Annual and Transition Report (foreign Private Issuer) (20-f)

Date : 04/22/2019 @ 8:06PM
Source : Edgar (US Regulatory)
Stock : 500 com Limited (WBAI)
Quote : 9.35  0.09 (0.97%) @ 11:00PM

Annual and Transition Report (foreign Private Issuer) (20-f)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 20-F

 

 

 

(Mark One)

¨ Registration statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934 or
     
x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2018

 

or

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from __________ to __________

or

 

¨ Shell company report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Date of event requiring this shell company report

 

Commission file number 001-36206

 

500.com Limited

(Exact Name of Registrant as Specified in Its Charter)

 

Cayman Islands 

(Jurisdiction of Incorporation or Organization)

 

12F, West Side, Block B, Building No. 7

Shenzhen Bay Eco-Technology Park

Nanshan District, Shenzhen 518115

The People’s Republic of China

(Address of Principal Executive Offices)

 

Qiang Yuan, Chief Financial Officer  

12F, West Side, Block B, Building No. 7

Shenzhen Bay Eco-Technology Park

Nanshan District, Shenzhen 518115 

The People’s Republic of 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 Securities and Exchange Act of 1934:

 

Title of Each Class   Name of Each Exchange on Which Registered
Ordinary shares, par value US$0.00005 per share*   New York Stock Exchange*

 

* Not for trading, but only in connection with the listing of the American depositary shares (“ADSs”) on the New York Stock Exchange. Each ADS represents the right to receive ten ordinary shares. The ADSs are registered under the Securities Act of 1933, as amended, pursuant to a registration statement on Form F-6. Accordingly, the ADSs are exempt from registration under Section 12(b) of the Securities Exchange Act of 1934, as amended, pursuant to Rule 12a-8 thereunder.

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

 

None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

 

Indicate the number of outstanding shares of each of the Issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

350,804,532 Class A ordinary shares and 74,400,299 Class B ordinary shares, par value US$0.00005 per share, as of December 31, 2018.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No  x

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Emerging Growth Company ¨

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. ¨

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP x International Financial Reporting Standards as issued by the International Accounting Standards Board ¨   Other ¨

 

If “Other” has been checked in response to the previous question, indicate by check mark which consolidated financial statement item the registrant has elected to follow.

 

Item 17 ¨           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 Securities Exchange Act of 1934). Yes ¨ No x

 

(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. Yes ¨ No ¨

 

 

 

 

 

 

TABLE OF CONTENTS

 

    Page
     
PART I   3
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 3
ITEM 3. KEY INFORMATION 3
ITEM 4. INFORMATION ON THE COMPANY 37
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 63
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 87
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 96
ITEM 8. FINANCIAL INFORMATION 96
ITEM 9. THE OFFER AND LISTING 97
ITEM 10. ADDITIONAL INFORMATION 98
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 106
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 107
PART II   109
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 109
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 109
ITEM 15. CONTROLS AND PROCEDURES 109
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 110
ITEM 16B. CODE OF ETHICS 110
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 110
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 111
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 111
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 112
ITEM 16G. CORPORATE GOVERNANCE 112
ITEM 16H. MINE SAFETY DISCLOSURE 112
PART III   113
ITEM 17. FINANCIAL STATEMENTS 113
ITEM 18. FINANCIAL STATEMENTS 113
ITEM 19. EXHIBITS 113

 

i

 

 

CONVENTIONS THAT APPLY TO THIS ANNUAL REPORT ON FORM 20-F

 

Unless otherwise indicated, references in this annual report on Form 20-F to:

 

· “ADRs” are to the American depositary receipts, which, if issued, evidence our ADSs;

 

· “ADSs” are to our American depositary shares, each of which represents ten ordinary shares;

 

· “China” and the “PRC” are to the People’s Republic of China, excluding, for the purposes of this annual report only, Taiwan and the special administrative regions of Hong Kong and Macau;

 

· “consolidated affiliated entities” refer to our consolidated affiliated entities, namely,

 

o Beijing Baifengrun Technology Co., Ltd., or Baifengrun Technology,

 

o Beijing Daguo Xiaoxian Culture Media Co., Ltd or Daguoxiaoxian, which was disposed of by the Company on February 9, 2018,

 

o Hangzhou Laiqi Information Technology Co., Ltd., or Hangzhou Laiqi, which was disposed of by the Company on May 20, 2016,

 

o Lhasa Yicai Network Technology Co., Ltd., or Lhasa Yicai,

 

o Hainan Jingli Network Technology Co., Ltd., or Hainan Jingli,

 

o Hainan Panfeng Network Technology Co., Ltd., or Hainan Panfeng,

 

o Hangzhou E-Sun Sky Network Technology Co., Ltd., or Hangzhou E-Sun Sky Network,

 

o The Multi Group Ltd, or TMG,

 

o Shangmeng Business Services Co., Ltd., or Shangmeng Services, which was disposed of by the Company on May 20, 2016,

 

o Shenzhen Caiyu Hudong Technology Co., Ltd., or Shenzhen Caiyu, which was disposed of by the Company on November 2, 2017,

 

o Shenzhen E-Sun Sky Network Technology Co., Ltd., or E-Sun Sky Network,

 

o Shenzhen E-Sun Network Co., Ltd., or E-Sun Network,

 

o Shenzhen Fenggu Network Technology Co., Ltd., or Shenzhen Fenggu, which was disposed of by the Company on June 30, 2018,

 

o Shenzhen Kaisheng Jinfu Enterprise Management Co., Ltd., or Shenzhen Kaisheng,

 

o Shenzhen Guangtiandi Technology Co., Ltd., or Guangtiandi Technology,

 

o Shenzhen Qufan Network Technology Co., Ltd., or Shenzhen Qufan, which was disposed of by the Company on February 9, 2018,

 

o Shenzhen Tongfu Technology Co., Ltd., or Tongfu Technology,

 

o Shenzhen Wubai Zhifu Co., Ltd., or 500Fu, which was disposed of by the Company on February 7, 2018,

 

  1  

 

 

o Shenzhen Yicai Network Technology Co., Ltd., or Shenzhen Yicai,

 

o Shenzhen Youlanguang Science and Technology Co., Ltd., or Youlanguang Technology,

 

o Zhejiang Shangmeng Technology Co., Ltd, or Sumpay.cn, which was disposed of by the Company on May 20, 2016, and

 

o Other intermediate holding companies.

 

· “The Multi Group” or “TMG” are to The Multi Group Ltd., 93% of which is owned by us, and the following wholly-owned subsidiaries:

 

o Lotto Warehouse Ltd, or Loto Warehouse;

 

o Multi Brand Gaming Ltd, or Multi Brand;

 

o Multi Warehouse Ltd, or Multi Warehouse;

 

o Multilotto Australia PTY, or Multilotto Australia.

 

o Multilotto UK Ltd, or Multilotto UK;

 

o Multi pay N.V., or Multi pay;

 

o Round Spot Services Ltd., or Round Spot;

 

o Wasp Media Ltd, or Wasp Media; and

 

o Oddson Europe Ltd, or Oddson Europe.

 

· “ordinary shares” are to our ordinary shares, par value US$0.00005 per share;

 

· “RMB” and “Renminbi” are to the legal currency of China;

 

· “US$” and “U.S. dollars” are to the legal currency of the United States;

 

· “EUR” are to the legal currency of the European Union; and

 

· “We,” “us,” “our company,” “our,” “the Group” or “the Company” are to 500.com Limited, its predecessor entities and its consolidated affiliated subsidiaries.

 

  2  

 

 

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not Applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following summary consolidated financial data for the periods and as of the dates indicated are qualified by reference to, and should be read in conjunction with, our consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects.”

 

Our historical results do not necessarily indicate our results to be expected for any future period.

 

    Year ended December 31,  
    2014     2015     2016     2017     2018     2018  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands, except for per share data)  
Consolidated Statement of Comprehensive Income (Loss) Data:                                                
Net Revenues     579,717       99,552       5,259       71,858       126,089       18,339  
Operating costs and expenses:                                                
Cost of services     (53,909 )     (24,355 )     (12,749 )     (37,483 )     (80,017 )     (11,638 )
Sales and marketing     (173,883 )     (87,022 )     (43,398 )     (63,295 )     (92,465 )     (13,448 )
General and administrative     (156,309 )     (232,244 )     (247,408 )     (224,321 )     (251,384 )     (36,562 )
Service development expenses     (59,398 )     (63,296 )     (70,741 )     (58,592 )     (61,909 )     (9,004 )
Write-off of deferred offering expenses     (3,241 )                              
                                                 
Total operating expenses     (446,740 )     (406,917 )     (374,296 )     (383,691 )     (485,775 )     (70,652 )
Other operating income     17,414       6,910       2,731       1,204       12,638       1,838  
Government grant     3,643       2,022       10,017       6,789       7,620       1,108  
Indemnity cost                 (9,979 )                  
Other operating expenses     (4,527 )     (2,975 )     (1,915 )     (34,691 )     (5,060 )     (736 )
                                                 
Operating profit (loss) from continuing operations     149,507       (301,408 )     (368,183 )     (338,531 )     (344,488 )     (50,103 )
Other income/(expenses), net                 -       821       (43 )     (6 )
Interest income     17,009       20,589       23,859       20,032       15,308       2,226  
Interest expense     (356 )     (2,138 )                        
Loss from equity method investments           (407 )     (406 )     (2,128 )     (15,025 )     (2,185 )
Impairment of equity method investments                       (28,781 )     (149,896 )     (21,801 )
Changes in fair value of the structured deposit     (1,124 )     1,124                          
Changes in fair value of contingent consideration                       (2,384 )            
Gain from disposal of subsidiaries                 136,914       5,477       2,805       408  
                                                 
Income (loss) before income taxes from continuing operations     165,036       (282,240 )     (207,816 )     (345,494 )     (491,339 )     (71,461 )
Income taxes (expenses) benefit     (7,987 )     (41,969 )     (2,143 )     14,025       19,602       2,851  
                                                 
Net income (loss) from continuing operations     157,049       (324,209 )     (209,959 )     (331,469 )     (471,737 )     (68,610 )
income from discontinued operations, net of applicable income taxes                 707       15,327       2,183       316  
Gain on disposal of discontinued operations, net of applicable income taxes                             10,160       1,478  
Net income from discontinued operations, net of applicable income taxes                 707       15,327       12,343       1,794  
Net income (loss)     157,049       (324,209 )     (209,252 )     (316,142 )     (459,394 )     (66,816 )
Net loss from continuing operations attributable to noncontrolling interest and redeemable noncontrolling interest           (312 )     (6,633 )     (6,734 )     (8,820 )     (1,283 )
Net income from discontinued operations attributable to noncontrolling interest                 346       7,691       1,099       161  
Less: Net (loss) income attributable to the noncontrolling interests           (312 )     (6,287 )     1,524       (4,486 )     (652 )
Less: Net (loss) attributable to redeemable noncontrolling interest                       (567 )     (3,235 )     (470 )
                                                 
