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TMCNet:  ASIAINFO-LINKAGE, INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

[February 28, 2013]

ASIAINFO-LINKAGE, INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Overview We are the leading provider of high-quality telecommunications software solutions and IT products and services in China. Our solutions, products and services include convergent solutions of billing, CRM, BI, and operation support system, system integration solutions, network management solutions and service application solutions. Our software and services enable our customers to build, maintain, operate, manage and improve their communications infrastructure. Our largest customers are the major telecommunications carriers in China and their provincial subsidiaries. We are also the leading provider in China's cable television BSS market, providing billing and CRM solutions and services. We won several important contracts to provide modernized BSS for consolidated provincial level cable operators, such as Jiangsu Cable TV and Zhejiang Cable TV, as well as operators in Chongqing and Beijing. We believe the successful implementation of these projects has brought additional value to our customers and positions us well for the future cable industry consolidation among multiple regional operators, which we expect to accelerate in the coming years.



We are also expanding our footprint in the international telecommunications software and services market by leveraging the valuable experience gained from our Chinese telecommunications carriers. In 2011, we won new contracts from customers in Southeast Asia, including Malaysia, Nepal and others, after a detailed selection process against other industry leading vendors, which is a significant achievement given the long selling cycle of business support software. In June 2012, we opened our first European based sales office in Cambridge, United Kingdom as part of our ongoing initiative to expand operations across EMEA markets. We expect additional revenue contribution from markets other than China over the next few years.

We commenced our operations in the U.S. in 1993 and moved our major operations from the U.S. to China in 1995. We began generating significant network solutions revenues in 1996 and significant software revenues in 1998. We conduct the bulk of our business through our operating subsidiaries, most of which are Chinese companies. On July 1, 2010, we completed the combination with Linkage and, in connection with the closing, changed our corporate name to "AsiaInfo-Linkage, Inc." We have derived, and believe that we will continue to derive, a significant portion of our revenues from a limited number of large telecommunications customers and their provincial subsidiaries, such as China Mobile, China Unicom and China Telecom. The following table shows our revenues and percentage of total revenues derived from such customers in recent periods.

Year Ended December 31, 2012 2011 2010 Percentage Percentage Percentage Revenues of Total Revenues of Total Revenues of Total (in thousands) Revenues (in thousands) Revenues (in thousands) Revenues China Mobile $ 287,355 52.5 % $ 252,693 52.5 % $ 210,396 61.3 % China Unicom 142,266 26.0 % 130,131 27.1 % 76,334 22.2 % China Telecom 94,478 17.2 % 89,916 18.7 % 51,088 14.9 % Total $ 524,099 95.7 % $ 472,740 98.3 % $ 337,818 98.4 % As a result of our reliance on our key customers in the telecommunications industry, our operating results are influenced by governmental spending policies in that sector. Historically, there have been a number of state-mandated restructurings in China's telecommunications sector. Some of these restructurings have led to cancellation or delays in telecommunications-related capital expenditures that have negatively impacted our operating results in certain periods. Other restructurings have caused our revenues to increase as carriers have increased spending on software and IT infrastructure designed to increase their competitiveness. Any future restructurings affecting our major telecommunications customers could have an adverse impact on our business.

42-------------------------------------------------------------------------------- Table of Contents For financial reporting purposes, we present our revenues as follows: • software products and solutions; • services; and • third party hardware.

In December 2010 we disposed of our IT security services business, and in December 2012 we entered into a contract to sell Lenovo Computer System and Technology Service Ltd., or Lenovo Computer, which had served as a holding company for certain IT assets.

Revenues We recognize revenue pursuant to the requirements of the Financial Accounting Standards Board, or the FASB, Accounting Standards Codification, or the ASC, when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable, and other applicable revenue recognition guidance and interpretations.

Our revenue is derived from three primary sources: (i) software licenses and related services, including implementation, customization and integration, post-contract customer support, or PCS, training and consulting; (ii) professional services for systems design, planning, consulting, and system integration; and (iii) the procurement of hardware on behalf of customers.

Our multiple-element arrangements relate to our software licenses and related services, including implementation, customization and integration, PCS, training, consulting and third-party hardware procurement.

Software products and solutions revenue. Revenues of software licenses and related services, including implementation, customization and integration, PCS, training and consulting, are recognized using the percentage of completion method over the service period based on the relationship of costs already incurred to the total estimated costs to be incurred because such customer orders require significant production, modifications, or customization of the software. For China projects, we consider total project costs (labor costs and other related costs) in calculating the percentage of completion and recognize cost of sales on an actual basis with no deferral of project costs, including pre-contract costs. Software arrangements with significant production, modifications, or customization are sold with bundled third-party hardware and PCS services. Because PCS services have never been sold separately in these arrangements, they do not have stand-alone fair value or vendor-specific objective evidence, or VSOE, of fair value. The percentage of completion method of revenue recognition is therefore applied to the period from the start of the significant production, modifications, or customization through the last element delivered, which is typically the end of the bundled PCS services period.

Revisions in estimated contract costs are made in the period in which the circumstances requiring the revision become known. Provisions, if any, are made currently for anticipated losses on uncompleted contracts. For certain projects outside of China, we defer revenue and cost until the revenue recognition criteria have been met.

Service revenue. Revenues of professional services for systems design, planning, consulting, and system integration are recognized when the services are performed.

In addition, we generate service revenues by acting as a sales agent for International Business Machines Corporation, or IBM, or its distributors, and a few other hardware vendors, for certain products sold to our customers, which we refer to as our IBM-Type Arrangements. The service fee under the IBM-Type Arrangements is determined as a percentage of the gross contract amount. We have evaluated the criteria outlined in guidance issued by the FASB, regarding reporting revenue gross as principal versus net as an agent, in determining whether to record as revenues the gross amount billed to our customers and related costs or the net amount earned after deducting hardware costs paid to the vendor, even though we bear inventory risks after the vendor ships the products to us and we bill gross amounts to our customers. We record the net amount earned 43 -------------------------------------------------------------------------------- Table of Contents after deducting hardware costs as agency service revenue because (1) the vendor is the primary obligor in these transactions, (2) we have no latitude in establishing the prices, (3) we are not involved in the determination of the product specifications, (4) we do not bear credit risk because we are contractually obligated to pay the vendor only when the customers pay us, and (5) we do not have the right to select suppliers.

