nine20fa-071608.htm
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________
 
FORM  20-F/A
(Mark One)

o  REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
o  SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report . . . . . . . . . . . . . . . . . . ..
 
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, Building No.1,
Capital A Partners, No.20 Gong Ti East Road,
Chaoyang District Beijing 100020,
The People’s Republic of China
(Address of principal executive offices)

Contact Person: Tommy Siu Lun Fork
Chief Financial Officer
Phone: +852-9021-9597
Facsimile: +852-2868-4483
Address: 22nd Floor, Building No. 1, Capital A Partners,
No.20 Gong Ti East Road, Chaoyang District Beijing 100020, China
 (Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
 

 
Securities registered or to be registered pursuant to Section 12(b) of the Act.
 
 
Title of each class  
 
  Name of each exchange on which registered  
 
 
     35,791,834 ordinary shares  
 
  Nasdaq Global Market
 
 
Securities registered or to be registered pursuant to Section 12(g) of the Act.
 
None
(Title of Class)
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
 
American Depositary Shares,
each representing one ordinary share, par value HK$0.025 per share
(Title of Class)
 
 

 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
 
 
35,791,834 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.
oYes ý No

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.
o Yes ý No
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.
ý Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                             Accelerated filer ý                                    Non-accelerated filer o

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this
filing:
U.S. GAAP  ý               International Financial Reporting Standards as issued             Other  o
 
by the International Accounting Standards Board  o
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
o Item 17 ý Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes ý No

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
o Yes o No
 

 
 

 
 
EXPLANATORY NOTE
 
 
This Amendment No. 1 on Form 20-F/A, or Amendment No. 1, amends our annual report on Form 20-F for the year ended December 31, 2007, which was filed with the Securities and Exchange Commission on July 15, 2008.  This Amendment No. 1 is being filed to correct certain clerical errors appearing in our 20-F.
 
 
Except as described above and reflected in this Amendment No.1, no part of the Registrant’s 20-F filed on July 15, 2008 is being amended, and no part of the Form 20-F/A as re-filed in this Amendment No.1 reflects any event occurring after the filing of the Form 20-F and should not be viewed as updating any information contained therein.
 
 
 
 
 
 

 
Item 18.                 Financial Statements.
 
The consolidated financial statements for our company are included at the end of this annual report.
 
 
 
 
 
 


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 registrant 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 16th day of July, 2008.
 


 
NINETOWNS INTERNET TECHNOLOGY GROUP    
COMPANY LIMITED
   
   
 
By: /s/ Shuang Wang                                                   
 
Name: Shuang Wang
 
Title: Chief Executive Officer
 

 
 

 

 

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
 
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
F – 2
 
F – 4
 
F – 6
 
F – 8
 
F – 9
 
F – 11
 
F – 41
 
 
 

F - 1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To: The Board of Directors and Shareholders of
Ninetowns Internet Technology Group Company Limited

We have audited the accompanying consolidated balance sheets of Ninetowns Internet Technology Group Company Limited, its subsidiaries and variable interest entities (collectively, the “Company”) as of December 31, 2006 and 2007, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2007, and related financial statement schedule included in Schedule I. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

As described in Note 2 to the consolidated financial statements, (1) effective on January 1, 2007, the Company adopted the recognition and measurement methods under Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”; (2) effective on January 1, 2006, the Company changed its method of accounting for stock-based compensation to conform to Statement of Financial Accounting Standard  No. 123 (revised 2004), "Share-Based Payment".

Our audits also comprehended the translation of Renminbi amounts into United States dollar amounts and, in our opinion, such translation has been made in conformity with the basis stated in Note 2. Such United States dollar amounts are presented solely for the convenience of the readers.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 10, 2008 expressed an adverse opinion on the Company’s internal control over financial reporting because of two material weaknesses.

F - 2


 


Deloitte Touche Tohmatsu CPA Ltd.
Beijing, the People's Republic of China
July 10, 2008
 
 

 
F - 3


NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
 
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)

   
Years Ended December 31,
 
   
2006
   
2007
   
2007
 
   
RMB
   
RMB
   
US$
 
                   
ASSETS
                 
Current assets:
                 
  Cash and cash equivalent
    598,648       649,863       89,088  
  Restricted cash
    -       853       117  
  Short-term investments:
                       
Available-for-sale securities
    -       10,962       1,503  
  Term deposits
    307,209       26,000       3,564  
  Trade receivables from customers
                       
Billed, less allowance for doubtful accounts
                       
of RMB1,088 in 2006 and RMB2,412 in
2007, respectively
    17,943       30,222       4,143  
Unbilled, less allowance for doubtful
accounts of RMB Nil and RMB Nil for  2006 and 2007, respectively
    832       874       120  
  Trade receivables from related parties
                       
Billed, less allowance for doubtful accounts
RMB Nil  and RMB20,887 in 2006 and 2007, respectively
    28,330       6,350       871  
  Inventories
    6,820       7,011       961  
  Prepaid expenses and other current assets
    27,653       17,059       2,339  
  Deferred tax assets
    1,698       1,300       178  
Total current assets
    989,133       750,494       102,884  
                         
  Property and equipment, net
    46,693       189,777       26,016  
  Deposits for acquisition of property and  equipment
    73,411       34,804       4,771  
  Investment in an affiliate
    -       2,450       336  
  Investments under cost method
    38,929       40,786       5,591  
  Acquired intangible assets, net
    22,697       73,851       10,124  
  Other non-current asset
    856       937       128  
  Goodwill
    193,570       78,081       10,705  
  TOTAL ASSETS
    1,365,289       1,171,180       160,555  

F - 4


   
Years Ended December 31,
 
   
2006
   
2007
   
2007
 
   
RMB
   
RMB
   
US$
 
                   
LIABILITIESMINORITY
INTERESTS AND SHAREHOLDERS’
EQUITY
                 
                   
Current liabilities:
                 