Net income (loss) attributable to 500.com Limited     157,049       (323,897 )     (202,965 )     (317,099 )     (451,673 )     (65,694 )
                                                 
Other comprehensive income (loss)                                                
Foreign currency translation gain (loss)     12,145       66,851       82,347       (55,805 )     23,023       3,349  
Unrealized gain (loss) on available for sale investments                 754       (733 )            
Other Comprehensive income (loss), net of tax     12,145       66,851       83,101       (56,538 )     23,023       3,349  
                                                 
Comprehensive Income (loss)     169,194       (257,358 )     (126,151 )     (372,680 )     (436,371 )     (63,467 )
Less: Comprehensive (loss) income attributable to redeemable noncontrolling interest and noncontrolling interest           (312 )     (6,287 )     1,348       (6,383 )     (928 )
Comprehensive income (loss) attributable to 500.com Limited     169,194       (257,046 )     (119,864 )     (374,028 )     (429,988 )     (62,539 )
                                                 
Earnings (losses) per share attributable to 500.com Limited-Basic:                                                
Net income (loss) from continuing operations     0.46       (0.84 )     (0.49 )     (0.80 )     (1.13 )     (0.164 )
Net income from discontinued operations                 0.001       0.02       0.03       0.004  
Net income (loss)     0.46       (0.84 )     (0.489 )     (0.78 )     (1.10 )     (0.16 )
                                                 
Earnings (losses) per share attributable to 500.com Limited- Diluted:                                                
Net income (loss) from continuing operations     0.44       (0.84 )     (0.49 )     (0.80 )     (1.13 )     (0.164 )
Net income from discontinued operations                 0.001       0.02       0.03       0.004  
Net income (loss)     0.44       (0.84 )     (0.489 )     (0.78 )     (1.10 )     (0.16 )
                                                 
Weighted average number of Class A and Class B ordinary shares outstanding:                                                
Basic     339,782,819       385,590,213       414,872,756       408,310,122       418,911,292       418,911,292  
Diluted     357,848,704       385,590,213       414,872,756       408,310,122       418,911,292       418,911,292  
                                                 
Non-GAAP financial data (1)                                                
Net income (loss) attributable to 500.com Limited     157,049       (323,897 )     (202,965 )     (317,099 )     (451,673 )     (65,694 )
Adjustment for share-based compensation expenses     89,922       158,628       163,341       91,143       108,628       15,799  
Adjustment for deferred tax expense relating to valuation allowance           40,105                          
Adjusted net income (loss) attributable to 500.com Limited (non-GAAP)     246,971       (125,164 )     (39,624 )     (225,956 )     (343,045 )     (49,895 )
Adjusted net income (loss) from continuing operations attributable to 500.com Limited (non-GAAP)     246,971       (125,164 )     (39,985 )     (233,592 )     (354,289 )     (51,528 )
Adjusted net income from discontinued operations attributable to 500.com Limited (non-GAAP)                 361       7,636       11,244       1,633  

 

 

 

(1) As a supplement to net income, we use the non-GAAP financial measure of adjusted net income which is U.S. GAAP net income as adjusted to exclude share-based compensation, deferred tax expenses/(profit) relating to outside basis differences and valuation allowance in our consolidated affiliated entities and costs incurred on convertible note. This non-GAAP financial measure is provided as additional information to help our investors compare business trends among different reporting periods on a consistent basis and to enhance investors’ overall understanding of our current financial performance and prospects for the future. This non-GAAP financial measure should not be considered in addition to or as a substitute for or superior to U.S. GAAP net income. In addition, our definition of adjusted net income may be different from the definition of such term used by other companies, and therefore comparability may be limited.

 

  3  

 

 

The following table sets forth our selected consolidated balance sheet data as of the indicated dates:

 

    As of December 31,  
    2014     2015     2016     2017     2018     2018  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands)  
Consolidated Balance Sheet Data:                                                
Total current assets     1,256,403       1,712,086       1,707,032       737,022       601,585       87,496  
Total assets     1,319,692       2,084,497       2,076,892       1,754,559       1,246,584       181,307  
Total current liabilities     157,876       157,822       209,475       175,937       99,694       14,499  
Total liabilities     202,070       218,161       268,849       223,197       111,634       16,235  
Total 500.com Limited shareholders’ equity     1,117,622       1,767,863       1,709,531       1,409,774       1,116,605       162,404  
Total shareholders’ equity     1,117,622       1,866,336       1,808,043       1,509,310       1,105,562       160,798  
Total liabilities, redeemable noncontrolling interests and shareholders’ equity     1,319,692       2,084,497       2,076,892       1,754,559       1,246,584       181,307  

 

Exchange Rate Information

 

Our business is primarily conducted in China and all of our revenues are denominated in Renminbi. Periodic reports made to shareholders will be expressed in Renminbi with translations of Renminbi amounts into U.S. dollars at the current exchange rate solely for the convenience of the reader. Conversions of Renminbi into U.S. dollars in this annual report are based on the noon buying rate as set forth in the H.10 statistical release of the Federal Reserve Board. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this annual report were made at a rate of RMB6.8755 to US$1.00, the noon buying rate in effect as of December 31, 2018. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade.

 

B. Capitalization and Indebtedness

 

Not Applicable.

 

C. Reasons for the Offer and Use of Proceeds

 

Not Applicable.

 

D. Risk Factors

 

Risks Related to Our Business and Industry

 

We have changed our business model a few times during the last few years, which makes it difficult to evaluate our business.

 

In recent years, we have begun new lines of businesses and suspended or disposed of existing lines of businesses, including:

 

· we launched our online lottery services in 2001 and became profitable in 2007. We have suspended all of our online lottery sales services since April 4, 2015, and have not generated any revenue from these operations since then.

 

· In December 2015, we acquired a 63% equity interest in Sumpay.cn and its wholly-owned subsidiaries, which provide third-party payment services in China, and disposed of this investment in May 2016.

 

· In July 2016, we acquired a 100% equity interest in Shenzhen Caiyu, a provider of sports information services in China and disposed of this investment in November 2017.

 

· In October 2016, we held a 51% equity interest in Shenzhen Kaisheng to provide online spot commodity trading services in China.

 

· In November 2016, we acquired a 51% equity interest in Qufan Internet Technology Inc., and Shenzhen Qufan Network Technology Co., Ltd. (together “Qufan”) to provide mobile poker games services in China, and disposed of this investment in February 2018.

 

  4  

 

 

· In July 2017, we acquired a 93% equity interest in The Multi Group Ltd., or TMG, which holds licenses to operate online gaming sites from Curacao, Malta, the United Kingdom, Ireland and Sweden.

 

· In March 2018, we entered into a framework agreement with the Sports Lottery Center, pursuant to which we will cooperate with the Sports Lottery Center to develop physical channels to sell sports lottery tickets. As of the date of this annual report, we had entered into framework agreements with Tianjin, Hunan and several other provincial (including regional and municipal) sports lottery centers and started trial operations in Tianjin, Hunan, Hubei, Guangxi and several other provinces and cities in China.

 

Many of our business lines are relatively new business models in an emerging and rapidly evolving market. This makes it difficult for you to evaluate our business, financial performance and prospects, and our historical growth rate may not be indicative of our future performance. We may not be able to realize our profit expectation when we began to offer any of these new lines of businesses. You should consider our prospects in light of the risks and uncertainties that fast-growing companies in a rapidly evolving market may encounter.

 

In particular, we have suspended all of our lottery sales services since April 4, 2015 in response to the promulgation of the Self-Inspection Notice and the Public Announcement and there is no clear indication as to how long our voluntary suspension will last as of the date of this annual report. As a result of the voluntary suspension of our online sports lottery sales services, our net revenues in 2015 were RMB99.6 million, representing an 82.8% decrease as compared to 2014, and we recorded a net loss attributable to 500.com Limited of RMB323.9 million in 2015, as compared to net income attributable to 500.com Limited of RMB157.0 million in 2014. We cannot assure you that even if we are able to resume our online sports lottery sales services in the future, our users’ purchasing activities for sports lottery products will return to previous levels and continue to grow at a comparable pace as compared to that of the period prior to the voluntary suspension.

 

We have suspended all of our online lottery sales services since April 4, 2015, and have not generated any revenue from these operations since then. There is no clear indication as to when the suspension will be lifted.

 

Since March 2015, all provincial sports lottery administration centers to which we provide sports lottery sales services have suspended accepting online purchase orders for lottery products, in response to the Notice related to Self-Inspection and Self-Remedy of Unauthorized Online Lottery Sales, or the Self-Inspection Notice, which was jointly promulgated by the Ministry of Finance, or the MOF, the Ministry of Civil Affairs and the General Administration of Sports of the People’s Republic of China on January 15, 2015.

 

The Self-Inspection Notice requires provincial and municipal government branches, including financial, civil affairs and sports bureaus, to conduct inspections and take remedial measures for unauthorized online lottery sales within their respective jurisdictions. The scope of inspection includes, among other things, commercial contract arrangements, online lottery products, lottery sales data exchange, online lottery sales channels, and sales commission fees in connection with unauthorized engagements of online sales agents by lottery administration centers. The Self-Inspection Notice further requires a formal report on the result of the self-inspection and self-remedy be submitted by each provincial or municipal government to the Ministry of Finance, the Ministry of Civil Affairs and the General Administration of Sports of the People’s Republic of China by March 1, 2015.

 

  5  

 

 

On February 24, 2015, we were informed by certain provincial sports lottery administration centers that as part of their respective self-inspection processes, such provincial sports lottery administration centers planned to suspend accepting online purchase orders for lottery products starting from February 25, 2015. On March 2, 2015, we were further informed by the remaining provincial sports lottery administration centers to which we provide sports lottery sales services that such provincial sports lottery administration centers also planned to suspend accepting online purchase orders for lottery products, in response to the Self-Inspection Notice. As a result, our transaction volume decreased significantly. On April 3, 2015, a public announcement, or the Public Announcement, with regard to online lottery sales in China was jointly released by eight competent government authorities, namely, the MOF, the Ministry of Public Security, the State Administration for Industry & Commerce, the Ministry of Industry and Information Technology, the Ministry of Civil Affairs, the People’s Bank of China, the General Administration of Sports of China and the China Banking Regulatory Commission. The Public Announcement mandates, among other things, that (i) all lottery institutions, internet companies, and other institutions or individuals which provide unauthorized online lottery sales services, either directly or through agents, shall immediately cease such services. The local governmental authorities of finance, civil affairs and sports shall investigate and sanction unauthorized online lottery sales in their respective jurisdictions according to relevant laws and regulations; (ii) the local government authorities of public security and industry & commerce shall investigate any issuance or sales of illegal lottery within their respective jurisdictions, with necessary assistance from local government authorities of finance, communication, banking regulatory commission, civil affairs, sports and local branches of the People’s Bank of China, and report any criminal activities to the judicial authority for prosecution; and (iii) the lottery issuance authorities that plan to sell lottery products online shall obtain the approval from the Ministry of Civil Affairs or the General Administration of Sports of China by submitting an application to the MOF for written approval. No entity shall provide online lottery sales services without the approval by the MOF.