Third party hardware revenue. Revenues of the procurement of hardware on behalf of customers, if not bundled with other arrangements, are recognized when shipped and customer acceptance obtained, if all other revenue recognition criteria are met. Costs associated with revenues are recognized when incurred.

If bundled with other arrangements, we generally bifurcate the third-party hardware from the development services and recognize the hardware revenue upon customer acceptance using estimated prices based on cost plus a margin, which we believe to be the fair value of the selling price.

Net revenue. Although we report our revenue on a gross basis, inclusive of hardware acquisition costs, we manage our business internally based on revenues net of hardware costs, or net revenues, a non-GAAP measure. We believe this approach is consistent with our strategy of providing our customers with high value IT professional services and, where efficient, outsourcing lower-end services such as hardware acquisition and installation. The following table shows our revenue breakdown on this basis and reconciles our net revenues to total revenues: Year Ended December 31, 2012 2011 2010 Revenues net of hardware costs: Software products and solutions revenue $ 496,991 $ 431,355 $ 301,970 Service revenue 32,271 31,513 26,596 Third party hardware revenue net of hardware costs 931 905 743 Total revenues net of hardware costs 530,193 463,773 329,309 Total hardware costs 17,679 17,211 14,074 Total revenues $ 547,872 $ 480,984 $ 343,383 We believe total revenues net of hardware costs more accurately reflects our core business, which is the provision of software solutions and services, and provides transparency to our investors. We believe this measure provides transparency to our investors because it is the measure used by our management to evaluate the competitiveness and performance of our business. In addition, third-party hardware revenue tends to fluctuate from period to period depending on the requirements of our customers. As a result, a presentation that excludes hardware costs allows investors to better evaluate the performance of our core business.

Cost of Revenues Software products and solutions costs. Software products and solutions costs consist primarily of three components: • packaging and written manual expenses for our proprietary software products and solutions; • compensation and travel expenses for the professionals involved in modifying, customizing or installing our software products and solutions and in providing consultation, training and support services; and • software license fees paid to third-party software providers for the right to sublicense their products to our customers as part of our solutions offerings.

The costs associated with designing and modifying our proprietary software are classified as research and development expenses as incurred.

44-------------------------------------------------------------------------------- Table of Contents The costs incurred for the implementation phases of projects outside of China, which provide multiple services and products (software, hardware, implementation, maintenance and managed services), are deferred and capitalized as inventories during the system implementation phase, and transferred to cost of sales upon revenue recognition.

Service costs. Service costs consist primarily of compensation and travel expenses for the professionals involved in designing and implementing IT services, management consulting and network solutions projects.

Third party hardware costs. We recognize hardware costs in full upon delivery of the hardware to our customers. In order to minimize our working capital requirements, we generally obtain from our hardware vendors payment terms that are timed to permit us to receive payment from our customers for the hardware before our payments to hardware vendors are due. However, in large projects we sometimes obtain less favorable payment terms from our customers, thereby increasing our working capital requirements.

Amortization of intangible assets, depreciation of properties and equipment, and rental expenses are also included in cost of revenue.

Operating Expenses (Income) Operating expenses (income) are comprised of sales and marketing expenses, research and development expenses, general and administrative expenses and government subsidies. Amortization of acquired intangible assets expenses consistently comprise a significant portion of our total operating expenses (income).

Sales and marketing expenses include compensation expenses for employees in our sales and marketing departments, third party advertising expenses, marketing events, sales commissions and sales consulting fees, as well as the depreciation and amortization expenses allocated to our sales and marketing departments.

Research and development expenses relate to the development of new software and the modification of existing software. We expense such costs as they are incurred.

General and administrative expenses include compensation expenses for employees in our general and administrative departments, third-party professional services fees, as well as the depreciation expenses allocated to our general and administrative departments.

Government subsidies represent rewards from government for the high-tech software innovation.

Taxes Except for certain hardware procurement and resale transactions, we conduct substantially all of our business through our Chinese subsidiaries and VIEs. To a smaller degree, our operations in Southeast Asia are conducted through our joint venture in Singapore and its subsidiaries. Prior to the enactment of the EIT Law, which became effective on January 1, 2008, FIEs were generally subject to a 30% state enterprise income tax plus a 3% local income tax. However, most of our operating subsidiaries in China, as FIEs, were entitled to certain preferential tax treatments, which thus reduced their effective rate of income tax to 15% or lower in some cases. Since the EIT Law became effective, all resident enterprises are subject to a flat 25% income tax rate, unless they are otherwise eligible for certain preferential tax treatments under the new rules.

Pursuant to the implementation rules to the EIT Law issued in December 2007, and the several subsequent transition rules, certain of our subsidiaries in China can continue to enjoy preferential tax rates, as long as they are qualified as HNTEs. Some of our subsidiaries and VIEs in China became subject to a normal 25% income tax rate, while certain of our subsidiaries and VIEs in China remain eligible for the lower rates under the transition rules. The HNTE status allows qualifying entities to be eligible for a 15% tax rate for three years. At the conclusion of the three year period, the qualifying enterprise has the option to renew its HNTE status for an additional three years through a simplified application process if such enterprise's business operations continue 45-------------------------------------------------------------------------------- Table of Contents to qualify for HNTE status. After the first six years, the enterprise would have to go through a new application process in order to renew its HNTE status. As of December 2008, we had received certification of HNTE status for AsiaInfo-Linkage Technologies (China), Inc., or AIBJ, AsiaInfo-Linkage Technologies (Chengdu), Inc., or AICD, and Linkage-AsiaInfo Technologies (Nanjing), Inc., or Linkage Nanjing, which allows those companies to compute tax at a reduced 15% tax rate effective from January 1, 2008 to December 31, 2010. AIBJ, AICD and Linkage Nanjing filed renewal applications in 2011. As of the end of 2011 and the beginning of 2012, AIBJ, AICD and Linkage Nanjing had obtained the renewed HNTE certificates issued by the government authorities. As such, we continued to compute tax at a reduced 15% tax rate for AIBJ, AICD and Linkage Nanjing. AIBJ and Linkage Nanjing were approved as a Key Software Enterprise, and were eligible for a further reduction in their tax rate to 10% for 2008, 2009 and 2010. In October 2012, government authorities in charge of the approval of KSE status released the application requirements for 2011 and 2012 KSE status. In the same month, AIBJ and Linkage Nanjing submitted the application for 2011 and 2012 KSE status to the relevant government authorities for approval. As of the date of this report, government authorities have not released the final approval. Because there is uncertainty as to whether AIBJ and Linkage Nanjing will receive KSE status, we have computed our current taxes based on the tax rate of 15% for both AIBJ and Linkage Nanjing.