  Accounts payable and accrued expenses
    14,312       19,260       2,640  
  Amount due to an affiliate
    -       1,450       199  
  Advance from customers
    10,321       14,461       1,982  
  Deferred revenue
    26,383       32,472       4,452  
  Income taxes payable
    6,334       6,520       894  
  Other taxes payable
    2,332       1,588       218  
  Unrecognized tax benefits
    -       832       114  
Total current liabilities
    59,682       76,583       10,499  
 
                       
Non-current liabilities
                       
  Deferred tax liabilities
    627       16,210       2,222  
                         
Total liabilities
    60,309       92,793       12,721  
                         
Minority interests
    -       5,483       752  
 
Commitments (Note 17)
                       
                         
Shareholders' equity:
                       
Ordinary shares, par value RMB
0.027(HK$ 0.025) per share: 8,000,000,000
shares authorized; 34,991,834 shares issued
and outstanding in 2006 and 2007
    926       926       127  
Additional paid-in capital
    871,642       873,568       119,755  
Treasury shares, at cost, 47,862 shares and
nil share in 2006 and 2007, respectively
    (1,268 )     -       -  
 Retained earnings
    394,056       145,345       19,925  
Statutory reserve
    47,287       64,831       8,888  
 Accumulated other comprehensive loss
    (7,663 )     (11,766 )     (1,613 )
 Total shareholders' equity
    1,304,980       1,072,904       147,082  
 
                       
TOTAL LIABILITIES, MINORITY
INTERESTS AND SHAREHOLDERS’
EQUITY
    1,365,289       1,171,180       160,555  


See notes to consolidated financial statements.

F - 5


NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
 
 
   
Years Ended December 31, 
 
   
2005
   
2006
   
2007
   
2007
 
   
RMB
   
RMB
   
RMB
   
US$
 
Net revenues:
                       
    Enterprise software and related customer 
maintenance services
                       
      external customers
    142,534       92,127       67,822       9,298  
      related parties (Note 15)
    60,954       24,706       9,505       1,303  
    Software development services
                               
      external customers
    7,600       23,084       25,642       3,515  
      related parties (Note 15)
    28,100       12,933       -       -  
    Computer hardware sales
    678       398       -       -  
    Business-to-business search services
    -       -       489       67  
    Total net revenues
    239,866       153,248       103,458       14,183  
Cost of revenues:
                               
    Enterprise software and related customer
maintenance services
    (495 )     -       -       -  
    Software development services (including
share-based compensation expense of nil in
2005, RMB1,039 in 2006 and RMB126 in 2007)
    (18,192 )     (16,805 )     (17,748 )     (2,433 )
    Computer hardware sales
    (482 )     (134 )     -       -  
    Business-to-business search services
    -       -       (5,109 )     (700 )
    Total cost of revenues
    (19,169 )     (16,939 )     (22,857 )     (3,133 )
Gross profit
    220,697       136,309       80,601       11,050  
Operating expenses:
                               
    Selling and marketing (including share-based
compensation expense of nil in 2005,
RMB3,371 in 2006, and RMB628 in 2007)
    (25,752 )     (13,604 )     (41,086 )     (5,633 )
    General and administrative (including share-
based compensation expense of nil in 2005,
RMB4,074 in 2006, and RMB1,145 in 2007)
    (48,778 )     (67,449 )     (86,334 )     (11,835 )
    Research and development  (including share-
based compensation expense of nil in 2005,
RMB1,843 in 2006, and RMB27 in 2007)
    (11,249 )     (29,825 )     (32,003 )     (4,387 )
(Allowance) recovery for doubtful accounts
    (760 )     1,521       (22,395 )     (3,070 )
Provision for impairment of goodwill
    -       -       (193,570 )     (26,536 )
Total operating expenses
    (86,539 )     (109,357 )     (375,388 )     (51,461 )
Government subsidies
    447       705       1,015       139  
Income (loss) from operations
    134,605       27,657       (293,772 )     (40,272 )
Interest income
    17,625       19,302       13,885       1,903  
Gain from sales of short-term investments
    -       -       43,546       5,970  
Income (loss) before provision for income taxes
and minority interest
    152,230       46,959       (236,341 )     (32,399 )
Provision for income taxes
    (626 )     (1,031 )     (243 )     (33 )
Net income (loss) before minority interest
    151,604       45,928       (236,584 )     (32,432 )
Minority interests in loss of subsidiary
    -       -       6,053       830  
Net income (loss)
    151,604       45,928       (230,531 )     (31,602 )
Net income (loss) per share:
                               
Basic
    4.39       1.32       (6.59 )     (0.90 )
 
 
F - 6

 
 
Diluted
    4.25       1.30       (6.59 )     (0.90 )
Weighted average shares used in computation:
                               
Basic
    34,539,976       34,773,005       34,966,830       34,966,830  
Diluted
    35,706,894       35,368,882       34,966,830       34,966,830  


See notes to consolidated financial statements.


F - 7


 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except share and per share data)
 
     
Ordinary Shares
     
Additional
Paid-in
   
 Treasury
   
 Shares
     
Retained
     
Statutory
     
Accumu-
lated
Other
Compre-hensive 
           
 Compre-hensive
 
     
Shares
   
 
Amount
   
 
Capital
   
 Shares
   
Amount
     
Earnings
       Reserve      
(Loss)
Income
     
Total
    Income   
             
RMB
     
RMB
         
RMB 
     
RMB
     
RMB
     
RMB
     
RMB
   
RMB 
 
                                                                           
Balance as of January 1, 2005 
    34,391,834       911       845,730    
-
   
-
      200,531       43,280       -       1,090,452    
 -
 
Ordinary shares converted to ADR shares for future exercises of share options
    600,000       15       15,585       (600,000 )     (15,600 )      -       -       -       -    
 -
 
Issuance of ADR shares for the exercises of employee share options
    -       -       -       284,774       7,404       -       -       -       7,404    
-
 
Provision for statutory reserve
    -       -       -       -       -       (4,007 )     4,007       -       -        -  
Net income
    -       -       -       -       -       151,604       -       -       151,604        151,604  
Foreign currency translation adjustments
    -       -       -        -        -        -        -       (3,095 )     (3,095 )     (3,095 )
                                                                              148,509  
 