 

We believe the close proximity of the promulgation of the Self-Inspection Notice and the Public Announcement signals a potential significant change of regulatory framework in the online lottery market in China. In light of such potential change of regulatory framework, we decided to voluntarily suspend all of our online lottery sales services on April 4, 2015. Since we voluntarily suspended our online lottery sales services and up to the date of this annual report, we had not generated any revenue from these services, which has caused our financial results to be materially and adversely impacted during the suspension period.

 

With the promulgation of the Self-Inspection Notice and the Public Announcement, the competent government authorities took further steps to regulate the lottery market in China and sanction unauthorized online lottery sales. After the issuance of the Self-Inspection Notice and the Public Announcement, there has been no indication as to when the online sales of sports lottery products will be permitted to resume, if at all. Therefore, as of the date of this annual report, there is no clear indication as to how long our voluntary suspension of online sports lottery sales services will last, and we have been working and will continue to work with the China Sports Lottery Administration Center to develop a management system to cope with any new regulatory framework to be adopted.

 

The rules and regulations on online lottery sales service market in China are relatively new and interpretations and implementation thereof have changed substantially on a number of occasions, and their further interpretations and implementation involve uncertainty.

 

During our 18-year history of providing online lottery sales services, we have encountered a number of significant changes on interpretations and implementation of the rules and regulations in respect of the provision of these services as further described below.

 

Operations under the Implementing Rules. On September 26, 2010, the MOF issued the Interim Measures for the Administration of Online Sales of Lottery, or the Interim Measures, which allows qualified service providers to provide online lottery sales services after obtaining the approval by and the operating permit from the MOF. On January 18, 2012, the MOF, the Ministry of Civil Affairs and the General Administration of Sports of China jointly promulgated the Implementing Rules of Regulation on Administration of Lottery, or the Implementing Rules, which set forth, among other things, detailed requirements and qualifications for the approvals to conduct online lottery sales. For a description of relevant PRC laws and regulations on online lottery services, see “Item 4B. Business Overview—Regulation on Lottery Services Industry and Online Lottery Sales.” Applications were submitted to the MOF in connection with the qualifications and approvals of our online lottery sales services for both sports and welfare lottery products provided on our websites, in accordance with the new measures.

 

Partial suspension in 2012. From March to November 2012, we suspended our online lottery sales services to substantially all of our customers in response to the Urgent Notice with regard to the Implementation of the Implementing Rules of Regulation on Administration of Lottery promulgated by the General Administration of Sports of China on February 28, 2012, or the Urgent Notice. We, however, continued to provide lottery sales services via our mobile applications to mobile users and via our online platform to a limited number of loyal customers and generated service fees from such services. The PRC regulations on lottery sales services via mobile applications and their interpretations are subject to uncertainty. Our PRC legal counsel has advised us, given that the MOF has approved us as an authorized entity to conduct online lottery sales on behalf of the China Sports Lottery Administration Center, our operation of lottery sales services prior to November 2012, including sales through our mobile applications and online platform, did not and will not likely to have a material adverse effect on us. However, under the rules and regulations on online lottery sales, the relevant PRC authorities have broad discretion on the lottery sales that are conducted without the approval by the MOF, and have the authority to impose sanctions thereon, including without limitation, levying fines, confiscating illegal income or suspending the operations and other sanctions. We have not received any legal sanctions, but there is no assurance that the competent authorities would not impose any legal sanction. Any legal sanctions imposed on us by the competent authorities could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

  6  

 

 

Approval in 2012 to Conduct Online Sports Lottery Sales. In October 2012, we were notified by the China Sports Lottery Administration Center that we were one of the two entities that had been approved by the MOF to conduct online sales of sports lottery products in China on behalf of the China Sports Lottery Administration Center. Since the operation of online sports lottery sales services by the China Sports Lottery Administration Center itself was in a pilot phase and subject to further approval by the MOF, our operation of online sales of sports lottery products may be subject to suspension if the China Sports Lottery Administration Center fails to obtain such further approval from the MOF. The competent authorities may establish certain management systems to supervise and monitor the online lottery sales, which systems may comprise a sales monitoring system, a back-office management system and an application service platform. The competent authorities may also ask the approved entities, like us, to adopt certain measures to meet specific regulatory requirements that may be adopted from time to time. For example, the competent authorities may monitor or adjust the categories of lottery products being sold online, and supervise the sales procedures and key data of our online lottery sales on a real-time basis, such as those relating to our customer account opening procedures, capital management, database information and risk controls. In addition, we may be required to enter into new lottery agency agreements with the relevant lottery administration center that could have different terms and conditions from those in our existing service agreements with the relevant sports lottery administration centers. As a result, we may have to amend our existing service agreements. Any unfavorable new regulatory requirements or amendments to the key terms of our existing service agreements could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Suspension since April 2015. As stated above, since April 4, 2015, we have voluntarily suspended our online sports lottery sales services in response to the issuance of the Self-Inspection Notice and the Public Announcement.

 

Our business, operation and financial results have been and will be further materially and adversely impacted by changes in interpretation or the implementation of rules and regulations governing the online lottery sale services in China.

 

Our business has been and may continue to be materially affected by changes to, or interpretation of, government regulation in Europe that may apply to online gaming.

 

Through TMG, we hold licenses to operate online gaming sites from Curacao, Malta, the United Kingdom, Ireland and Sweden, and are required to renew them periodically. Some European jurisdictions have introduced regulations attempting to restrict or prohibit online gaming, while other jurisdictions have taken the position that online gaming is legal and have adopted or are in the process of considering legislation to regulate online gaming.

 

Sweden represents our top European market (generating approximately 71% of TMG’s total revenue in 2018), but did not have a license requirement until January 2019. The Swedish government submitted a legislative proposal to the European Commission in late 2017, and by making this legislative proposal, the legislation entered a three-month period of standstill that ended on March 31, 2018, during which European Union authorities reviewed the proposal. The Swedish government began accepting license applications from interested operators in mid-2018, and the new regulatory framework took effect on January 1, 2019. We operated in Sweden under the Curacao license before we obtained the Swedish license on December 20, 2018.

 

While certain European countries are adopting a regulated online gaming approach, there are some opposing views. Some countries, where there are state-owned monopolies, are taking action aimed at banning foreign online gaming operators. Any decision of the European Court of Justice or legislation promulgated by the European Commission that effectively prohibits online gaming in European Union member states could have a severe material adverse effect on our business, revenues, operating results and financial condition.

 

  7  

 

 

As companies and consumers involved in online gaming are located around the globe, including our licensees and players, there is uncertainty regarding which government has the authority to regulate or legislate the industry.

 

Future decisions may have a material impact on our operations and financial results. There is a risk that governmental authorities may view us or our licensees as having violated the local law of their end users. Therefore, there is a risk that civil and criminal proceedings, including class actions brought by or on behalf of public entities or private individuals, could be initiated against us, our licensees, internet service providers, credit card processors, advertisers and others involved in the online gaming industry and could involve substantial litigation expense, penalties, fines, injunctions or other remedies or restrictions being imposed upon us, our licensees or others while diverting the attention of key executives. Such proceedings could have a material adverse effect on our business, revenues, operating results and financial condition.

 

There can be no assurance that prohibiting legislation will not be proposed and passed in potentially relevant European jurisdictions to legislate or regulate various aspects of the Internet or the online gaming industry. The burden of compliance with any such legislation may have a material adverse effect on our business, financial condition and results of operations.

 

Our operations in certain jurisdictions may violate local laws and regulations. The interpretation and enforcement of such laws and regulations could adversely impact our business.

 

We have sought legal advice regarding the legality of our online gaming services in certain European jurisdictions in which we operate. We have been advised by local counsel in certain jurisdictions, including Austria, Germany and the Netherlands, that certain of Multilotto’s operations in such jurisdictions are prohibited by local gaming laws and regulations. Local counsel, however, also advised us that there may be a reasonable legal basis to believe that such local laws contradict relevant European Union law, particularly Article 56 of the Treaty on the Functioning of the European Union regarding freedom of providing services among European Union member states. If such local laws violate European Union law, Multilotto’s operations would not be prohibited.

 

In 2017, net revenue from Germany, Austria, the Netherlands and Switzerland accounted for 3.6%, 0.4%, 1.5% and 0.9% of our total net revenue. In 2018, net revenue from Germany, Austria, the Netherlands and Switzerland accounted for 5.4%, 0.4%, 2.0% and 0.7% of our total net revenue, respectively.

 

Our business, operation and financial results may be adversely impacted by the interpretation and enforcement of laws and regulations governing online gaming services in these and other jurisdictions in which we operate.

 

Our game providers may fail to obtain or renew or may experience material delays in obtaining requisite approvals, licenses and permits, which could negatively impact our business.

 

Certain of our game providers require various approvals, licenses and permits to conduct their business, including business to business, or B2B, gaming and software licenses. We cannot assure you that these providers will not encounter significant problems in obtaining new or renewing existing approvals, licenses and permits, or that they will continue to satisfy the conditions to which such approvals, licenses and permits granted. If previously obtained approvals, licenses and permits are revoked and/or if the providers fail to obtain and/or maintain the necessary approvals, licenses and permits required to conduct their business and/or host or manage games as currently provided, we may be required to temporarily suspend the operation of certain gaming services, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

  8  

 

 

Implementation of new lines of business, such as our recent cooperation with the Sports Lottery Center to develop physical channels to sell sports lottery tickets and certain other new business initiatives, may not yield desirable profits or improve our results of operations.

 

From time to time, we may implement new lines of business or offer new products and product enhancements as well as new services within our existing lines of business. For example, we began to cooperate with the China Sports Lottery Administration Center, or the Sports Lottery Center, in March 2018 to develop physical channels to sell sports lottery tickets, install sports lottery terminals and provide relevant maintenance and operational services in accordance with local development plans for the sports lottery business.

 

There are substantial risks and uncertainties associated with these efforts, particularly when considering the market is not fully developed. In developing these new lines of business or services, we may invest significant time and resources. Initial timetables for the introduction and development of these lines of business and services may not be achieved and profitability targets may not prove feasible. External factors, such as compliance with regulations, competition and shifting market preferences, may also impact the successful implementation of these new lines business or services. Our personnel and technology systems may fail to adapt to the changes in these new lines of business or we may fail to effectively integrate new services into our existing operations. In addition, we may be unable to compete effectively due to the different competitive landscape in the new areas of business. Furthermore, these lines of business could have a significant impact on the effectiveness of our internal control system. Failure to successfully manage these risks in the development and implementation of these lines of business and services could have a material adverse effect on our business, results of operations and financial condition.