Sales of hardware procured in China are subject to a 17% VAT. Most of our sales of hardware procured outside of China are made through our U.S. parent company, AsiaInfo-Linkage, Inc., or one of its subsidiaries, Hong Kong AsiaInfo-Linkage Technologies Ltd., and thus are not subject to the VAT. We effectively pass VAT on hardware sales through to our customers and do not include them in revenues reported in our financial statements. Companies that develop their own software and register the software with the relevant authorities in China are generally entitled to a VAT refund. If the net amount of the VAT payable exceeds 3% of software sales and software-related services, the excess portion of the VAT is refundable immediately. The policy was extended by a new tax circular issued in January 2011. The benefit of the rebate of VAT is included in software revenue.

Historically, the VAT refund is not taxable for income tax purpose as long as the refund is used for research and development activities. However, according to a new tax circular which was issued by the PRC State Administration of Taxation in 2009, although the VAT refund would remain non-taxable, all the expenses associated with the refund are not tax deductible for income tax purposes. This circular also stipulates that any VAT refund not spent within the five-year period following its receipt must be added back to taxable income in the sixth year. In accordance with instructions from certain local tax jurisdictions, we report VAT refund as taxable income in calculating our income tax provision for certain years.

Our PRC subsidiaries and VIEs are subject to business tax at the rate of 3% or 5%, respectively, on certain types of service revenues, which are presented in our statement of operations net of business tax incurred.

In July 2012, the Ministry of Finance and the State Administration of Taxation jointly issued Circular No. 71 regarding the pilot collection of VAT in lieu of business tax in certain areas and industries in the PRC. Such VAT pilot program was phased in Beijing, Jiangsu, Anhui, Fujian, Guangdong, Tianjin, Zhejiang, and Hubei between September and December 2012. Starting from September 1, 2012, certain subsidiaries and VIEs became subject to VAT at the rates of 6% or 3%, on certain service revenues which were previously subject to business tax.

Effective from December 1, 2010, our PRC subsidiaries are also subject to urban maintenance and construction tax as well as education fee surcharges at the rate of 7% and 3% of VAT and business tax paid, respectively.

In January 2011, the State Council issued a new circular providing an exemption from business taxes for eligible software companies on software development and testing, system integration, consulting and maintenance services. The circular also retains various policies granted by previous circulars, including the VAT rebate on sales of software. The implementation guidance of this new circular has not been issued as of the date of this report, although implementation guidance for VAT rebates on sales of software was issued in October 2011.

46-------------------------------------------------------------------------------- Table of Contents We are also subject to U.S. income taxes on revenues generated in the U.S., including revenues from our limited hardware procurement activities through our US parent company, AsiaInfo-Linkage, Inc., and interest income earned in the U.S.

Foreign Exchange A majority of our revenues and expenses relating to hardware sales and the software and service components of our business are denominated in RMB. The value of our shares will be affected by the foreign exchange rate between U.S.

dollars and RMB because the value of our business is effectively denominated in RMB, while our shares are traded in U.S. dollars. In addition, as we pursue our global strategy, we need to settle transactions in various currencies of Southeast Asian countries, expect to continue to do so in future, and expect that such activities may create similar foreign exchange risk associated with the currencies of these jurisdictions. Depreciation of the value of the U.S.

dollar will also reduce the value of the cash we hold in U.S. dollars, which we may use for purposes of future acquisitions or other business expansion. We actively monitor our exposure to these risks and adjust our cash position in the RMB and the U.S. dollar when we believe such adjustments will reduce our foreign exchange risks and otherwise appropriate. We did not engage in any significant foreign exchange transactions during the fiscal year 2012.

Pursuant to the rate of exchange quoted by People's Bank of China, as of December 31, 2012 the exchange rate between the RMB and the U.S. dollar decreased 0.24% to U.S.$1.00 = RMB6.2855, compared to the rate of U.S.$1.00 = RMB6.3009 as of December 31, 2011.

Critical Accounting Policies We prepare our consolidated financial statements in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amount of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenues and cost of revenues under customer contracts, warranty obligations, bad debts, inventories, short-term investments, long-term investments, long-lived assets, income taxes, goodwill and other intangible assets, stock options, and litigation. We base our estimates and judgments on historical experience and on various other factors that we believe are reasonable. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable, and other applicable revenue recognition guidance and interpretations.

Our revenue is derived from three primary sources: (i) software licenses and related services, including implementation, customization and integration, post-contract customer support, or PCS, training and consulting; (ii) professional services for systems design, planning, consulting, and system integration; and (iii) the procurement of hardware on behalf of customers.

Our multiple-element arrangements relate to our software licenses and related services, including implementation, customization and integration, PCS, training, consulting and third-party hardware procurement.

Revenues of software licenses and related services, including implementation, customization and integration, PCS, training and consulting, are recognized using the percentage of completion method over the service period based on the relationship of costs already incurred to the total estimated costs to be incurred because such customer orders require significant production, modifications, or customization of the software. For 47-------------------------------------------------------------------------------- Table of Contents China projects, we consider total project costs (labor costs and other related costs) in calculating the percentage of completion and recognize cost of sales on an actual basis with no deferral of project costs, including pre-contract costs. Software arrangements with significant production, modifications, or customization are sold with bundled third-party hardware and PCS services.

Because PCS services have never been sold separately in these arrangements, they do not have stand-alone fair value or VSOE of fair value. The percentage of completion method of revenue recognition is therefore applied to the period from the start of the significant production, modifications, or customization through the last element delivered, which is typically the end of the bundled PCS services period. Revisions in estimated contract costs are made in the period in which the circumstances requiring the revision become known. Provisions, if any, are made currently for anticipated losses on uncompleted contracts. For certain projects outside of China, we defer revenue and cost until the revenue recognition criteria have been met.