                                                                               
Balance as of December 31, 2005 
    34,991,834       926       861,315       (315,226 )     (8,196 )     348,128       47,287       (3,095 )     1,246,365       -  
Issuance of ADR shares for the exercises of employee share options
    -       -       -       267,364       6,928       -       -       -       6,928       -  
Employee share options compensation
    -       -       10,327       -       -       -       -       -       10,327        -  
Net income
    -       -       -       -       -       45,928       -       -       45,928       45,928  
Foreign currency translation adjustments
    -       -       -       -       -       -       -       (4,568 )     (4,568 )     (4,568 )
                                                                              41,360  
                                                                                 
Balance as of December 31, 2006
    34,991,834       926       871,642       (47,862 )     (1,268 )     394,056       47,287       (7,663 )     1,304,980       -  
Cumulative effect of unrecognized tax benefit  on adoption of FIN 48
    -       -       -       -       -       (636 )     -        -       (636 )     -  
 
Issuance of ADR shares for the exercises of employee share options
    -       -       -       47,862       1,268       -       -       -       1,268       -  
Provision for statutory reserve
    -       -       -       -       -       (17,544 )     17,544       -       -       -  
Net loss
     -       -       -       -       -       (230,531 )     -       -       (230,531 )     (230,531 )
Foreign currency translation adjustments
                                                            (6,977 )     (6,977 )     (6,977 )
Employee share options compensation
    -       -       1,926       -       -       -       -       -       1,926       -  
Unrealized gain on available for sale securities
    -        -       -        -        -        -        -       2,874       2,874       2,874  
                                                                              (234,634 )
Balance as of December 31, 2007
    34,991,834       926       873,568       -       -       145,345       64,831       (11,766 )     1,072,904       -  
 
                                                                               
           
US$127
   
US$119,755
   
US$-
   
US$-
   
US$19,925
   
US$8,888
   
(US$1,613)
   
US$147,082
         
 

F - 8


NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share and per share data)

   
Years Ended December 31,
 
   
2005
   
2006
   
2007
   
2007
 
   
RMB
   
RMB
   
RMB
   
US$
 
Cash flows from operating activities:
                       
  Net income (loss)
    151,604       45,928       (230,531 )     (31,602 )
  Adjustments to reconcile net income to net cash
                               
     provided by operating activities:
                               
     Loss on disposal of property and equipment
    263       511       1,544       212  
     Depreciation of property and equipment
    2,877       6,194       9,867       1,353  
     Amortization of acquired intangible assets
    2,416       2,943       14,466       1,983  
     Gain from sale of trading securities
    -       -       (43,204 )     (5,923 )
     Gain from sale of available for sale securities
    -       -       (342 )     (47 )
     Allowance (recovery) for doubtful debts
    760       (1,521 )     22,395       3,070  
     Provisions for goodwill impairment
                    193,570       26,536  
     Proceeds from sales of trading securities
    -       -       94,834       13,001  
     Purchase of trading securities
    -       -       (51,630 )     (7,078 )
     Minority interest in loss of subsidiary
    -       -       (6,053 )     (830 )
     Employee share-based compensation
    -       10,327       1,926       264  
   Changes in operating assets and liabilities:
                               
     Inventories
    401       903       (191 )     (26 )
     Trade receivables from customers
    (2,843     2,854       (15,312 )     (2,099 )
     Trade receivables from related parties
    1,188       27,311       2,577       353  
     Prepaid expenses and other assets
    16,668       (12,313 )     11,986       1,643  
     Accounts payable and accrued expenses
    (7,022 )     164       (17,518 )     (2,402 )
     Advance from customers
    10,639       (318 )     4,140       567  
     Deferred revenue
    (29,344 )     (41,503 )     6,089       835  
     Deferred taxes, net
    -       (1,071 )     (1,125 )      (154 )
     Income taxes payable
    (77 )     947        315        43  
     Other taxes payables
    (1,158 )     (524 )     (744 )     (102 )
                                 
Net cash provided by (used in) operating activities
    146,372       40,832       (2,941 )     (403 )
                                 
Cash flows from investing activities:
                               
     Increase in restricted cash
    -       -       (853 )     (117 )
     Decrease (Increase) of term deposits
    (56,087 )     (100,209 )     281,209       38,550  
     Cash paid for investments under cost method
    -       (38,929 )     (4,500 )     (617 )
     Cash paid for establishment of an affiliate
                    (2,450 )     (336 )
     Purchases of available-for-sale securities
                    (10,076 )     (1,381 )
     Proceeds from sales of available-for-sale securities
    -       -       2,330       319  
     Purchase of property and equipment
    (31,376 )     (19,774 )     (71,782 )     (9,840 )
     Purchase of intangible assets for internal use
    -       (17,200 )     -       -  
 Payment for acquisition of property and equipment
    (23,388 )     (371 )     (34,804 )     (4,771 )
     Acquisition of a business, net of cash acquired of RMB 3,119
    -       -       (101,881 )     (13,967 )
                              -  
Net cash (used in) provided by investing activities
    (110,851 )     (176,483 )     57,193       7,840  
                                 
Cash flows from financing activities:
                               
     Exercise of share options
    7,404       6,928       1,268       174  
     Return of capital to minority shareholder upon dissolution of a subsidiary
    -       (600 )     -       -  
     Decrease in amounts due to shareholders
    (5,360 )     -       -       -  
                                 
Net cash provided by financing activities
    2,044       6,328       1,268       174  
                                 
Effect of exchange rate changes
    (3,084 )     (3,503 )     (4,305 )     (590 )
                                 
Net increase (decrease) in cash and cash equivalents
    34,481       (132,826 )     51,215       7,021  
Cash and cash equivalents at the beginning of the year
    696,993       731,474       598,648       82,067  
                              -  
 
 
F - 9

 
Cash and cash equivalents at the end of the year
    731,474       598,648       649,863       89,088  
                                 
Supplemental non-cash investing activities:
                               