 

The success of our business depends on our ability to maintain and enhance our reputation and brand.

 

We believe that our reputation in the industry and among our users as a leading reliable and trustworthy online lottery service provider and our “500wan” brand is of significant importance to the success of our business. A well-recognized brand is critical to increasing our user base and, in turn, increasing our net revenues from service fees. Since the online lottery service market is highly competitive, our ability to remain the market leader in China depends largely on maintaining and enhancing our reputation and brand, which may be difficult and expensive.

 

We have developed our reputation and established a leading position by providing our users with what we believe are superior and trustworthy services. We have conducted, and may continue to conduct, various marketing and brand promotion activities. We cannot assure you, however, that these activities will be successful and achieve the brand promotion and activity enhancement goals we expected. In addition, any negative publicity in relation to our services or products, regardless of its veracity, could harm our brand image and, in turn, have adverse effects on our user loyalty and stickiness, or result in a reduction in the number of our users. For example, we are aware of certain complaints against our websites on a number of online forums with regard to purchase order processing and prize collections. Even though the allegations made in such complaints were not factually proven or the amounts in issue were diminutive, such complaints can nonetheless have a detrimental effect on our reputation. If we fail to maintain and enhance our reputation and brand, or if we incur excessive expenses in our efforts to do so, our business, financial condition and results of operations may be materially and adversely affected.

 

Our product portfolio depends on the offerings of the lottery administration centers and could change unfavorably for us as a result of decisions made by them.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, the lottery products we serviced were issued and sold by national and provincial lottery administration centers. We do not have the right to issue lottery products and could not prevent the discontinuation of lottery products that were offered. If the national lottery administration centers had decided to discontinue one or more lottery products or to replace them with other products, this could have led to a decline in our purchase orders and thus would have had an adverse effect on our financial position and results of operations. In addition, if we had wanted to provide services on newly issued lottery products, we would have had to enter into service agreements with the lottery administration centers that issue or sell such new lottery products. We cannot assure you that such service agreements could have been entered into on terms favorable to us, or at all. If our competitors are able to enter into service agreements to service popular newly issued lottery products while we cannot, it could have an adverse effect on our revenue and brand name.

 

  9  

 

 

Lottery products offered by provincial lottery administration centers may have been discontinued or subject to restriction and regulations by the relevant national lottery administration centers. In particular, in March 2015 all provincial sports lottery administration centers we serviced suspended accepting online purchase orders for lottery products in response to the Self-Inspection Notice, which materially and adversely affected our results of operations and financial conditions since such suspension. In addition, due to the popularity of certain lottery products we service, those provincial lottery administration centers with which we did not have service agreements might have chosen to issue similar lottery products on more competitive terms. This may have resulted in a decrease in the purchase orders of those lottery products we serviced and, in turn, resulted in a decrease in the revenue we were able to generate from those lottery products. We cannot assure you that we will be able to reach an agreement with a provincial lottery administration center to obtain the right to service its lottery products that compete with the products we currently service. In addition, the relevant lottery authorities could mandate the change of the rules or prize scheme of our current lottery products or stop the issuance of those lottery products altogether due to social policy or other considerations, which could have an adverse effect on our results of operations.

 

We depend on our agreements with a few provincial lottery administration centers for our service fees and such agreements could be terminated, amended or fail to be renewed.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, substantially all of our revenues were provided by service fees paid to us by a few provincial lottery administration centers. We have entered into non-exclusive service agreements with these lottery centers for terms of one year or five years, and the lottery administration centers may choose to enter into similar arrangements with other service providers. We have long-term, mutually beneficial partnerships with a few provincial lottery administration centers, such as Jiangxi Sports Lottery Administration Center. The service fees received from the lottery administration centers represent revenues recognized before the reduction of incentives paid to users and the residual amount of the lottery pool contributed by us to the lottery centers. Previously, we had a service agreement with Jiangxi Sports Lottery Administration Center that expired in March 2018 and was not renewed. If any of the provincial sports lottery administration centers terminates or decides not to renew its agreement with us, or if the agreement is amended to our disfavor, this could have an adverse effect on our business, results of operations and prospects, and we could lose a substantial portion of our revenues.

 

By March 2015, all sports lottery administration centers have suspended accepting online purchase orders for lottery products in response to the Self-Inspection Notice, and we have voluntarily suspended our online lottery sales services in response to the issuance of the Self-Inspection Notice and the Public Announcement since April 4, 2015. There has been no indication as to when the online sales of sports lottery products will be permitted to resume, if at all. Therefore, as of the date of this annual report, there is no clear indication as to how long our voluntary suspension of online lottery sales services will last.

 

We operate in an intensely competitive environment, which may lead to declining revenue growth or other circumstances that would negatively affect our results of operations.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, we operated in the new and dynamically growing online market for lottery products. There is no guarantee that we could have maintained our position as one of the market leaders. If we are unable to resume our online sports lottery sales services in the future, we anticipate significant competition, primarily from other online lottery service providers that may obtain relevant approvals and licenses to provide online lottery sales services in China. When the approval and licensing system for online lottery service providers is fully implemented in China in the future, we may face increased competition from companies that do not currently operate in the online lottery services industry. For example, if major portal websites obtain relevant approvals and licenses to offer lottery sales services, they may be able to offer similar services at a lower cost or to a larger user group due to their larger operational scales and user bases, which will put us at a competitive disadvantage. We may also face competition from traditional offline lottery agents. If we do not recognize market trends or user demand in a timely manner, we may lose our market share to our competitors, which would have a negative impact on our results of operations.

 

  10  

 

 

The lottery industry in China in general and the online lottery service industry in particular may not grow as quickly as expected, which may adversely affect our revenues and business prospects.

 

Our business and prospects depend on the continuing development and expansion of the lottery industry in China in general and the online lottery service industry in particular. Both China’s lottery industry has, and, prior to the voluntary suspension of online sports lottery sales services in general in China in early 2015, the online lottery service industry had, experienced substantial growth in recent years in terms of both the number of people purchasing lottery products and revenue generated. We cannot assure you, however, that the lottery industry or the online lottery service industry in China may grow as rapidly as it has in the past. Growth of China’s lottery industry and the online lottery services industry are affected by numerous factors, such as GDP growth, growth of individual disposable income, regulatory changes, public perception and receptiveness, users’ trust and confidence level in the online lottery market, users’ general online purchase experience, technological innovations, development of the Internet and Internet-based services, and the macroeconomic environment. For example, the suspension by provincial lottery administration centers in response to the Self-Inspection Notice in March 2015 has had, and is expected to continue to, materially and adversely affected online lottery market in China as long as the suspension continues. If the lottery industry or online lottery service industry in China does not grow as quickly as expected or if we fail to benefit from such growth by failing to successfully implement our business strategies, our user base may decrease and our business and prospects may be adversely affected.

 

Online spot commodity trading is a highly-regulated industry and any regulatory change may result in changes in trading models and trading rules of the exchanges, which could adversely affect our business and prospects.

 

As a relatively new industry, online spot commodity trading industry in China has undergone and continues to undergo significant changes in its regulatory regime. On November 11, 2011, the State Council issued Decision of the State Council on Straightening Out and Rectifying Various Types of Trading Venues to Effectively Prevent Financial Risks, or Circular 38. On July 12, 2012, the general office of the State Council issued the Implementation Opinions on Straightening Out and Rectifying Various Types of Trading Venues, or Circular 37, to further regulate various trading exchanges established with approval from provincial or other local governments. Pursuant to Circular 37, each of the provincial governments shall conduct inspections of trading exchanges within its jurisdiction based on the guidance of Circulars 38 and 37. Exchanges that are not in compliance may be banned from launching new products, be ordered to make rectification or even be shut down.

 

The Shanghai Gold Exchange that we plan to focus our operation on, is not subject to such provincial inspection as a national exchange. However, different provincial governments and different departments of the central government may have different interpretations and implementation practices of Circulars 38 and 37. If the Shanghai Gold Exchange were to be found non-compliant under Circulars 38 and 37, and were to be required to change or adjust its trading models or rules accordingly, our operation on that exchange may become less profitable or even infeasible. We may have to transfer our business and customers to other exchanges, which may result in extra expenses and adversely affect our customers’ trading experience as well as our results of operations and financial condition. If we decide to continue to operate on that exchange, we may need to adjust our business model or our business on that exchange may become less profitable both in the short term and in the long term.

 

Apart from Circulars 38 and 37, the State Council and provincial governments may adopt new or revise current laws and regulations, and the interpretation and implementation of such laws and regulations may vary from one locality to another. For example, the government may impose restrictions on the commodities available for trading, limit the maximum leverage ratios or trading frequencies for certain commodities, impose qualification requirements on individual investors who can trade certain commodities, or require physical settlement of spot commodity transactions. The government may even prohibit online spot trading of certain commodities. Complying with these regulations and rules could potentially make it not feasible for us to continue with certain businesses that we currently engage in or reduce our customer trading volume or customer base, thus materially and adversely affecting our revenue and business prospects.

 

We depend on the technology and advanced information system, which may fail or be subject to disruption.

 

We are dependent on our IT systems for handling purchase orders, and the efficiency and reliability of our systems are in turn dependent on the functionality and stability of the underlying technical infrastructure. The functionality of the servers used by us and the related hardware and software infrastructure are of considerable significances to our business, our reputation and our ability to attract business partners and users. Our IT systems may be damaged or interrupted by increases in usage, human errors, unauthorized access, destruction of hardware, power cuts not covered by backup facilities, system crashes, software problems, virus attacks, natural hazards or disasters, or similar disruptions or disruptive events. Furthermore, our current IT systems may be unable to support a significant increase in online traffic or increased number of users, whether as a result of organic or inorganic growth of the business. We have in place business continuity procedures, disaster recovery systems and security measures to protect against network or technical failures or disruptions. Despite such procedures, failures in computer processing and weakness in the existing software and hardware cannot be entirely prevented or eliminated. Any failure of our IT system and infrastructure could lead to significant costs and disruptions that could reduce our revenues, harm our reputation and have a material adverse effect on our operations.

 

  11  

 

 

In addition, we rely on bandwidth providers, communications carriers, data centers and other third parties for key aspects of the process in providing services to our users. Any failure or interruption in the services and products provided by these third parties could limit our ability to operate certain of our businesses, which could in turn have a material adverse effect on our business and financial condition.

 

We may not be able to develop and launch new services or new technologies in a timely manner or at all, and new services or technologies we manage to develop or provide may not be successful.