Revenues of professional services for systems design, planning, consulting, and system integration are recognized when the services are performed.

In addition, we generated service revenues by acting as a sales agent pursuant to the IBM-Type Arrangements. The service fee under our IBM-Type Arrangements is determined as a percentage of the gross contract amount. We have evaluated the criteria outlined in guidance issued by FASB regarding reporting revenue gross as principal versus net as agent, when determining whether we would record as revenues the gross amount billed to our customers and related costs or the net amount earned after deducting hardware costs paid to the vendor, even though we bear inventory risks after the vendor ships the products to us and we bill gross amounts to our customers. We record the net amount earned after deducting hardware costs as agency service revenue because (1) the vendor is the primary obligor in these transactions, (2) we have no latitude in establishing the prices, (3) we are not involved in the determination of the product specifications, (4) we do not bear credit risk because we are contractually obligated to pay the vendor only when the customers pay us, and (5) we do not have the right to select suppliers.

Revenues of the procurement of hardware on behalf of customers, if not bundled with other arrangements, are recognized when shipped and customer acceptance obtained, if all other revenue recognition criteria are met. Costs associated with revenues are recognized when incurred. If bundled with other arrangements, we generally bifurcate the third-party hardware from the development services and recognize the hardware revenue upon customer acceptance using estimated prices based on cost plus a margin, which we believe to be the fair value of the selling price.

Revenue recognized in excess of billings is recorded as unbilled receivables and is included in accounts receivable. Amounts billed but not yet collected are recorded as billed receivables and are included in accounts receivable. All billed and unbilled amounts are expected to be collected within one year.

Billings for installation and customization services are rendered based on agreed upon milestones specified in customer contracts. Billings in excess of revenues recognized are recorded as deferred revenue.

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.

We record a valuation allowance to reduce our deferred tax assets to the amount that we believe is more likely than not to be realized. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of their recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance would be charged to income in the period such change occurred.

48-------------------------------------------------------------------------------- Table of Contents 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.

Interest and penalties on income taxes will be classified as a component of the provisions for income taxes.

The HNTE certificates of AIBJ and AICD were renewed at the end of 2011 and the HNTE certificate of Linkage Nanjing was renewed at the beginning of 2012, which allows those companies to continue to enjoy a 15% preferential tax rate from January 1, 2011 until December 31, 2013. AIBJ and Linkage Nanjing were KSEs eligible for a 10% tax rate for 2008, 2009, and 2010. In October 2012, government authorities in charge of the approval of KSE status released the application requirements for 2011 and 2012 KSE status. AIBJ and Linkage Nanjing have applied for 2011 and 2012 KSE status, but there is uncertainty as to whether they will receive such status, so we have computed our current taxes based on the tax rate of 15% for both AIBJ and Linkage Nanjing.

Under the EIT Law, a "resident enterprise" which may include an enterprise established outside of the PRC with management located in the PRC, will be subject to PRC income tax. We believe we and our subsidiaries registered outside the PRC are not resident enterprises under the EIT law.

Intangible Assets and Goodwill. Intangible assets consist of certain identifiable intangible assets resulting from business acquisitions and primarily comprise customer relationships, trade name and trademarks, core technologies and existing technologies. We amortize these intangible assets over their respective estimated useful lives, which range from 0.5 to 19 years.

Intangible assets are reviewed for impairment when events or changes in circumstances indicate that their carrying amounts may not be recoverable based upon the estimated undiscounted cash flows.

The excess of the purchase price over the fair value of net assets acquired is recorded on the consolidated balance sheets as goodwill. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.

Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (October 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in stock prices, business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.

Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The estimation of fair value of each reporting unit using a discounted cash flow, or DCF, methodology also requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results and market conditions. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for the reporting unit.

In September 2011, the FASB issued an authoritative pronouncement related to testing goodwill for impairment. The guidance permits us to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, goodwill is then tested following a two-step process. The first step compares the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value of 49-------------------------------------------------------------------------------- Table of Contents each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit's goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill. We did not believe that the fair value of our reporting unit would clearly be in excess of its carrying value in fiscal year 2012. Therefore, we chose not to perform the qualitative assessment but directly performed the two-step goodwill impairment test.

We had one reporting unit as of December 31, 2012 and 2011, our telecommunications reporting unit. The goodwill allocated to the reporting unit was $433.5 million and $433.5 million as of December 31, 2012 and 2011, respectively.

We performed our annual goodwill impairment test on October 1, 2012, which resulted no goodwill impairment loss to be recognized. During the fourth quarter of 2012, we noted that our market capitalization was below its carrying value.

We considered such factors as goodwill impairment indicators and performed a two-step goodwill impairment test as of December 31, 2012 which resulted no goodwill impairment loss to be recognized.

In the goodwill impairment test, we used the income approach, which we believed to be more reliable than the market approach in determining the fair value of our reporting unit. Accordingly, we adopted the DCF method under the income approach, which considers a number of factors that include expected future cash flows, growth rates and discount rates, and requires us to make certain assumptions and estimates regarding industry economic factors and the future profitability of our business. The assumptions are inherently uncertain and subjective.

When applying the DCF method for the reporting unit, we incorporated the use of projected financial information and a discount rate developed using market participant based assumptions. The cash flow projections were based on five-year financial forecasts developed by management that included revenue projections, capital spending trends, and investments in working capital to support anticipated revenue growth. The discount rate selected was 15.5% with the considerations of the risk and nature of the reporting unit's cash flows and the rates of return market participants would require to invest their capital in our reporting unit.

Our revenue growth rate assumption was indirectly dependent on government budgetary policy for the telecommunications and internet industries in China.

The laws and regulations applicable to the telecommunications and internet industry in China remain unsettled and could have a material adverse effect on our business and may lead to a decrease of growth rate. Our customer base is concentrated and the loss of one or more customers would have a significant effect on our estimated growth rate. Please see "Risk Factors" for a discussion of other risks and uncertainties that may adversely affect our growth.

As of December 31, 2012, the estimated fair value of the reporting unit was 8% in excess of its carrying value. In addition, we performed a sensitivity analysis of the results. If the discount rate were to increase by 1% or the revenue growth rate of future projection decreased by 1%, the fair value would remain higher than the carrying value of the reporting unit.