Amount payable for purchase of property and equipment                      3,258        477  
Supplemental cash flow information:
                               
Cash paid during the year for income taxes
    703       1,156       909       125  
 
 
 

F - 10

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
1. 
ORGANIZATION AND PRINCIPAL ACTIVITIES
   
Ninetowns Internet Technology Group Company Limited ("Ninetowns") was incorporated as an exempted limited liability company in the Cayman Islands on February 8, 2002 under the Companies Law of the Cayman Islands. At the time of its incorporation, all of the outstanding ordinary shares of Ninetowns were held by Jitter Bug Holdings Limited ("Jitter Bug"). Substantially all of Ninetown's business is conducted in the People's Republic of China (the "PRC") through its subsidiaries and variable interest entities ("VIE"). Ninetowns, its subsidiaries, and its "VIEs" (collectively, the "Company") are principally engaged in the sale of enterprise software and provision of the related after-sales maintenance services, software development services and in April 2007, the Company acquired a 70% equity interest in a Business to Business ("B2B") search engine operator (see note 3) and started to be engaged in the provision of B2B search services.

As of December 31, 2007, a summary of the subsidiaries and VIEs of Ninetowns was as follows:
 
 
Name of entity
 
Place of
Incorporation/
Establishment
 
Effective
ownership interest
 
Principal activities
 
Subsidiaries:
           
 
Ixworth Enterprises Limited ("Ixworth")
 
 
British Virgin Islands ("BVI")
 
100%
 
Investment holding
 
Asia Pacific Logistics Limited ("Asia Pacific")
 
 
BVI
 
100%
 
Investment holding
 
Better Chance International Limited ("Better Chance")
 
 
BVI
 
100%
 
Investment holding
 
Beprecise Investments Limited (“Beprecise”)
 
 
BVI
 
100%
 
Investment holding
 
Ample Spring Holdings Limited (“Ample Spring”)
 
 
BVI
 
70%
 
Investment holding
 
New Take Limited
 
Hong Kong
 
100%
 
Investment holding
               
 
Shielder Limited
 
Hong Kong
 
100%
 
Investment holding
               
 
Beijing New Take Electronic Commerce Limited ("Beijing New Take")
 
PRC
 
100%
 
Inactive
               
 
Beijing Ninetowns Times Electronic Commerce Limited ("Beijing Ninetowns Times")
 
PRC
 
100%
 
Provision of software development services
               
 
Beijing Ninetowns Digital Technology Limited ("Beijing Ninetowns Digital Technology")
 
PRC
 
100%
 
Sale of enterprise software and provision of the related after-sales services, sale of computer hardware and accessories, and provision of software development services
               
 
Beijing Ninetowns Ports Software and Technology Co., Ltd ("Beijing Ninetowns Ports")
 
PRC
 
100%
 
Sale of enterprise software and provision of the related after-sales services, sale of computer hardware and accessories, and provision of software development services
               
 
Beijing Ninetowns Network and Software Co., Limited (“Beijing Ninetowns Network”)
 
PRC
 
100%
 
Sale of enterprise software and provision of the related after-sales services, and provision of technique consulting services
               
 
Guangdong Ninetowns Technology Co., Ltd. ("Guangdong Ninetowns")
 
PRC
 
100%
 
Sale of enterprise software and provision of the related after-sales services, sale of computer hardware and accessories, and provision of software development services

F - 11

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
1. 
ORGANIZATION AND PRINCIPAL ACTIVITIES - continued

 
Name of entity
 
Place of
Incorporation/
Establishment
 
Effective
ownership interest
 
Principal activities
 
Shanghai New Take Digital Technology Limited ("Shanghai New Take")
 
PRC
 
100%
 
Sale of enterprise software and provision of the related after-sales services, sale of computer hardware and accessories, and provision of software development services
               
 
Variable interest entities:
           
               
 
Beijing Ronghe Tongshang Network Technology Limited (“Ronghe Tongshang”)
 
PRC
 
100%
 
Provision of online solution for international trade
 
 
Beijing Baichuan Tongda Science and Technology Development Co., Ltd. (“Baichuan Tongda”)
 
PRC
 
70%
 
Provision of Internet content services in the areas of B2B

PRC regulations prohibit direct foreign ownership of business entities providing internet content, or ICP, services in the PRC such as the business of providing online solution for international trade. In December 2006, Ronghe Tongshang was established in the PRC by three designated equity owners who are PRC citizens and legally own Ronghe Tongshang. Pursuant to a series of contractual arrangements with Ronghe Tongshang, the Company provides exclusive technical consulting and management services to Ronghe Tongshang.  A summary of the major terms of the agreements are as follows:

 
l
The Company has the sole discretion to determine the amount of the fees it will receive and it intends to transfer substantially all of the economic benefits of Ronghe Tongshang to the Company;
 
l
The equity owners irrevocably granted the Company the right to make all operating and business decisions for Ronghe Tongshang on behalf of the equity owners;
 
l
All registered capital owned by the three equity owners were pledged to the Company as a collateral against the service fee payable to the Company;
 
l
The Company provides guarantees on the execution of all business contracts entered by Ronghe Tongshang in its business operation. Ronghe Tongshang pledges its assets to the Company as a collateral for such guarantee. Through December 31, 2007, Ronghe Tongshang has not yet entered into any business contracts that would require guarantees from the Ninetowns;
 
l
The Company may dispose of the collateralized registered capital at its sole discretion without limitation or restriction. The Company has the right and sole discretion to purchase all or part of the registered capital from equity owners when such purchase becomes legally allowable;
 
l
The equity owners may not dispose of or enter into any other agreements involving the common shares without prior agreement by the Company. 
 
 
Because the above arrangement, which assigned all of the equity owners' rights and obligations to the Company resulting in the equity owners lacking the ability to make decisions that have a significant effect on Ronghe Tongshang's operations and the Company's ability to extract the profits from the operation of Ronghe Tongshang, and assume the Ronghe Tongshang's residual benefits. Because the Company is the sole variable interest holder of Ronghe Tongshang, it is the primary beneficiary of Ronghe Tongshang. Consistent with the provision of Financial Accounting Standards Board ("FASB") Interpretation No. 46 (Revised), "Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51" ("FIN 46R"), the Company consolidates Ronghe Tongshang from its inception.

