tongshang. Tootoo.com is owned by Ronghe Tongshang. In May
2007, we launched tootoo.com, our new B2B vertical search
platform. We plan to leverage our B2G expertise with our recent
acquisitions and contractual relationships to position tootoo.com as a leading
B2B search and service provider.
Control over
Baichuan
In April
2007, in connection with our acquisition through our wholly-owned subsidiary,
Ixworth, of a 70% interest in Ample Spring, we entered into a series of
contractual agreements with Baichuan, Mr. Wang and Mr. Ren, previously
shareholders of Baichuan, which provide us with effective control over
Baichuan.
Related party trade
receivables
In
connection with the transactions described above, we had trade receivables from
related parties amounting to RMB4.0 million (US$0.5 million) or 18.1% of
our billed receivables as of December 31, 2006. These receivables consisted
primarily of proceeds from sales of enterprise software and fees from software
development services.
Board memberships
Mr. Wang
and Mr. Ren are two of the five directors of iTowNet. iTowNet is 51.0% owned by
the PRC Inspections Administration and 49.0% owned by Import & Export.
Import & Export is in turn 100.0% beneficially owned by Mr. Wang and Ms.
Dong. Mr. Wu is the sole supervisor of iTowNet.
Stock option
grants
Please
refer to Item 6, “Directors, Senior Management and Employees — Compensation of
directors and executive officers.”
C. Interests
of experts and counsel
Not
applicable.
Item 16C.
Principal Accountant Fees and Services.
The
following table sets forth the aggregate fees in connection with certain
professional services rendered by Deloitte Touche Tohmatsu, an independent
registered public accounting firm, for the periods indicated. We did not pay any
tax related or other fees to our principal accountants during the periods
indicated.
|
For the year ended December
31
|
|
2005
|
2006
|
2006
|
Audit
fees(1)
|
RMB2,463,000
|
RMB3,789,000
|
US$486,000
|
Audit
related
fees
|
372,000
|
526,000
|
67,000
|
Total
|
RMB2,835,000
|
RMB4,315,000
|
US$553,000
|
(1)
|
Audit
fees are the aggregate fees billed for each of the fiscal years for
professional services rendered by our principal accountants for their
audit and review of our annual financial statements and interim financial
statements in connection with the statutory requirement and our initial
public offering in 2004.
|
Audit Committee Pre-Approval Policy
and Procedures
Our audit
committee will pre-approve all audit and non-audit services provided by our
independent registered public accounting firm. These services may include audit
services, audit-related services, tax services and other services, as described
above. On an annual basis, our audit committee will review and approve the audit
services to be rendered by our independent registered public accounting firm
prior to the engagement of the service. Audit services not covered by the annual
engagement letter, audit-related services and tax services are estimated to
result in an amount of more than US$10,000 require the express approval of our
audit committee prior to engagement. Our audit committee may delegate
pre-approval authority to one or more members of our audit committee. The
decisions of any audit committee member to whom authority is delegated to
pre-approve a service shall be presented to the full audit committee at its next
scheduled meeting. Our Chief Financial Officer, Tommy Siu Lun Fork is required
to report to our audit committee on a quarterly basis regarding the extent of
services actually provided and the fees for the services performed.
Exhibit
Number
|
Description
|
12.1
|
Certification
of Chief Executive Officer pursuant to SEC Rule
13a-14(a)
|
12.2
|
Certification
of Chief Financial Officer pursuant to SEC Rule
13a-14(a)
|
13.1
|
Certification
of Chief Executive Officer pursuant to SEC Rule
13a-14(b)
|
13.2
|
Certification
of Chief Financial Officer pursuant to SEC Rule
13a-14(b)
|
15.1 |
Consent
of Deloitte Touche Tohmatsu CPA
Ltd. |
Signatures
The company
hereby certifies that it meets all of the requirements for filing its annual
report on Form 20-F/A and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf on this 27th day of June,
2008.
|
NINETOWNS INTERNET TECHNOLOGY
GROUP COMPANY LIMITED
|
|
|
|
By:
/s/ Shuang
Wang |
|
Name:
Shuang Wang |
|
Title:
Chief Executive Officer
|