We recognized no impairment loss on goodwill in 2012, 2011 and 2010.

Impairment of long-term and short-term investments. We review our long-term and short-term investments for other-than-temporary impairment in accordance with relevant accounting literature, based on the specific identification method. We consider available quantitative and qualitative evidence in evaluating potential 50 -------------------------------------------------------------------------------- Table of Contents impairment of our investments. If the cost of an investment exceeds the investment's fair value, we consider, among other factors, general market conditions, government economic plans, the duration and the extent to which the fair value of the investment is less than the cost, and our intent and ability to hold the investment. In view of the declines of fair value below the carrying cost of certain short-term and long-term investments, we performed an evaluation to determine whether any of the declines were other-than-temporary. We determined that there were no fair value declines in long-term and short-term investments, and thus made no provision for impairment losses, in 2012. We recognized $0 and $950 in impairment losses on long-term investments in 2012 and 2011, respectively. We recognized $0 and $144 in impairment losses on short-term investments in 2012 and 2011, respectively.

Consolidated Results of Operations Year Ended December 31, 2012 Compared to Year Ended December 31, 2011 Revenues. Total revenues increased 13.9% to $547.9 million in 2012, from $481.0 million in 2011. Revenue from software products and solutions was $497.0 million, representing a 15.2% increase from $431.4 million in 2011. Service revenue was $32.3 million, representing a 2.4% increase from $31.5 million in 2011. Revenue from third party hardware was $18.6 million, representing an increase of 2.7% from $18.1 million in 2011. The growth in revenue was mainly attributable to the increased demands for our solutions and services from the China and Southeast Asia telecommunication customers.

Cost of revenues. Our total cost of revenues increased 22.2% to $333.8 million in 2012, from $273.1 million in 2011, primarily due to increased implementation headcount of approximately 1,200 engineers and wage inflation which led to an increase in overall labor costs of $35.3 million. The increase also reflected the addition of new customers, such as China Unicom's northern six provinces and international customers, which involved projects requiring significant upfront investment.

Gross profit. Our gross profit increased 3.0% in 2012 to $214.1 million, from $207.9 million in 2011. The increase in gross profit was mainly due to the increased demands from our telecom customers.

Operating expenses. Total operating expenses increased 26.3% to $192.4 million in 2012, from $152.3 million in 2011. The increase was primarily driven by increases of approximately 460 of R&D engineers for product development, international expansion, which was partially off-set by a decrease in amortization of acquired intangible assets related to the Linkage acquisition of $20.3 million in 2012 compared to $25.1 million in 2011.

Sales and marketing expenses increased 11.3% to $83.5 million in 2012, from $75.0 million in 2011. The increase was mainly due to hiring of approximately 25 professionals along with wage inflation, led to the increase in employee salary and welfare of $3.0 million and higher sales commission related expenses of $2.5 million incurred upon signing new contracts with our three major telecom customers.

General and administrative expenses increased 39.8% to $28.8 million in 2012, from $20.5 million in 2011. The increase was mainly due to the addition of approximately 40 professionals and wage inflation, which led to the increase in employee compensation of $3.6 million, as well as an increase in third-party professional service fees of $2.5 million.

Research and development expenses increased 38.9% to $81.8 million in 2012, from $58.9 million in 2011. The year-over-year increase was primarily driven by the addition of approximately 460 R&D engineers, a portion of which were shifted from our delivery organization, along with wage inflation resulted in the increase in employee salary and welfare of $20.6 million. The investment in R&D was mainly for product development and product standardization for current and anticipated overseas expansion.

Government subsidies decreased 21.0% to $1.7 million in 2012, as compared to $2.1 million in 2011.

51 -------------------------------------------------------------------------------- Table of Contents Income from operations. Income from operations decreased to $21.7 million in 2012, from $55.6 million in 2011, reflecting our increased headcount and wage inflation, as well as upfront investment in product standardization and international market expansion. Operating margin was 4.0% in 2012, as compared to 11.6% in 2011.

Income tax expense (benefit). In 2012 we had an income tax expense of $5.1 million as compared to income tax benefit of $12.1 million in 2011. Our effective tax rate was 15% for 2012 as compared to (20)% for 2011. The negative effective tax rate in 2011 was mainly caused by a one-time adjustment to deferred taxes resulting in a benefit due to a change in the statutory tax rate of Linkage Nanjing for 2011 from 25% to 15% where certain acquired deferred tax liabilities were tax effected at 25% but adjusted to a lower amount due to the tax rate reduction, as Linkage Nanjing was notified that its HNTE status was approved in 2011. Without such one-time adjustment, the effective tax rate for 2011 would have been 10%. The lower effective tax rate for 2011 when compared to 2012 also reflected the 10% preferential tax rate granted to AIBJ and Linkage Nanjing for their KSE certificate which was obtained upon filing of final 2010 annual taxes in the first quarter of 2011. However, such KSE certificates were not been obtained for 2011 and 2012 as of December 31, 2012.

Income from continuing operations. Net income from continuing operations was $29.7 million in 2012, as compared to $72.9 million in 2011.

Income from discontinued operations. In line with our strategy of focusing on our core telecommunications software solutions, we discontinued certain non-core businesses during the past several years. In December 2010, we sold our IT security business for approximately $15.0 million in cash. The IT security business has been reflected as discontinued operations since the year ended December 31, 2010. In December 2012, we entered into a contract to sell Lenovo Computer, which had served as a holding company for certain IT assets, and have reflected it as discontinued operations. The income from discontinued operations in 2012 and 2011 were $0.2 million and $0.1 million, respectively.

Net income attributable to AsiaInfo-Linkage, Inc. In 2012, we recorded net income attributable to AsiaInfo-Linkage, Inc. of $32.8 million or $0.45 per basic share, compared to $74.6 million or $1.02 per basic share in 2011.

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010 Revenues. Total revenues increased 40.1% to $481.0 million in 2011, from $343.4 million in 2010. Our revenues for full year 2010 included only six months of consolidated operating results after the closing of the merger of AsiaInfo and Linkage. Full year 2011 and 2010 statements of operations are not comparable.