F - 12

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)

1. 
ORGANIZATION AND PRINCIPAL ACTIVITIES - continued
Baichuan Tongda is a PRC company which was established on February 24, 2004 for providing internet content services in the areas of B2B services. The founders of Baichuan Tongda were two PRC citizens ("original shareholders"). In April 2007, as part of the acquisition transaction of Ample Spring and Baichuan Tongda (described in Note 3) , two designated PRC citizens (“70% registered shareholders”) acquired 70% of the registered capital from the original shareholders. Pursuant to a series of contractual arrangements with Baichuan Tongda and the 70% registered shareholders, the Company bears the risk of, and enjoys the reward from the ownership of Baichuan Tongda. A summary of the major terms of the arrangements is as follows:

 
l
The 70% registered shareholders irrevocably granted the Company the right to make all operating and business decisions for Baichuan Tongda on behalf of the 70% registered shareholders;
 
l
All registered capital owned by the 70% registered shareholders is pledged to the Company as a collateral against the service fee payable to the Company;
 
l
The Company may dispose of the collateralized registered capital at its sole discretion without limitation or restriction. The Company has the right and sole discretion to purchase all or part of the registered capital from the 70% registered shareholders when such purchase becomes legally allowable;
 
l
The 70% registered shareholders may not dispose of or enter into any other agreements involving the shares owned by them without prior agreement by the Company;
 
l
The Company is engaged by Baichuan Tongda as the exclusive service provider for business and technical support services and is entitled to a fee for the serviced provided;
 
l
The Company has made an entrustment loan to Baichuan Tongda in the amount of RMB30,000 to finance the operations of Baichuan Tongda.
 
Through the above arrangements, the Company is the primary beneficiary of Baichuan Tongda. Accordingly, under the requirement of FIN46(R), Baichuan Tongda has become a variable interest entity of the Company and the financial statements of Baichuan Tongda have been consolidated by the Company since the designated 70% registered shareholders acquired the 70% equity interests from the original shareholders.

The following financial information of the above two VIEs was included in the accompanying consolidated financial statements.

   
December 31,
 
         
2006
   
2007
 
         
RMB
   
RMB
 
Total assets
          396       27,752  
Total liabilities
          (1,000 )     (51,325 )
 
       
 
         
   
Years  Ended December 31, 2007
 
   
2005
   
2006
   
2007
 
   
RMB
   
RMB
   
RMB
 
Total revenue
    -       -       274  
Total net loss
    -       (1,604 )     (14,315 )
 
 
F - 13

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
 
Basis of presentation - The consolidated financial statements of the Company have been prepared in accordance with the accounting principles generally accepted in the United States of America ("US GAAP"). All amounts in the accompanying consolidated financial statements and the related notes are expressed in Renminbi ("RMB"). The amounts expressed in United States dollars ("US$") are presented solely for the convenience of the readers and are translated at a rate of RMB7.2946 to US$1, the approximate rate of exchange at December 31, 2007. Such translations should not be construed to be the amounts that would have been reported under US GAAP.

Basis of consolidation - The consolidated financial statements include the financial statements of Ninetowns and its subsidiaries and VIEs. All significant intercompany transactions and balances are eliminated on consolidation.

Use of estimates - The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company bases its estimates on historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Significant accounting estimates reflected in the Company's consolidated financial statements include allowance for doubtful accounts, estimated cost to complete in a percentage of completion arrangement, estimated useful lives and impairment of acquired intangible assets and goodwill, valuation allowance for deferred tax assets and purchase price allocation relating to the business acquired.
 
 
Cash and cash equivalents - Cash and cash equivalents consist of cash on hand, demand deposits and highly liquid investments, which are unrestricted as to withdrawal and use, and have remaining maturities of three months or less when purchased.

Restricted cash—The Company’s restricted cash is related to deposits required by certain customers for the software development services provided by the Company.
 
 
Term deposits - Term deposits consist of deposits placed with financial institutions with remaining maturity of greater than three months but less than one year.

Short-term investments – Short-term investments are comprised of marketable equity securities, which are classified as trading and available-for-sale. Marketable securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with realized gains and losses recognized in earnings. The Company purchased and sold trading securities during 2007 but there were no outstanding balances at December 31, 2007. Short-term investments classified as available for sale are stated at fair values. Unrealized gains or losses for available for sale securities from the changes in fair value are recorded into equity account as other comprehensive income (loss). Realized gains or losses for disposal of available for sale securities are directly recorded in the consolidated statement of operations.

The Company reviews investment in available-for-sale securities at the end of each balance sheet date for other-than-temporary declines in fair value below the cost basis based on the specific identification method. If the Company determines a decline in fair value below the cost basis is other-than-temporary, accumulated unrealized loss is accounted for as realized loss and included in earnings. No other-than temporary impairment losses were recorded during the years ended December 31, 2005,  2006 and 2007.


F - 14

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued
 
Inventories - Inventories are stated at the lower of cost or market price. Cost is determined by the weighted average method. Provision for diminution in value on inventories is made using specific identification method. No inventory provisions were made in 2005, 2006 and 2007.

Accounts receivable and allowance for doubtful accounts - Accounts receivable mainly represents amounts earned and are collectible from customers.  Accounts receivable are stated at the amount the Company expects to collect.  The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make the required payments and uses the specific identification method to record such allowances.  Management of the Company considers the following factors when determining the collectability of accounts receivable:  a customer's credit-worthiness, past collection history, and changes in a customer's payment terms. Allowance for doubtful accounts is made based on aging of accounts receivable and on any specifically identified accounts receivable that may become uncollectible.