 

Our success in attracting new users and keeping existing users engaged have in the past depended on our ability to consistently develop and launch new and innovative services and technologies. Although we will continue to focus on research and development going forward, if and when we are able to resume our online lottery service we cannot assure you that we will continue to be able to develop our technology to keep up-to-date with developments across the online lottery service industry and to launch new products or technologies in a timely manner or at all. New technologies and software are also less likely to be reliable, robust and resistant to viruses or failure. Given the fast-growing online lottery service industry, we may not have enough time to fully test the new technologies and software we have developed before deploying them on our websites, which might cause service problems and negative user experience.

 

In particular, the number of people who access the Internet through non-PC devices such as mobile phones has increased in recent years. The software we have developed for these devices may not be widely adopted by users of such non-PC devices. If we are unable to attract and retain a substantial number of non-PC device users to our services or if we are slow to develop services and technologies that are more compatible with non-PC devices relative to our competitors, we may fail to capture a significant share of new users or lose our existing users who switch to non-PC devices for their lottery purchase activities.

 

We could be subject to foreign laws and regulations applicable to lottery services, which could have important legal consequences for us.

 

We conduct our operations in China, and will continue to do so in the future. We have blocked direct access to our websites and mobile applications from the United States through IP address filtering. We have implemented an identity verification procedure as part of the prize collection process. A user who has won a prize is required to provide his or her valid PRC identification card number and valid PRC bank account number to us for identity and age verification through a government-designated entity before we transfer the prize money to such user’s online account registered at our websites and mobile applications. Despite such measures taken by us, it is conceivable that a user with a valid Chinese bank account and a Chinese identification card could place an order or collect a prize at our websites or mobile applications from a jurisdiction other than China and the United States, or that a user could devise a way to evade our blocking measures and access our websites and mobile applications from the United States. In addition, we have not been able to implement the same identity verification process over users registered with websites of third-party online service providers, which conduct their own identity verification processes, and these users may place purchase orders with us and collect prize money they win without providing their identity to us. As a result, we could be subject to foreign laws and regulations applicable to lottery services, which could have important legal consequences for us. The fact that our websites and mobile applications are accessible from a foreign jurisdiction could render our business operations subject to the laws and regulations of such jurisdiction, even though we do not have a physical presence in that jurisdiction. As a result, we could be required to obtain the requisite approval or license for lottery services in such jurisdiction, or could be deemed to have violated the prohibition against lottery services in that jurisdiction.

 

  12  

 

 

If we were found to have violated any applicable foreign laws and regulations applicable to lottery services, we could face civil or even criminal liabilities, such as injunctions, restrictive orders, damage awards or fines. Even if we successfully defend ourselves against such allegations, we could nevertheless incur considerable costs in such defense or suffer reputational damage due to the negative publicity associated with such allegations.

 

Our systems and controls to restrict access to our websites from persons located in the United States may not be adequate.

 

In the United States, some credit card companies have classified online purchase orders of U.S. state-issued lottery products as online gambling and thus denied such purchase orders, even though many such purchases are exempt from the Unlawful Internet Gambling Enforcement Act, or UIGEA, enacted in 2006. The UIGEA is silent on whether lottery products issued by non-U.S. state entities are exempt from the definition of online gambling. There are several other U.S. federal laws relevant to online gaming, including the Professional and Amateur Sports Protection Act, the Federal Interstate Wire Act, the Illegal Gambling Business Act, the Interstate Transportation of Wagering Paraphernalia Act and the Interstate and Foreign Travel or Transportation in Aid of Racketeering Enterprising Act. In addition, laws and regulations exist in various individual U.S. states that limit or prohibit online games of chance. Although prior to the voluntary suspension of our online sports lottery sales services in April 2015, the services we provided to our users were solely related to lottery products issued and sold by national and authorized provincial lottery administration centers in China, we cannot assure you that the United States Department of Justice or other federal or state regulatory authorities will not deem our business as being in violation of the UIGEA or any of the laws mentioned above if purchase orders are placed on our platform from users in the United States not successfully blocked by our system. Violations of such laws can lead to criminal and civil penalties, including substantial fines, injunctions, damage claims and jail terms for persons accountable.

 

As a precaution, we have implemented technological and other measures to prevent persons in the United States from accessing our websites and mobile applications. These measures could fail or otherwise be inadequate, either currently or as a result of future technological developments. This may result in allegations or accusations of our violations of the above-mentioned or other applicable laws or regulations of the United States, and actions brought against us based on such violations, which could have a material adverse effect on our operations, financial performance and prospects.

 

Our service agreements with certain third-party Internet companies may be amended or terminated.

 

We generate a portion of our net revenues pursuant to cooperation agreements with certain third-party Internet companies. We build and maintain embedded lottery purchase webpages for websites of these Internet companies which redirect user purchase orders to our websites. We pay these third-party Internet companies a predetermined fixed percentage of the total purchase amount generated by purchase orders redirected to us from their websites. In 2016, 2017 and 2018, such payments to certain Internet companies accounted for nil, 7.2% and 0.3% of our net revenues, respectively. We also provide lottery information packages to the lottery information channels of some portal websites. The third-party Internet companies that we work with may request amendments to the material terms of our cooperation agreements in a manner that is unfavorable to us or decide to terminate such cooperation agreements. In particular, if any of these companies decide to start offering its own online lottery services after terminating its cooperation arrangement with us, users formerly redirected to our websites through websites of these companies may decide to use these companies’ services instead, which would have a negative impact on our net revenues.

 

We are exposed to contractual claims by third parties arising from regulatory actions, which could damage our reputation and results of operations.

 

We have entered into various service, online payment and advertisement agreements with a number of third parties. Many of these agreements contain warranties, indemnities and termination provisions in which we have made representations and warranties to the counterparties as to the legitimacy of our operations and our compliance with relevant laws and regulations. If a claim or regulatory action is brought against our counterparties alleging that our historical business conduct breached such provisions on which our counterparties have relied, whether as a result of judicial proceedings or a change of law or otherwise, we may face material claims or regulatory actions and may owe damages to the relevant third parties. We may also remain liable for any outstanding fees payable to the counterparty of an agreement which has been terminated.

 

  13  

 

 

Any extended periods in the future without our users winning substantial prizes could result in losses in revenues and profits for us.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, eight prizes of over RMB10 million, 76 prizes of RMB5 million to RMB10 million, and 570 prizes of RMB1 million to RMB5 million had been awarded to users who purchased their lottery products using our online lottery service platform. Our users’ record of winnings is one of the factors contributing to our ability to attract new users and retain existing users. Winning of number-based lotteries arises purely by chance during the lottery draws. No assurance can be given that there will not be long periods in the future without any of our users winning a prize of a significant amount, which could lead to a reduction in user activity and therefore a shortfall in our revenue and profit.

 

Our operations and services relating to sports lottery products depend on the scheduling and live broadcasting of major sports events.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, our operations and services relating to sports lotteries were affected by the scheduling and live broadcasting of the underlying sports events. In particular, a significant portion of our service fees prior to the voluntary suspension of our online sports lottery sales services in April 2015, were derived from results of international soccer games. Disruptions to the scheduling and broadcasting of those games may have a material impact on our results of operations. In some instances, the scheduling of major sports events occurs seasonally (for example, European soccer) or at regular but infrequent intervals (for example, the FIFA World Cup). The cancellation, postponement or curtailment of significant sports events, due to, among other things, adverse weather conditions, terrorist acts, other acts of war or hostility or the outbreak of infectious diseases, or cancellation of, disruption to, or postponement of the live broadcasting of such sports events, due to contractual disputes, technical or communication problems, or the insolvency of a major broadcaster, could materially adversely affect our operations and services relating to sports lotteries.

 

Future strategic acquisitions may have a material adverse effect on our business, reputation and results of operations.

 

We may acquire additional assets, products, technologies or businesses that are complementary to our existing business if we are presented with appropriate opportunities. Future acquisitions and subsequent integration of newly acquired assets and businesses into our own would require significant attention from our management and could result in a diversion of resources from our existing business, which in turn could have an adverse effect on our business operations. Acquired assets or businesses may not generate the financial results we expect. In addition, acquisitions could result in the use of substantial amounts of cash, potentially dilutive issuances of equity securities, the occurrence of significant goodwill impairment charges, amortization expenses for other intangible assets and exposure to potential unknown liabilities of the acquired business. Moreover, the cost of identifying and consummating acquisitions may be significant. In addition to possible shareholders’ approval, we may also have to obtain approvals and licenses from the relevant government authorities in the PRC for the acquisitions and to comply with any applicable PRC laws and regulations, which could result in increased cost and delay.

 

Negative publicity about our operations, or problems such as underage and compulsive lottery activities, fraud and corruption in sports matches may adversely affect our reputation and business.

 

Social responsibility policies are a key consideration in lottery laws and regulations. There are concerns as to the ability of online lottery service providers to effectively block minors from purchasing lottery products online and the possible increase in compulsive lottery activity due to the relative ease of making online lottery purchases. Publicity regarding such concerns could harm our brand and image. If the perception develops that online lottery operators or the lottery industry as a whole is failing to adequately protect minors and vulnerable lottery purchasers, we may face increased social resistance. Damage to the industry’s reputation could also lead to the withdrawal of support for the industry from the government or the tightening of regulations, which may have a material adverse effect on our business.

 

  14  

 

 

Negative publicity about potential fraud (including money laundering) and corruption in sports matches (including collusion and match-fixing), even if not directly or indirectly connected with us or our services, may adversely impact our reputation and the willingness of the public to participate in the purchase of sports lotteries. As a result, the number of potential users available to us could be adversely affected.

 

Undetected errors with regard to historical or real-time data in our information platform could adversely affect our user experience, which may materially and adversely affect our reputation and business.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, our information database provided to our users real-time updated information on all 13 national lottery products and 96 provincial lottery products, as well as historical data, charts analytical tools and account management tools and functions. Although we intended to ensure the accuracy and reliability of all data in our information database, in a number of instances, users had complained on online forums of being misled by the wrong historical data and users have also alleged that the winning numbers posted by us differ from the actual winning numbers published by the relevant national or provincial lottery administration centers. Such complaints and allegations, whether with or without merit, may damage our reputation as a credible online lottery service provider and adversely affect user experience, which could materially and adversely affect our reputation and business.

 

We may fail to detect fraudulent activities of our users or employees.

 

Online transactions may be subject to sophisticated schemes or collusion to defraud or other illegal activities, and there is a risk that our platform may be used for those purposes either by our users or our employees. While we intended to continue our efforts to protect our business and our users from such illegal activities, including a user identity verifying system and pre-payment procedures to protect against fictitious transactions, the controls and procedures we have implemented may not be effective in all cases. Failure to protect our operations and our users from fraudulent activity either by other users or our employees could result in reputational damage to us and could materially and adversely affect our results of operations.

 

Failure to adequately protect user account information could have a material adverse effect on us.