Revenue from software products and solutions was $431.4 million, representing a 42.8% increase from $302.0 million in 2010. Service revenue was $31.5 million, representing an 18.5% increase from $26.6 million in 2010. Revenue from third party hardware was $18.1 million, representing an increase of 22.3% from $14.8 million in 2010.

Cost of revenues. Our total cost of revenues increased 57.1% to $273.1 million in 2011, from $173.8 million in 2010, primarily due to increased implementation headcount and employee compensation, resulting in an increase in overall labor costs, and the addition of new customers such as China Unicom's northern six provinces and international customers, projects which required significant upfront investment. In addition, amortization of acquired intangible assets related to the Linkage merger was $20.1 million in 2011 and $10.0 million in the second half of 2010.

Gross profit. Our gross profit increased 22.6% in 2011 to $207.9 million, from $169.6 million in 2010.

Operating expenses. Total operating expenses increased 39.1% to $ 152.3 million in 2011, from $109.5 million in 2010. Other than the additional operating expenses following the Linkage merger, the increase was primarily driven by increased headcount and product development for international expansion. In addition, amortization of acquired intangible assets related to the Linkage acquisition was $25.1 million in 2011, and $11.0 million in the second half of 2010.

52 -------------------------------------------------------------------------------- Table of Contents Sales and marketing expenses increased 49.9% to $75.0 million in 2011, from $50.0 million in 2010. Other than the additional sales and marketing expenses following the Linkage merger, the increase was mainly due to amortization of acquired intangible assets related to the Linkage merger of $25.1 million and higher sales commission expenses incurred upon signing new contracts with our three major telecom customers.

General and administrative expenses decreased 11.7%, to $20.5 million in 2011, from $23.3 million in 2010. The decrease was largely attributable to non-recurring expenses of $4.2 million related to the Linkage merger in 2010, offset by the effect of additional general and administrative expenses following the Linkage merger.

Research and development expenses increased 62.8% to $58.9 million in 2011, as compared to $36.2 million in 2010. Other than the additional research and development expenses following the Linkage merger, the year-over-year increase was primarily driven by the addition of research and development engineers, investment in product development and product standardization for current and anticipated overseas expansion.

In the second quarter of 2011, we received and recorded a government subsidy of $2.1 million as a reward for high-tech software innovation.

Income from operations. Income from operations decreased to $55.6 million in 2011 from $60.1 million in 2010, reflecting our increased headcount and product standardization and development for international expansion. Operating margin was 11.6% in 2011, as compared to 17.5% in 2010.

Income tax (benefit) expense. In 2011 we had an income tax benefit of $12.1 million as compared to income tax expense of $9.6 million in 2010. Our effective tax rate was (20)% for 2011 as compared to 15% for 2010. The decrease in effective tax rate was mainly caused by a one-time adjustment to deferred taxes due to a change in the statutory tax rate of Linkage Nanjing for 2011 from 25% to 15% where certain acquired deferred tax liabilities were tax effected at 25% but adjusted to a lower amount due to the tax rate reduction, as Linkage Nanjing was notified that its HNTE status was approved in 2011. Without such one time adjustment, the effective tax rate for 2011 would have been 10%. The decrease in our effective tax rate from 2010 to 2011 also reflected the 10% preferential tax rate granted to AIBJ and Linkage Nanjing for their KSE certificate which was obtained upon filing of final 2010 annual taxes in the first quarter of 2011.

Income from continuing operations. Net income from continuing operations was $72.9 million in 2011, as compared to $53.7 million in 2010.

Income from discontinued operations. In December 2010, we sold our IT security business for approximately $15.0 million in cash. The IT security business has been reflected as discontinued operations since the year ended December 31, 2010.

Net income attributable to AsiaInfo-Linkage, Inc. In 2011, we recorded net income attributable to AsiaInfo-Linkage, Inc. of $74.6 million or $1.02 per basic share, compared to $56.2 million or $0.92 per basic share in 2010.

53-------------------------------------------------------------------------------- Table of Contents Selected Unaudited Quarterly Combined Results of Operations The following table sets forth unaudited quarterly statements of operations data for the years ended December 31, 2012 and 2011. We believe this unaudited information has been prepared substantially on the same basis as the annual audited combined financial statements appearing elsewhere in this report and includes all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation. You should read the quarterly data together with the consolidated financial statements and the notes to those statements appearing elsewhere in this report. The consolidated results of operations for any quarter are not necessarily indicative of the operating results for any future period. We expect that our quarterly revenues may fluctuate significantly.

Three Months Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2012 2012 2012 2012 2011 2011 2011 2011 (Amounts in thousands of U.S. dollars, except per share data) Selected quarterly operations data Total revenues $ 165,683 $ 132,221 $ 126,271 $ 123,697 $ 131,091 $ 119,226 $ 116,186 $ 114,481 Total cost of revenues 97,978 82,889 77,634 75,263 76,830 66,929 67,101 62,235 Gross profit 67,705 49,332 48,637 48,434 54,261 52,297 49,085 52,246 Total operating expenses 52,658 47,134 46,660 45,923 43,377 37,138 34,556 37,238 Income from continuing operations 15,065 3,908 5,325 5,426 10,495 12,585 32,253 17,563 Income (loss) from discontinued operations, net of taxes 237 0 (1 ) (7 ) 42 104 (2 ) (54 ) Net income 15,302 3,908 5,324 5,419 10,537 12,689 32,251 17,509 Less: net loss (income) attributable to noncontrolling interest (325 ) (711 ) (901 ) (943 ) 56 (600 ) (698 ) (331 ) Net income attributable to AsiaInfo-Linkage, Inc. 15,627 4,619 6,225 6,362 10,481 13,289 32,949 17,840 Earnings per share: Net income per share from continuing operations attributable to AsiaInfo-Linkage, Inc. common stockholders: Basic $ 0.21 $ 0.06 $ 0.09 $ 0.09 $ 0.15 $ 0.18 $ 0.45 $ 0.24 Diluted $ 0.21 $ 0.06 $ 0.09 $ 0.09 $ 0.14 $ 0.18 $ 0.45 $ 0.24 Net income (loss) per share from discontinued operations attributable to AsiaInfo-Linkage, Inc. common stockholders: Basic $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 Diluted $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 Net income attributable to AsiaInfo-Linkage, Inc. common stockholders: Basic $ 0.21 $ 0.06 $ 0.09 $ 0.09 $ 0.15 $ 0.18 $ 0.45 $ 0.24 Diluted $ 0.21 $ 0.06 $ 0.09 $ 0.09 $ 0.14 $ 0.18 $ 0.45 $ 0.24 54 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Our liquidity and capital resources are provided mainly from cash collection from customers resulting from our core operating activities. Our capital requirements are primarily working capital requirements related to hardware sales and costs associated with the expansion of our business, such as research and development and sales and marketing expenses. We recognize hardware costs in full upon delivery of the hardware to our customers. In order to minimize our working capital requirements, we generally obtain from our hardware vendors payment terms that are timed to permit us to receive payment from our customers for the hardware before our payments to hardware vendors are due. With respect to our billing cycle, we generally require our customers to pay 80% to 90% of the invoice value of the hardware upon delivery. We typically place orders for hardware against back-to-back orders from customers and seek favorable payment terms from hardware vendors. However, we sometimes obtain less favorable payment terms from our customers, thereby increasing our working capital requirements.