Changes in the allowance for doubtful accounts were as follows:

     
2006
   
2007
 
     
RMB
   
RMB
 
               
 
Balance at January 1,
    4,851       1,088  
 
Provision for allowance for doubtful debts
    2,487       25,078  
 
Recovery
    (4,008 )     (2,683 )
 
Write offs
    (2,242 )     (184 )
                   
 
Balance at December 31,
    1,088       23,299  
 
Property and equipment - Property and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives of property and equipment are as follows:
 
 
Buildings
20 years
 
Leasehold improvements
shorter of lease term or 5 years
 
Furniture, fixtures and office equipment
5 years
 
Computer equipment
5 years
 
Motor vehicles
5 years

Acquired intangible assets - Acquired intangible assets, which consist primarily of customer relationships, buyer database, completed technology and purchased software for internal use, are carried at cost, less accumulated amortization.

Amortization is calculated on a straight-line basis over the expected useful life of the assets of five years. Amortization expenses for the years ended December 31, 2005, 2006 and 2007 were RMB2,416 and RMB2,943 and RMB14,466 respectively.
 
 
Impairment of long-lived assets - The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When these events occur, the Company measures impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, the Company would adjust the carrying value of the asset based on the fair value and
 

F - 15

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued
 
recognize an impairment loss. There were no impairment losses in the years ended December 31, 2005, 2006 and 2007.
 
 
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. The Company completes a two-step goodwill impairment test. 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.

Management performed the annual goodwill impairment test as of December 31, 2005, 2006 and 2007 and no impairment losses were recorded in 2005 and 2006.  In 2007, based on the impairment assessment performed by management, the Company incurred a total goodwill impairment charge of RMB193,570.  This impairment charge is related to the Company's segments of enterprise software and related customer maintenance service and software development services. The Company's financial outlook from maintenance services of the free software offered by the Chinese government has been negatively impacted due to several factors.  First, the Chinese government's declining promotion of its free software has resulted in a corresponding decline in the need for the Company's maintenance services. Additionally, the Company believes there is uncertainty surrounding the Chinese government's future promotional plans for its free software.  As a result, the Company decided to revise downward the financial performance projection and assumptions of its enterprise software and related customer maintenance service segment, resulting in a goodwill impairment loss of RMB187,770 recognized for this segment. For the software development service segment, the Company has experienced a slowdown in the demand for such services by the government and therefore has also revised downward the financial performance projection and assumptions of this segment, resulting in an impairment loss of RMB5,800 recognized for this segment.

The changes in the carrying amount of goodwill by reporting unit for the years ended December 31, 2006 and 2007 were as follows:

   
Enterprise software and related customer maintenance service
   
Software development services
      B2B                  
Total
 
   
RMB
   
RMB
   
RMB
   
RMB
 
Balance as of January 1, 2006 and December 31, 2006
    187,770       5,800       -       193,570  
Goodwill acquired during the year
    -       -       78,081       78,081  
Goodwill impairment during the year
    (187,770 )     (5,800 )     -       (193,570 )
Balance as of December 31, 2007
    -       -       78,081       78,081  
 

F - 16

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued
 
Investments under cost method – For investment in an investee over which the Company does not have significant influence, the Company carries the investment at cost adjusted for other-than-temporary declines in fair value and recognizes income when receiving dividends from distribution of investee’s earnings. The Company reviews the investments under cost method for impairment whenever events or changes in circumstances indicate that the carrying value may no longer be recoverable. An impairment loss is recognized in earnings equal to the difference between the investment cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. The fair value of the investment would then become the new cost basis of the investment. No impairment charges were recorded for the years ended December 31, 2005, 2006 and 2007.

Investment in an affiliate - Investment in an affiliate over which the Company exercises significant influence, but not control, are accounted for using the equity method. The Company's share of earnings (losses) of the affiliate is included in the consolidated statements of operations, The Company established its affiliate in 2007 and the affiliate had not commenced its operations at December 31, 2007.

Income taxes - Deferred income taxes are provided using the asset and liability method. Under this method, deferred income taxes are recognized for tax credits and net operating losses available for carry-forwards and significant temporary differences. Deferred tax assets and liabilities are classified as current or non-current based upon the classification of the related asset or liability in the financial statements or the expected timing of their reversal if they do not relate to a specific asset or liability. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion of, or all of, the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws and regulations applicable to the Company as enacted by the relevant tax authorities.
 
On January 1, 2007, the Company adopted FASB Interpretation No.48 (“FIN 48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No.109. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more likely-than-not to be sustained upon audit by the relevant tax authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The total amount of unrecognized tax benefits as of the date of adopting FIN 48 was RMB636 and a total FIN48 liability including late payment interest of RMB832 included in income tax expense in the income statement by the end of 2007.  The Company's tax years from 2003 to 2007 are subject to examination by the tax authorities.

Revenue recognition –The Company's revenue is mainly derived from four primary sources: (i) sale of enterprise software and related customer maintenance services; (ii) software development services; (iii) sale of computer hardware and (iv) B2B search services.

Revenue from the sale of enterprise software and related customer maintenance service is recognized when there is evidence of an arrangement, the delivery or service has occurred, the fee is fixed or determinable, and collectability is probable. As the Company does not have vendor-specific objective evidence to establish the fair values of the undelivered elements, the Company recognizes revenue from sales of enterprise software and maintenance service on a straight-line basis over the service period which is typically 12 months.
 
 
For certain customers, the Company installs the software at the customer's place of business and charges the customer a fixed fee based on actual usage of the software. Accordingly, the Company recognizes the related revenue when the customer uses the software.
 

F - 17

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued
 
Revenues from software development services requiring significant production, modification, or customization of the software are recognized over the installation and customization period based on the percentage of completion method as prescribed by Statement of Position No. 81-1, "Accounting for Performance of Construction-Type and Certain Product-Type Contracts".  Percentage-of-completion is measured principally by the percentage of actual hours incurred to date for each contract to the estimated total hours to be incurred for each contact at completion.

Certain revenue from software development services also includes hardware procurement under customer's request. Since the Company does not have vendor-specific objective evidence to allow for separating various components of such software development service contracts, the Company recognizes such revenues when all components under the contracts are delivered and the project is completed upon the receipt of a written acceptance from the customer.
 