 

We process our users’ personal data (including name, address, age, bank details and lottery purchase history) as part of our business and therefore must comply with data protection laws in China. Data protection laws restrict our ability to collect and use personal information relating to our users and potential users. Notwithstanding our IT and data security and other systems, we may not be effective in detecting any intrusion or other security breaches, or safeguarding against sabotage, hackers, viruses and cybercrime. We are exposed to the risk that personal data could be wrongfully accessed and/or used, whether by employees, users or other third parties, or otherwise lost or disclosed or processed in breach of data protection laws. If we or any of the third-party service providers whom we rely on fail to transmit user information and payment details online in a secure manner or if any such theft or loss of personal user data were to otherwise occur, it could subject us to liabilities under the data protection laws or result in the loss of the goodwill of our users.

 

We have no insurance coverage against product liability claims or business interruptions.

 

As the insurance industry in China is still in an early stage of development, insurance companies in China currently offer limited business insurance products. We do not have any product liability insurance or business interruption insurance. As we continue to increase the number of lottery products we service, we may be increasingly exposed to claims related to such lottery products. Any such claims, business disruption, or natural disaster could result in us incurring substantial costs and a diversion of our resources away from our business, which would have an adverse effect on our business and results of operations.

 

We might not be able to adequately protect our intellectual property rights.

 

We believe our trademarks, software, technology know-how and other intellectual property provide competitive advantages to us, which are important to our achievements to date and our future success. We have invested significant resources to develop our brand name, 500wan, which is an important asset to us. We cannot assure you that steps taken to protect our intellectual property rights will be sufficient to prevent infringement of our intellectual property rights. If we fail to adequately protect our intellectual property rights, including our rights in our trademarks and know-how, it could have a material adverse effect on our operations.

 

  15  

 

 

The validity, enforceability and scope of protection available under intellectual property laws with respect to the Internet industry in China are uncertain and evolving. Implementation and enforcement of PRC intellectual property-related laws have historically been deficient and ineffective. Accordingly, protection of intellectual property rights in China may not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend our copyrights or other intellectual property rights or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and any adverse determination thereof could result in substantial costs and diversion of resources and management attention away from our business.

 

We may be subject to allegations or liabilities for infringement of third-party intellectual property rights based on the content available on our websites or information services we provide.

 

We provide our users with real-time and historical lottery-related news, data, analyses, real-time match scores and other contents on our information platform. We obtain such contents from a third-party professional sports information agency as well as publicly available sources. The user forum of our websites also hosts a significant amount of content generated by our users. We cannot assure you that we will not be subject to allegations, claims or lawsuits by third parties regarding the use of lottery or sports-related information or any other content on our websites, which may infringe upon the intellectual property rights of such third parties. If such claims are found valid by the courts and we are ordered to remove the content from our websites, our information platform will become less attractive and our user experience and satisfaction will be adversely affected. Even if we successfully defend ourselves against such claims or allegations, we could nevertheless incur considerable costs in such defense or suffer reputational damage due to the negative publicity associated with such claims or allegations.

 

We rely on our senior management and key employees.

 

Our success is dependent upon the expertise and continued service of our senior management and other key personnel. Our CEO, Mr. Zhengming Pan, who has substantial experiences in management and corporate finance, is also crucial to our operations and development. Most of our senior management team members have 17 years of experience in information technology or Internet-related industries. They are crucial to our smooth operation and continued innovation. In addition, we rely on a limited number of specialized staff members in certain areas of our IT operations where we do not receive support from external service providers. Furthermore, our ability to expand our operations to accommodate our anticipated growth will also depend on our ability to attract and retain additional personnel such as qualified risk managers, finance, management, marketing, technical and other personnel. Competition for these employees is intense due to the limited number of qualified personnel. It may be difficult for us to manage our business and meet our objectives if we fail to attract and retain such personnel and our results of operations or financial condition may be adversely affected.

 

We are dependent on external service providers with respect to payment and settlement processing, and the provision of faulty services by these providers could lead to financial loss and damage to our reputation.

 

We are dependent on cooperation with external service providers with specialist knowledge and technology for processing lottery purchase orders. This includes, among other things, data and voice communication, procurement, installation, further development, maintenance and servicing of hardware and software, server housing and payment processing. It is possible that one or more of the external service providers do not perform the services, or that they do not perform them in a timely and accurate manner. It is therefore possible that, due to failures or omissions by the external service providers that we have engaged, we will not be in a position to perform our own services faultlessly or on time. This could lead to revenue losses, liability for damage, and substantial damage to our reputation.

 

We depend on payment processing for the success of our business.

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, we required our users to deposit funds in their registered accounts in advance of any lottery purchases. Users’ prize money was also deposited in and withdrawn from their respective accounts. Therefore, the provision of convenient, trusted and effective payment processing services to our users and potential users are critical to our business. If we are able to resume our online sports lottery sales services in the future and there is any deterioration or perceived deterioration in the quality of the payment processing services provided by us or any interruption to those services, or if our payment processing services are not performed in a timely manner, our users and potential users may be deterred from using our online lottery services, and we may be subject to user complaints and allegations concerning the mishandling of their funds, which may damage our reputation and have a material adverse effect on our business and results of operations.

 

  16  

 

 

Our quarterly net revenues and operating results may fluctuate, which makes our results of operations difficult to predict and may cause our quarterly results of operations to fall short of expectations.

 

Our quarterly revenues and operating results have fluctuated in the past and may continue to fluctuate depending upon a number of factors, many of which are out of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly and annual net revenues and costs and expenses as a percentage of our net revenues may be significantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause the price of our ADSs to fall. Other factors that may affect our financial results include, among others:

 

· when and how we resume our online lottery sales services in the future;

 

· seasonality of sports events on which sports lotteries are based;

 

· change of lottery issuance schedules by the lottery issuance authorities;

 

· changes in government policies or regulations, or their enforcement;

 

· economic conditions in China and worldwide; and

 

· geopolitical events or natural disasters such as war, threat of war, earthquake or epidemics.

 

Our operating results tend to be seasonal. For instance, we may have lower net revenues during the first quarter of each year primarily due to the Chinese New Year holidays in that quarter.

 

We could be subject to administrative penalties or business losses if our current user identity verifying system cannot sufficiently prevent us from taking purchase orders from underage users.

 

According to the Regulation on Administration of Lottery issued by the State Council which came into effect on July 1, 2009, a lottery service provider may be subject to administrative penalties from the local civil affairs authority or the sports administration authorities if it takes lottery purchase orders from underage users. The lottery administration centers have the right to terminate their service agreements with a service provider if it becomes subject to administrative penalties. It is still unclear which security mechanisms have to be introduced for online service providers to protect minors. Although we have adopted a user identity verifying system which allows us to filter out underage users, we cannot assure you that our current system is sufficient for us to identify all underage users. If the relevant authorities determine that we are in violation of any relevant regulations, we may be subject to administrative penalties and we may lose our service agreements with the lottery operation centers.

 

  17  

 

 

In addition, a registration process that is as simple as possible and takes only a short time to complete is an important factor in our ability to attract new users. Currently, the age verification step of our registration process is relatively simple. If it becomes apparent that this measure is inadequate, the registration process might have to be made lengthier and difficult for more in-depth checks, such as requiring users to provide a copy of their Chinese ID card or other identification documents as part of the registration process, which could decrease the number of new registrations or lead to a decrease in users. This could have a material adverse effect on our financial condition and results of operations.

 

If we fail to maintain an effective system of internal control over financial reporting, we may lose investor confidence in the reliability of our financial statements.

 

We are subject to reporting obligations under the U.S. securities laws. The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on the company’s internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of our internal control over financial reporting. In addition, an independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting.

 

Our management has concluded that our internal control over financial reporting was effective as of December 31, 2018. See “Item 15. Controls and Procedures.” Our independent registered public accounting firm has issued an attestation report, which has concluded that our internal control over financial reporting was effective in all material aspects as of December 31, 2018. However, if we fail to maintain effective internal control over financial reporting in the future, our management and our independent registered public accounting firm may not be able to conclude that we have effective internal control over financial reporting at a reasonable assurance level. This could in turn result in loss of investor confidence in the reliability of our financial statements and negatively impact the trading price of our ADSs. Furthermore, we have incurred and anticipate that we will continue to incur considerable costs, management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.

 

Our grant of employee share options, restricted shares or other share-based compensation and any future grants could have an adverse effect on our net income.

 

U.S. GAAP prescribes how we account for share-based compensation and may have an adverse impact on our results of operations or the price of our ADSs. U.S. GAAP requires us to recognize share-based compensation as compensation expense in the consolidated statement of comprehensive income generally based on the fair value of equity awards on the date of the grant, with compensation expense recognized over the period in which the recipient is required to provide service in exchange for the equity award. The expenses associated with share-based compensation may reduce the attractiveness of issuing share options or restricted shares under our equity incentive plan. However, if we do not grant share options or restricted shares, or reduce the number of share options or restricted shares we grant, we may not be able to attract and retain key personnel. If we grant more share options or restricted shares to attract and retain key personnel, the expenses associated with share-based compensation may adversely affect our net income.

 

  18  

 

 

Our operations subject us to foreign exchange risk.

 

We operate in Europe, Africa, South America and North America. We are exposed to foreign exchange risk to the extent that there is a mismatch between the currencies in which revenues, expenses and borrowings are denominated. Much of our current revenue is derived from our interest in TMG, which uses the EUR as its functional currency. As a result, we are exposed to translational foreign exchange risk when we translate TMG’s financial statements from the EUR to the RMB. Because our reporting currency is the RMB, we may be exposed to translation risk when the income statements of us and our subsidiaries are converted into U.S. dollars using the average exchange rate for the period, and whilst revenues and costs are unchanged in local currency, changes in exchange rates may lead to effects on the converted balances of revenue, costs and the result in U.S. dollars. Potential adverse changes in economic conditions could have an adverse effect on our business, financial condition and results of operations.