In addition to this careful management of our billing cycle, we have also historically financed working capital and other financing requirements through private placements of equity securities, our initial public offering in 2000 and, to a limited extent, bank loans.

On December 4, 2009, we executed the Combination Agreement to combine our business with the business of Linkage through our acquisition of 100% of the outstanding share capital of Linkage Technologies, and we completed the combination with Linkage on July 1, 2010.

Our full year net cash provided by operating activities in 2012 was $48.1 million, primarily driven by operating profit from our telecommunications business. We had cash and cash equivalents, restricted cash and short-term investment totalling $353.8 million as of December 31, 2012 as compared to $321.6 million as of December 31, 2011. The increase was a result of our positive operating cash flow of $ 48.1 million, offset by negative investing cash flow of $47.5 million during the period.

Our net cash provided by operating activities in 2012 was $48.1 million, which reflected our net income of $29.9 million adjusted by net non-cash related expenses, such as amortization, depreciation and stock-based compensation expenses, totalling of $50.7 million and a net decrease in the components of our working capital of $32.5 million. Accounts receivable as of December 31, 2012 was $285.7 million, consisting of $107.2 million in billed receivables and $178.5 million in unbilled receivables. Our billed receivables are recorded based on agreed-upon milestones included in our customer contracts.

Our days of sales outstanding as of December 31, 2012 was 144 days, as compared to 147 days at the end of the year 2011. The decrease in days of sales outstanding from December 31, 2012 to December 31, 2011 was primarily related to our enhanced receivables collection efforts, which led to a $34.1 increase in collection of accounts receivable in 2012 compared to 2011, mainly from the collection of accounts receivable from China Mobile. Our DSO is impacted by a variety of factors that impact customer payment cycles, including the outcome of customer negotiations regarding payment terms, the relative maturity of the CRM, Billing, BI, or other technology involved in a particular project, the systems used by the customer, geographic region, the scale of the project, and other factors. In addition, in a year we typically perform thousands of contracts for dozens of customers (comprising the major telecom carriers in the PRC and their provincial subsidiaries), and the payment terms of each contract can vary based on these factors.

Our full year net cash used in investing activities was $47.5 million in 2012.

This was primarily due to our purchase of $31.0 million in short-term investments, a $18.4 million increase in restricted cash and our purchase of $13.6 million in property and equipment and a $0.9 million purchase of Beijing Naomi Technology Limited, employee housing loans granted of $1.6 million which was partially offset by the proceeds from sales of short-term investments for $18.0 million.

Our full year net cash used in financing activities was $0.8 million. This was primarily due to our $1.0 million payment for the purchase of the remaining 20% equity interest in Hangzhou Zhongbo in 2012.

55-------------------------------------------------------------------------------- Table of Contents As of December, 2012, we had total credit facilities of $150.5 million for working capital purposes, expiring in March 2014, which were secured by bank deposits of $33.5 million. As of December 31, 2012, unused credit facilities were $122.8 million and used facilities totalled $27.7 million. The used facilities were pledged as security for issuing standby letters of credit to customers, borrowing of short-term bank loans and accounts payable to hardware suppliers. Additional bank deposits of $6.1 million were used for issuing standby letters of credit and bank acceptance drafts as of December 31, 2012.

Total bank deposits pledged as security for credit facilities, standby letters of credit, accounts payable, short-term bank loans and bank acceptance drafts totalled $39.6 million as of December 31, 2012 and were presented as restricted cash in our consolidated balance sheets. During the year ended December 31, 2012, the largest aggregate amount that we had used of our credit facilities was $27.7 million.

In May 2011, we entered into a land use right transfer agreement with the Beijing Municipal Bureau of Land and Resources pursuant to which we would acquire land use rights with a 50-year term, for a consideration of approximately $3.0 million, which was paid in June 2011 and August 2011.

Pursuant to the agreement, we have committed a minimum of $24.1 million for capital expenditures to the building construction project, which commenced in April 2012, and to complete construction by April 30, 2014.

We anticipate that our available funds and cash flows provided by operations will be sufficient to meet our anticipated needs for working capital, capital expenditures for the building construction and business expansion considering overseas projects purchase through 2013. We may need to raise additional funds in the future, however, in order to fund acquisitions, develop new or enhanced services or products, respond to competitive pressures to compete successfully for larger projects involving higher levels of hardware purchases, or if our business otherwise grows more rapidly than we currently predict. We anticipate that we would raise additional funds, if necessary, through new issuances of equity or debt securities, or through credit facilities extended by lending institutions.

Under PRC laws and regulations, our PRC subsidiaries and VIEs are subject to certain restrictions with respect to paying dividends or otherwise transferring a portion of their net assets to us. The amounts restricted include the paid-in capital and the statutory reserve of our PRC subsidiaries and VIEs. The aggregate amounts of capital and statutory reserves restricted and not available for distribution was $88.9 million and $89.8 million (8.7% and 9.2% of net assets) as of December 31, 2012 and December 31, 2011, respectively.

Furthermore, cash transfers from our PRC subsidiaries to our subsidiaries outside of China are subject to PRC government control of currency conversion.

Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries and VIEs to remit sufficient foreign currency to pay dividends or make other payments to us, or otherwise satisfy their foreign currency denominated obligations.

Off-Balance Sheet Arrangements We have not entered into any transactions, agreements or other contractual arrangements to which an entity unconsolidated with us is a party and under which we have (i) any obligation under a guarantee, (ii) any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity, (iii) any obligation under derivative instruments that are indexed to our shares and classified as stockholders' equity in our consolidated balance sheets, or (iv) any obligation arising out of a variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

As of December 31, 2012, we had short-term credit facilities for working capital purposes totalling $150.5 million, expiring in March 2014, of which $27.7 million had been used as security for issuing standby letters of credit to customers, borrowing of short-term bank loans, and accounts payable to hardware suppliers. Unused short-term credit facilities were $122.8 million. Total bank deposits pledged as security for credit facilities, standby letters of credit, accounts payable, short-term bank loans and bank acceptance drafts totalled $39.6 million as of December 31, 2012 and were presented as restricted cash in the consolidated balance sheets.

56-------------------------------------------------------------------------------- Table of Contents Tabular Disclosure of Contractual Obligations The following table presents a breakdown of our outstanding contractual obligations by maturity as of December 31, 2012: Payment due by period (amounts in thousands of US$) Less than More than Total 1 year 1-3 years 3-5 years 5 years Contractual Obligations Operating lease obligations 10,040 8,426 1,609 5 0 Software purchase obligations 3,182 1,591 1,591 0 0 Purchase obligations 90,607 66,323 22,268 1,676 340 In May 2011, we entered into a land use right transfer agreement with the Beijing Municipal Bureau of Land and Resources, under which we acquired land use right for a 50-year term. Pursuant to the agreement, we have committed a minimum of $24.1 million for capital expenditures to the building construction project, to commence construction by April 30, 2012, and to complete construction by April 30, 2014.

Other long-term liabilities, such as unrecognized tax benefits, have been excluded from the table due to the uncertainty of the timing of payments combined with the absence of historic trends to be used as a predictor for such payments.

Accounting Pronouncements Newly adopted accounting pronouncements In May 2011, the FASB issued an authoritative pronouncement on fair value measurement. The guidance is the result of joint efforts by the FASB and International Accounting Standards Board to develop a single, converged fair value framework. The guidance is largely consistent with existing fair value measurement principles in GAAP. The guidance expands the existing disclosure requirements for fair value measurements and makes other amendments, mainly including: • Highest-and-best-use and valuation-premise concepts for nonfinancial assets-the guidance indicates that the highest-and-best-use and valuation-premise concepts only apply to measuring the fair value of nonfinancial assets.

• Application to financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk-the guidance permits an exception to fair value measurement principles for financial assets and financial liabilities (and derivatives) with offsetting positions in market risks or counterparty credit risk when several criteria are met. When the criteria are met, an entity can measure the fair value of the net risk position.

• Premiums or discounts in fair value measure-the guidance provides that premiums or discounts that reflect size as a characteristic of the reporting entity's holding (specifically, a blockage factor that adjusts the quoted price of an asset or a liability because the market's normal daily trading volume is not sufficient to absorb the quantity held by the entity) rather than as a characteristic of the asset or liability (for example, a control premium when measuring the fair value of a controlling interest) are not permitted in a fair value measurement.

• Fair value of an instrument classified in a reporting entity's stockholders' equity-the guidance prescribes a model for measuring the fair value of an instrument classified in stockholders' equity; this model is consistent with the guidance on measuring the fair value of liabilities.

• Disclosures about fair value measurements-the guidance expands disclosure requirements, particularly for Level 3 inputs. Required disclosures include: (i) For fair value measurements categorized in Level 3 of the fair value hierarchy: (1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, (2) a description 57 -------------------------------------------------------------------------------- Table of Contents of the valuation process in place (e.g., how the entity decides its valuation policies and procedures, as well as changes in its analyses of fair value measurements, from period to period), and (3) a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs.

(ii) The level in the fair value hierarchy of items that are not measured at fair value in the statement of financial position but whose fair value must be disclosed.

The guidance is to be applied prospectively and is effective for interim and annual periods beginning after December 15, 2011, for public entities. Early application by public entities is not permitted. The adoption of this guidance did not have a significant effect on our consolidated financial statements.

In June 2011, the FASB issued an authoritative pronouncement to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The guidance should be applied retrospectively. For public entities, the guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. In December 2011, the FASB issued an authoritative pronouncement related to deferral of the effective date for amendments to the presentation of reclassifications of items out of accumulated other comprehensive income. This guidance allows the FASB to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the FASB is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before update the pronouncement issued in June 2011. We adopted this guidance on January 1, 2012 and have separately presented the consolidated statements of comprehensive income since that date.

In September 2011, the FASB issued an authoritative pronouncement related to testing goodwill for impairment. The guidance is intended to simplify how entities, both public and non-public, test goodwill for impairment. The guidance permits an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if a public entity's financial statements for the most recent annual or interim period have not yet been issued. The adoption of this pronouncement did not have a significant effect on our consolidated financial statements, as we chose to directly perform the two-step goodwill impairment test for 2012.

In July 2012, the FASB issued an authoritative pronouncement related to testing indefinite-lived intangible assets, other than goodwill, for impairment. Under the guidance, an entity testing an indefinite-lived intangible asset for impairment has the option of performing a qualitative assessment before calculating the fair value of the asset. If the entity determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is not more likely than not (i.e., a likelihood of more than 50 percent) impaired, the entity would not need to calculate the fair value of the asset.

The guidance does not revise the requirement to test indefinite-lived intangible assets annually for impairment. In addition, the guidance does not amend the requirement to test these assets for impairment between annual tests if there is a change in events or circumstances; however, it does 58-------------------------------------------------------------------------------- Table of Contents revise the examples of events and circumstances that an entity should consider in interim periods. The guidance was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of this guidance did not have a significant effect on our consolidated financial statements.

Recent accounting pronouncements not yet adopted In December 2011, the FASB has issued an authoritative pronouncement related to disclosures about offsetting assets and liabilities. The guidance requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. We do not expect the adoption of this guidance to have a significant effect on our consolidated financial statements.

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