 
Sales of computer equipment and accessories are recorded when the goods are delivered, title is passed to the customers and the Company has no further obligations to provide services relating to the operation of such equipment.

The Company provides online business-to-business search services by selling keywords to improve the customers' rankings in search results on the Company's marketplaces.  Service fees are paid in advance in respect of such services for a specific contracted service period.  All service fees are initially deferred when received and revenue is recognized ratably over the term of the respective service contracts as the services are rendered.

The Company reports revenue net of business taxes. Business taxes included in revenue during 2005, 2006, and 2007 totaled RMB10,375, RMB4,919 and RMB4,402 respectively. Software revenue includes the benefit of the rebate of value added taxes on the sales of software and software-related services received from the Chinese tax authorities as part of the PRC government’s policy of encouraging of software development in the PRC. Pursuant to certain PRC rules relating to value-added taxes, Beijing Ninetowns Times, Beijing Ninetowns Digital Technology, Beijing Ninetowns Ports and Beijing Ninetowns Network are entitled to a refund of value-added taxes paid at a rate of 14% of the sales value for self-developed software products, excluding revenues from maintenance services and upgrade rights that are sold separately. Revenues from the sale of software products include the refund of such value-added tax which totaled RMB19,766, RMB10,500 and RMB4,347 for the years ended December 31, 2005, 2006 and 2007, respectively.

Cost of revenue - Cost of revenue includes production costs for products sold, and direct costs associated with the delivery of software development and maintenance services, including salaries, employee benefits and overhead costs associated with employees providing the related services.
 
 
Research and Development - Research and development expenses include payroll, employee benefits and other costs associated with product development. Technological feasibility for the Company's software products is reached shortly before the products are released for production. Costs incurred after technological feasibility has historically been immaterial.  Accordingly, the Company expenses all research and development costs when incurred.
 
 
Advertising costs - Advertising costs are expensed in the period incurred. The Company incurred advertising costs totaling RMB1,979, RMB2,281 and RMB6,277 during the years ended December 31, 2005, 2006 and 2007, respectively.

Government subsidies - Government subsidies represent amounts granted by local governments to reward companies that have made contributions in the development of the electronic and software industries as
 

F - 18

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued
 
well as those companies that contribute significantly to local taxes.  The Company reports government subsidies when it becomes due and receivable and the Company does not have any obligations to repay the amounts received.
 
Foreign currency translation - The functional currency of the Company's subsidiaries and VIEs established in the PRC is the RMB. The functional currency of Ninetowns and its subsidiaries established in countries other than PRC is the US$. Transactions dominated in other currencies are recorded in the applicable functional currencies at the rates of exchange prevailing when the transactions occur. Monetary assets and liabilities denominated in other currencies are translated into the applicable functional currencies at rates of exchange in effect at the balance sheet dates. Non-monetary assets and liabilities are remeasured into the applicable functional currencies at historical exchange rates. Exchange gains and losses are recorded in the consolidated statements of operations.  
 
 
The Company has chosen the RMB as its reporting currency. Assets and liabilities are translated at the exchange rates at the balance sheet date, equity accounts are translated at historical exchange rates and revenues, expenses, gains and losses are translated using the average rate for the year. Translation adjustments are reported as cumulative translation adjustments and are shown as a separate component of other comprehensive loss in the statement of shareholders’ equity.

Comprehensive income - Comprehensive income includes net income/(loss), foreign currency translation adjustments and unrealized gain or loss on investment in available-for-sale securities and is reported as a component of consolidated statements of shareholders’ equity.

Foreign currency risk - The RMB is not a freely convertible currency. The State Administration for Foreign Exchange under the authority of the People's Bank of China controls the conversion of the RMB into foreign currencies. The value of the RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the China Foreign Exchange Trading System market. Cash and cash equivalents and term deposits of the Company included aggregate amounts of RMB830,155 at December 31, 2006 and RMB637,270 at December 31, 2007 which were denominated in RMB.
 
 
Concentration of credit risk - Financial instruments that potentially expose the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, trade receivables, and term deposits. The Company places its cash and cash equivalents with financial institutions with high-credit ratings and quality. The Company conducts credit evaluations of customers and generally does not require collateral or other security from its customers. The Company establishes an allowance for doubtful accounts primarily based upon the age of the receivables and factors surrounding the credit risk of specific customers.

Fair value of financial instruments - The carrying amounts of cash and cash equivalents, term deposits, trade receivables, and accounts payable approximate their fair value due to the short-term nature of these instruments.
 
Share-based compensation - The Company grants stock options to its employees and directors. Prior to January 1, 2006, the Company accounted for employee share-based compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB Opinion 25"), and its related interpretations which required the Company to record a compensation charge for the excess of the fair value for the stock at the grant date over the amount an employee must pay to acquire the

F - 19

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued

stock. The compensation expense is recognized over the applicable service period, which is usually the vesting period.

In December 2004, the Financial Accounting Standards Board ("FASB'') issued Statements of Financial Accounting Standard ("SFAS") No. 123R, which is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation'' and supersedes APB Opinion No. 25. Effective January 1, 2006, the Company adopted SFAS No.123R and recognized compensation cost on a straight-line basis over the requisite service period which is the vesting period. The Company elected the modified prospective method. Under this method, share-based compensation expense recognized 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 value as of the grant date, and (b) compensation expense for all share-based compensation awards granted on or subsequent to January 1, 2006, based on grant-date fair value.
 