 

Risks Related to Our Corporate Structure

 

If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in the Internet and the lottery business, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

 

Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in the Internet and lottery businesses. We conduct our operations in China principally through contractual arrangements among our company 500.com Limited, our wholly-owned PRC subsidiary, E-Sun Sky Computer, our consolidated affiliated entities in the PRC and their respective shareholders. Our previous online lottery services were primarily provided through E-Sun Sky Network, the wholly-owned subsidiary of E-Sun Network, Lhasa Yicai, Hainan Jingli, Hainan Panfeng and Hangzhou E-Sun Sky Network, the wholly-owned subsidiaries of E-Sun Sky Network, Hainan Jingli, Hainan Panfeng and Hangzhou E-Sun Sky Network were established in 2018 to operate in the physical sales of sports lottery tickets business, and Guangyi Network and Hainan Menghuanxingchen, the wholly-owned subsidiaries of E-Sun Sky Computer, Guangyi Network was disposed of in June 2018, Hainan Menghuanxingchen was established in May 2018 to operate in the physical sales of sports lottery tickets business. E-Sun Sky Network owns and manages our operating websites, namely, www.500wan.com and www.500.com. Guangtiandi Technology and Youlanguang Technology were established to provide technical support to E-Sun Sky Network. Youlanguang Technology provides services to E-Sun Sky Network relating to the management of our users’ registration information and accounts, Shenzhen Yicai, and Shenzhen Fenggu, the wholly-owned subsidiaries of Youlanguang Technology, we disposed of Shenzhen Fenggu in June 2018, while Guangtiandi Technology provides services to E-Sun Sky Network relating to the implementation of the technical interface with the provincial lottery administration centers, and the maintenance of our lottery ticket database. Baifengrun Technology, a wholly-owned subsidiary of Guangtiandi Technology, was acquired to develop and operate mobile phone game services to third-party customers. 500Fu, a wholly-owned subsidiary of Youlanguang, was established to provide third-party payment services, which was disposed of in February 2018. Shenzhen Caiyu was acquired through E-Sun Sky Network to provide sports information and data services. We disposed of our interest in Shenzhen Caiyu in November 2017. Shenzhen Qufan was acquired through Guangtiandi Technology to provide online poker gaming services. We disposed of our interest in Shenzhen Qufan in February 2018. Shenzhen Kaisheng was the subsidiary of Guangtiandi Technology to provide online spot commodity trading services. Our contractual arrangements with E-Sun Network, Guangtiandi Technology, Youlanguang Technology, Tongfu Technology, Shenzhen Qufan and their respective shareholders (i) enable us to exercise effective control over these entities, and (ii) give us the obligation to absorb losses and the right to receive benefits of these entities, requiring us to treat them as our consolidated affiliated entities and to consolidate their operating results. For a detailed discussion of these contractual arrangements, see “Item 4C. Organization Structure.”

 

We cannot assure you, however, that we will be able to enforce these contracts. Although we believe we comply with current PRC regulations, we cannot assure you that the PRC government would agree that these contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future. PRC laws and regulations governing the validity of these contractual arrangements are open to varying interpretations and the relevant government authorities have broad discretion in interpreting these laws and regulations. If the PRC government determines that we are not in compliance with applicable laws and regulations, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our websites, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcement actions against us that could be harmful to our business. The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business.

 

  19  

 

 

We rely on contractual arrangements with our consolidated affiliated entities in China and their shareholders for our operations, which may not be as effective as direct ownership in providing operational control.

 

Since PRC laws restrict foreign equity ownership in companies engaged in the Internet and lottery businesses in China, we rely on contractual arrangements with our consolidated affiliated entities and their respective shareholders to operate our business in China. If we had direct ownership of E-Sun Network, Guangtiandi Technology, Youlanguang Technology or Tongfu Technology, Shenzhen Qufan, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of E-Sun Network, Guangtiandi Technology, Youlanguang Technology or Tongfu Technology, Shenzhen Qufan, which in turn could effectuate changes at the management level, subject to any applicable fiduciary obligations. However, under the current contractual arrangements that were executed on June 1, 2011, amended on May 2, 2013, supplemented December 28, 2013 and further amended on November 18, 2015, further supplemented on January 10, 2017 and further amended on July 3, 2017, we rely on our consolidated affiliated entities and their respective shareholders’ performance of their contractual obligations to exercise effective control over our business in China. In addition, our contractual arrangements generally have a term of 10 years with an automatic extension for a number of years to be determined by E-Sun Sky Computer and Qufan Information Technology, which is subject to E-Sun Sky Computer’s and Qufan Information Technology unilateral termination right. In general, neither our consolidated affiliated entities nor their respective shareholders may terminate the contracts prior to the expiration date. However, the shareholders of E-Sun Network, Guangtiandi Technology, Youlanguang Technology, Tongfu Technology or Shenzhen Qufan, may not act in the best interests of our company or may not perform their obligations under these contracts, including the obligation to renew these contracts when their initial term expires. Such risks exist throughout the period in which we intend to operate our business through the contractual arrangements with our consolidated affiliated entities and their respective shareholders. We may replace the shareholders of our consolidated affiliated entities at any time pursuant to our contractual arrangements with them and their shareholders. However, if any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC law, arbitration and courts and therefore will be subject to uncertainties in the PRC legal system. See “Item 3D. Risk Factors—Risks Related to Our Corporate Structure—Any failure by our consolidated affiliated entities or their respective shareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business.” Therefore, these contractual arrangements may not be as effective as direct ownership in providing us with control over these consolidated affiliated entities.

 

Any failure by our consolidated affiliated entities or their respective shareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business.

 

Our consolidated affiliated entities and their respective shareholders may fail to take certain actions required for our business or follow our instructions despite their contractual obligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, which may not be effective.

 

All of these contractual arrangements are governed by PRC laws and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as compared to certain other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our consolidated affiliated entities, and our ability to conduct our business may be adversely affected.

 

  20  

 

 

Contractual arrangements with our consolidated affiliated entities may result in adverse tax consequences to us.

 

Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by the PRC tax authorities within 10 years after the taxable year when the arrangements or transactions are conducted. We could face material and adverse tax consequences if the PRC tax authorities were to determine that the contractual arrangements among 500.com Limited, E-Sun Sky Computer, Qufan Information Technology, our subsidiary in China, our consolidated affiliated entities in China and their respective shareholders were not entered into on an arm’s-length basis and therefore constituted unfavorable transfer pricing arrangements. Unfavorable transfer pricing arrangements could, among other things, result in an upward adjustment of income subject to taxation. Under the contractual agreements we agreed to provide unconditional financial support, through the nominee shareholders, to each consolidated affiliated entity in manners permitted by PRC laws and regulations and further agreed to waive the repayment of any such financial support if needed by such consolidated affiliated entity, which may also result in income tax burden on the nominee shareholders and the consolidated affiliated entities. In addition, the PRC tax authorities may impose interest on late payments on our consolidated affiliated entities for the adjusted but unpaid taxes. Our results of operations may be materially and adversely affected if our consolidated affiliated entities’ tax liabilities increase significantly or if they are required to pay interest on late payments.

 

The shareholders of our consolidated affiliated entities may have potential conflicts of interest with us, which may materially and adversely affect our business.

 

We provide no incentives to the shareholders of our consolidated affiliated entities for the purpose of encouraging them to act in our best interests in their capacity as the shareholders of our consolidated affiliated entities. We may replace any of the shareholders of our consolidated affiliated entities at any time pursuant to the exclusive option agreements. In addition, each of the shareholders of our consolidated affiliated entities has executed a shareholder’s voting power assignment agreement to authorize any person or entity designated by 500.com Limited as permitted by applicable law to vote on their behalf and exercise full voting rights as shareholders of the consolidated affiliated entities. We cannot assure you that when conflicts arise, the shareholders of our consolidated affiliated entities will act in the best interests of our company or that conflicts will be resolved in our favor. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of our consolidated affiliated entities, we would have to rely on legal proceedings, which may be expensive, time-consuming and disruptive to our operations. There is also substantial uncertainty as to the outcome of any such legal proceedings.

 

We may rely principally on dividends and other distributions on equity paid by our PRC subsidiary to fund any cash and financing requirements we may have. Any limitation on the ability of our PRC subsidiary to pay dividends to us could have a material adverse effect on our ability to conduct our business.

 

We are a holding company and we rely principally on dividends and other distributions on equity paid by our wholly-owned PRC subsidiary, E-Sun Sky Computer, for our cash and financing requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders and service any debt we may incur. If E-Sun Sky Computer incurs debt on its own behalf in the future, the instruments governing the debt may restrict their abilities to pay dividends or make other distributions to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements E-Sun Sky Computer currently has in place with our consolidated affiliated entities in a manner that would materially and adversely affect its ability to pay dividends and other distributions to us.

 

Under PRC laws and regulations, E-Sun Sky Computer, as a wholly foreign-owned enterprise in the PRC, may pay dividends only out of its accumulated profits as determined in accordance with PRC accounting standards and regulations. In addition, a wholly foreign-owned enterprise such as E-Sun Sky Computer is required to set aside at least 10% of its accumulated after-tax profits each year, if any, to fund a statutory reserve fund until the aggregate amount of such a fund reaches 50% of its registered capital. At its discretion, it may allocate a portion of its after-tax profits based on PRC accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. Any limitation on the ability of E-Sun Sky Computer to pay dividends or make other distributions to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business.

 

  21  

 

 

PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may limit our use of the proceeds we receive from our public offering to fund our expansion or operations.

 

As an offshore holding company with a PRC subsidiary, we may (i) make additional capital contributions to our existing PRC subsidiary, E-Sun Sky Computer, (ii) establish new PRC subsidiaries and make capital contributions to these new PRC subsidiaries, (iii) make loans to our PRC subsidiaries or consolidated affiliated entities, or (iv) acquire offshore entities with business operations in China in an offshore transaction. However, most of these uses are subject to PRC regulations and approvals. For example:

 

· capital contributions to our PRC subsidiaries, whether existing or newly established ones, must be approved by the PRC Ministry of Commerce or its local counterparts;

 

· loans by us to our PRC subsidiaries, each of which is a foreign-invested enterprise, to finance their activities cannot exceed the statutory limit, which is the difference between the registered capital and the amount of the total investment as approved by the Ministry of Commerce or its local counterparts, and must be registered with the PRC State Administration of Foreign Exchange, or SAFE, or its local branches; and

 

· loans by us to our consolidated affiliated entities, which are domestic PRC entities, must be approved by the National Development and Reform Commission and must also be registered with SAFE or its local branches.

 

On August 29, 2008, SAFE promulgated the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign Invested Enterprises, or SAFE Circular 142, regulating the conversion by a foreign-invested enterprise of foreign currency registered capital into Renminbi by restricting how the converted Renminbi may be used. On March 30, 2015, SAFE promulgated SAFE Circular 19, which came into force replacing SAFE Circular 142 on June 1, 2015. SAFE Circular 19 removed certain restrictions previously provided under SAFE Circular 142 for conversion by a foreign-invested enterprise of foreign currency registered capital into RMB and use of such RMB capital. However, SAFE Circular 19 continues to prohibit foreign-invested enterprises from, among other things, using RMB fund converted from its foreign exchange capitals for expenditure beyond its business scope, providing entrusted loans or repaying loans between non-financial enterprises.

 

We expect that the PRC regulations of loans and direct investment by offshore holding companies to PRC entities may continue to limit our use of the proceeds we receive from our initial public offering. There are no costs associated with registering loans or capital contributions with relevant PRC governmental authorities, other than nominal processing charges. Under the relevant PRC laws and regulations, the PRC governmental authorities are required to process such approvals or registrations or deny our application within a prescribed time period, which is usually less than 90 days. The actual time taken, however, may be longer due to administrative delays. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all, with respect to our future plans to use the U.S. dollar proceeds we receive from our initial public offering for our expansion and operations in China. If we fail to receive such registrations or approvals, our ability to use the proceeds of our initial public offering and to capitalize our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and ability to fund and expand our business.