 
For share-based compensation awards that were granted prior to January 1, 2006 that are not yet vested and continue to be reported under APB Opinion 25, the following is the Company's pro forma net income that would have been reported if such awards were accounted for under SFAS 123(R):

     
Year ended December 31,
 
     
2005
 
     
RMB
 
         
 
  Net income, as reported
    151,604  
 
  Add: Share-based compensation, as reported
    -  
 
  Less: Share-based compensation determined using the
       
 
  fair value method
    (14,616 )
           
 
  Pro forma net income
    136,988  
 
 
  Weighted average shares used in computation
     
 
  Basic
    34,539,976  
           
 
  Diluted
    35,706,894  

 
  Net income per share:
     
 
  Basic, as reported
    4.39  
 
  Basic - pro forma
    3.97  
 
  Diluted, as reported
    4.25  
 
  Diluted - pro forma
    3.84  
 
The fair value of each option granted is estimated on the date of grant using the minimum value method for options granted before Ninetowns became a public company, as permitted for non-public companies, and using the Black-Scholes option pricing model for options granted after Ninetowns became a public company. The value of options was estimated on the date of the respective grant using the following weighted average assumptions:


F - 20

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued

The value of options granted was estimated on the date of grant using the following weighted average assumption:
 
 
 
Options grants
 
     
 
Weighed average risk-free rate of return
5%
 
Weighted average expected option life
6.25 years
 
Weighted average volatility rate
55%
 
Weighted average dividend yield
0%
 
Net income(loss) per share - Basic net income per share is computed by dividing net income attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the year. Diluted net income per ordinary share reflects the potential dilution that could occur if securities or other contracts to issue ordinary shares were exercised into ordinary shares. Ordinary share equivalents are excluded from the computation of the diluted net income per share in periods when their effect would be anti-dilutive.
 
Reclassification - Certain amounts and balances in the 2005 and 2006 consolidated financial statements have been reclassified to conform to the 2007 presentation.

Recently Issued Accounting Pronouncements In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in US GAAP, and expands disclosures about fair value measurement. SFAS No. 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, “Effective Date of FASB Statement No. 157”, which delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at the fair value in the financial statements on a recurring basis (at least annually). SFAS No. 157 is effective for fiscal years beginning after July 1, 2008; FSP 157-2 delays the effective date for certain items to July 1, 2009. The Company is currently assessing the potential impact that adoption of this statement may have on its financial statements.

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 believes there will be no material impact on its financial statements upon adoption of this standard.

In December 2007, the Financial Accounting Standards Board issued FASB Statement No. 141 (Revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R provides additional guidance on improving the relevance, representational faithfulness, and comparability of the financial information that a reporting entity provides in its financial reports about a business combination and its effects. This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company has not yet begun the process of assessing the potential impact the adoption of SFAS No. 141R may have on its consolidated financial position or results of operations.
 
 

F - 21

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
2.
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - continued
 
In December 2007, the Financial Accounting Standards Board issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51  (“SFAS 160”). SFAS 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company has not yet begun the process of assessing the potential impact the adoption of SFAS No. 160 may have on its consolidated financial position or results of operations.

In March 19, 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities to improve the relevance, comparability, and transparency of financial information provided to investors by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format,cross-referencing within footnotes to enable financial statement users to locate important information, and the disclosure of derivative features that are credit risk-related. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company has not yet begun the process of assessing the potential impact the adoption of SFAS No. 161 may have on its consolidated financial position or results of operations.

3.
ACQUISITIONS
 
Acquisition of 70% equity interest in Ample Spring and Baichuan Tongda

In April 2007, the Company acquired a 70% equity interests in both Ample Spring and Baichuan Tongda for the purpose of engaging in B2B search business. Baichuan Tongda is a vertical search engine provider established in February 2004 in the PRC. Ample Spring was set up in January 2007 in BVI by the same shareholders of Baichuan Tongda for the purpose of receiving payments only. Therefore, the acquisitions of 70% equity interest in Ample Spring and in Baichuan Tongda are treated as a single transaction. Total consideration for this single transaction is RMB105,000, which was paid in 2007. Because PRC regulations prohibit direct foreign ownership of business entities providing internet content, or ICP, services in the PRC such as Baichuan Tongda's online B2B search service, the acquisition of 70% equity interest in Baichuan Tongda was actually through contractual arrangements as described in Note 1.

The acquisition is accounted for using purchase method of accounting. The results of operations of Baichuan Tongda have been included in the Company’s consolidated financial statements from the date of acquisition.


F - 22

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)

3.
ACQUISITIONS - continued
 
The Company’s purchase price was allocated as follows:

     
RMB
 
Estimated
useful life
           
 
  Current assets
    4,592    
 
  Non-current assets
    6,075    
 
  Current liabilities
    (20,726 )  
 
  Non-current liabilities
    (17,106 )  
 
  Intangible assets acquired:
         
 
  Customer relationship
    2,455  
5 years
 
  Buyer database
    2,044  
5 years
 
  Completed technology
    61,121  
5 years
 
  Goodwill
    78,081    
 
   Minority interest
    (11,536  
             
 
  Total consideration
    105,000    
 
The fair values of the intangible assets were determined using the "cost", "income approach-excess earnings" and "relief from royalty" valuation methods. In performing the purchase price allocation, the Company considered, among other factors, forecasted financial performance of the acquired business, market performance, and the market potential of the acquired business in China. The acquired goodwill is not deductible for tax purposes.

The following unaudited pro forma information summarizes the results of operations for the Company, including the acquisition of a 70% interest in Ample Spring, assuming that the acquisition occurred as of January 1, 2006, and 2007 respectively. The following pro forma financial information is not necessarily indicative of the results that would have occurred had the acquisitions been completed at the beginning of the periods indicated, nor is it indicative of future operating results:
 
     
Years Ended December 31,
 
     
2006
   
2007
 
     
RMB
   
RMB
 
     
(Unaudited)
 
 
(Unaudited)
 
 
Total revenue
    158,173       107,908  
 
Net income (loss)
    36,717       (238,661 )
 
Net income (loss) per share
               
 
       - Basic
    1.06       (6.83 )
 
       - Diluted
    1.04       (6.83 )

The pro forma results of operations give effect to certain pro forma adjustments, including amortization of acquired intangible assets with definite lives associated with the acquisition.

F - 23

NINETOWNS INTERNET TECHNOLOGY GROUP COMPANY LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
(In thousands, except share and share-related data)
 
4.
SHORT-TERM INVESTMENTS
 
Short-term investments are classified as available-for-sale securities. Available-for-sale securities consisted principally of balanced funds issued by major financial institutes.
 <