 

  22  

 

 

Risks Related to Doing Business in China

 

The complexities, uncertainties and rapid changes in PRC regulation of Internet business and companies require significant resources for compliance.

 

The PRC government extensively regulates the Internet industry, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the Internet industry. These Internet-related laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be in violations of applicable laws and regulations. Issues, risks and uncertainties relating to PRC regulation of the Internet business include, but are not limited to, the following:

 

There are uncertainties relating to the regulation of the Internet business in China, including evolving licensing practices. This means that permits, licenses or operations at some of our companies may be subject to challenge, or we may fail to obtain permits or licenses that may be deemed necessary for our operations or we may not be able to obtain or renew certain permits or licenses. The major permits and licenses that could be involved include, without limitation, the Permit for Operation of Value-Added Telecom Services, or VAS license, issued by the Ministry of Industry and Information Technology, or the MIIT. Pursuant to the VAS license issued to E-Sun Sky Network by Telecommunication Management Bureau of Guangdong Province in February 2013, E-Sun Sky Network is permitted to provide internet information services. The license was renewed in 2017 and is effective until September 2022. We will need to renew each of the licenses upon its expiration, and apply for permits and alteration of the license in advance of any change to the license holder regarding its shareholding structure, controlling shareholders, merger and acquisition, business scope and etc., and apply for alteration of the license for any change to the name, legal representative of the license holder. However, we cannot assure you that each of the licenses will be successfully and timely renewed, or that the license will continue to cover all aspects of our online lottery service business upon its renewal. If we fail to maintain any of these required licenses or approvals, we may be subject to various penalties, including fines and the discontinuation of or restriction on our operations. Any such disruption in our operations may have a material and adverse effect on our results of operations.

 

New laws and regulations that regulate Internet activities, including online lottery services, may be promulgated. If these new laws and regulations are promulgated, additional licenses may be required for our operations. If our operations do not comply with these new regulations after they become effective, or if we fail to obtain any licenses required under these new laws and regulations, we could be subject to penalties.

 

We only have contractual control over our operating websites, namely, www.500wan.com and www.500.com. We do not directly own our websites due to the restriction of foreign investment in businesses providing value-added telecom services in China, including Internet content provision services. If the authorities challenge our corporate structure or rights to our websites, it could significantly disrupt our business, subject us to sanctions, compromise enforceability of related contractual arrangements, or have other adverse effects on us.

 

The interpretation and application of existing PRC laws, regulations and policies and any new laws, regulations or policies relating to the Internet industry have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, the Internet business in China, including our business. We cannot assure you that we have obtained all the permits or licenses required for conducting our business in China or will be able to maintain our existing licenses or obtain any new licenses required under any new laws or regulations. There are also risks that we may be found to violate existing or future laws and regulations given the uncertainty and complexity of China’s regulation of Internet business.

 

In addition, new laws and regulations governing the use of the Internet could be issued at the national or provincial level, or existing regulations could be interpreted more strictly. No assurance can be given that business on the Internet in general or our online services in particular will not be adversely impacted by further regulations. Technical limitations on Internet use can also be developed or implemented. For example, restrictions can be implemented on personal Internet use in the workplace in general or access to our site in particular. This could lead to a reduction of user activities or a loss of users which in turn could have a material adverse effect on our financial condition and results of operations.

 

  23  

 

 

Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of draft PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.

 

The Ministry of Commerce published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law, together with their implementation rules and ancillary regulations. The draft Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. The Ministry of Commerce is currently soliciting comments on this draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects.

 

Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company should be treated as a foreign-invested enterprise, or an FIE. According to the definition set forth in the draft Foreign Investment Law, FIEs refer to enterprises established in China pursuant to PRC law that are solely or partially invested by foreign investors. The draft Foreign Investment Law specifically provides that entities established in China (without direct foreign equity ownership) but “controlled” by foreign investors, through contract or trust for example, will be treated as FIEs. Once an entity falls within the definition of FIE, it may be subject to foreign investment “restrictions” or “prohibitions” set forth in a “negative list” to be separately issued by the State Council later. If an FIE proposes to conduct business in an industry subject to foreign investment “restrictions” in the “negative list,” the FIE must go through a market entry clearance by the Ministry of Commerce before being established. If an FIE proposes to conduct business in an industry subject to foreign investment “prohibitions” in the “negative list,” it must not engage in the business. However, an FIE, during the market entry clearance process, may apply in writing to be treated as a PRC domestic enterprise if its foreign investor(s) is/are ultimately “controlled” by PRC government authorities and its affiliates and/or PRC citizens. In this connection, “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding 50% of more of the voting rights of the subject entity; (ii) holding less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to exert material influence on the board, the shareholders’ meeting or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations.

 

The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. See “Item3D. Risk Factors—Risks Related to Our Corporate Structure” and “Item 4.C. Information on the Company—Organizational Structure—Contractual Arrangements with Our Consolidated Affiliated Entities.” Under the draft Foreign Investment Law, variable interest entities that are controlled via contractual arrangement would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is included in the “negative list” as restricted industry, the VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC government authorities and its affiliates or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal.

 

The draft Foreign Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure, whether or not these companies are controlled by Chinese parties, while it is soliciting comments from the public on this point. Moreover, it is uncertain whether the internet and online sales of lottery products, in which our variable interest entities operate, will be subject to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued. If the enacted version of the Foreign Investment Law and the final “negative list” mandate further actions, such as Ministry of Commerce market entry clearance, to be completed by companies with existing VIE structure like us, we face uncertainties as to whether such clearance can be timely obtained, or at all.

 

  24  

 

 

The draft Foreign Investment Law, if enacted as proposed, may also materially impact our corporate governance practice and increase our compliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from investment implementation report and investment amendment report that are required at each investment and alteration of investment specifics, an annual report is mandatory, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these information reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.

 

The 2006 M&A Rules establish complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it difficult for us to pursue growth through acquisitions in China.

 

The 2006 M&A Rules include provisions that purport to require approval of the Ministry of Commerce for acquisitions by offshore entities established or controlled by domestic companies, enterprises or natural persons of onshore entities that are related to such domestic companies, enterprises or natural persons, and prohibit offshore entities from using their foreign-invested subsidiaries in China, or through “other means,” to circumvent such requirement. As part of our growth strategy, we obtained control over E-Sun Network, Youlanguang Technology and Guangtiandi Technology in June 2011, Tongfu Technology in December 2015, and Shenzhen Qufan in January 2017 by entering into contractual arrangements with VIEs and their respective shareholders. We did not seek the approval of the Ministry of Commerce for those transactions based on the legal advice we obtained from our PRC legal counsel in those transactions that such approval was unnecessary. However, the 2006 M&A Rules also prohibit companies from using any “other means” to circumvent the approval requirement set forth therein and there is no clear interpretation as to what constitutes “other means” of circumvention of the requirement under the 2006 M&A Rules. The Ministry of Commerce and other applicable government authorities would therefore have broad discretion in determining whether an acquisition is in violation of the 2006 M&A Rules. If PRC regulatory authorities take a view that is contrary to ours, we could be subject to severe penalties. In addition, we may in the future grow our business in part by acquiring complementary businesses in China. If we are required to obtain the approval from the Ministry of Commerce, completion of such transaction may be delayed or even inhibited. Our ability to expand our business or maintain or expand our market share through future acquisitions would as such be materially and adversely affected.

 

In addition, in August 2011 the Ministry of Commerce issued the Rules of Ministry of Commerce on Implementation of Security Review System of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Rules. The MOFCOM Security Review Rules, effective from September 1, 2011, require certain merger and acquisition transactions to be subject to merger control review or security review. The MOFCOM Security Review Rules further provide that, when deciding whether a specific merger or acquisition of a PRC enterprise by foreign investors is subject to the security review by the Ministry of Commerce, the principle of substance over form should be applied and foreign investors are prohibited from bypassing the security review requirement by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. There is no explicit provision in the MOFCOM Security Review Rules stating that our business falls into the scope subject to the security review. However, as these rules are relatively new and there is a lack of clear statutory interpretation on the implementation of these new rules, there can be no assurance that the Ministry of Commerce will not apply these rules to our contractual arrangements with E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology and Shenzhen Qufan If we are found to be in violation of the MOFCOM Security Review Rules, or fail to obtain any required approvals, the relevant regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating income, revoking our PRC consolidated affiliated entities’ business or operating licenses or requiring us to restructure or unwind the relevant ownership structure or operations. Any of these actions could cause significant disruption to our business operations and may materially and adversely affect our business, financial condition and results of operations. Further, if the business of any target company that we would like to acquire in the future falls into the ambit of security review, complying with the requirements of the relevant rules could be prohibitively time consuming or we may be legally prohibited from acquiring such company either by equity or asset acquisition, capital contribution or through any contractual arrangement, which could have a material and adverse impact on our ability to expand our business or maintain our market share.

 

  25  

 

 

Governmental control of currency conversion may affect the value of your investment.

 

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of foreign currency out of China. We receive all of our service fees in Renminbi in China. Under our current corporate structure, most of our income is primarily derived from dividend payments from our PRC subsidiary. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiary to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency-denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from SAFE or its local branch is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

 

Fluctuations in exchange rates of the Renminbi could materially affect our reported results of operations.

 

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. In July 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the revised policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy resulted in a more than 20% appreciation of the RMB against the U.S. dollar in the following three years. Since July 2008, however, the RMB has traded within a narrow range against the U.S. dollar. As a consequence, the RMB has fluctuated significantly since July 2008 against other freely traded currencies, in tandem with the U.S. dollar. On June 20, 2010, the People’s Bank of China announced that the PRC government would further reform the RMB exchange rate regime and increase the flexibility of the exchange rate, and between June 30, 2010 and December 31, 2013, the value of the Renminbi appreciated approximately 12.0% against the U.S. dollar, although the value of the Renminbi depreciated approximately 2.5% against the U.S. dollar in 2014. In August 2015, the People’s Bank of China changed the way it calculates the mid-point price of Renminbi against the U.S. dollar, requiring the market makers who submit for reference rates to consider the previous day’s closing spot rate, foreign exchange demand and supply as well as changes in major currency rates. As a result, in 2015, the value of the Renminbi depreciated approximately 4.68% against the U.S. dollar, and in 2016, the value of the Renminbi further depreciated approximately 7.09% against the U.S. dollar. However, the value of Renminbi appreciated approximately 5.81% against the U.S. dollar in 2017, while the value of Renminbi depreciated approximately 5.04% against the U.S. dollar in 2018. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. dollar in the future.

 

As we may rely on dividends and other fees paid to us by our subsidiaries and affiliated consolidated entities in China, any significant revaluation of the Renminbi may materially and adversely affect our cash flows, net revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. To the extent that we need to convert U.S. dollars received from our initial public offering into Renminbi for our operations, an appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.

 

  26  

 

 

Our operations may be adversely affected by changes in China’s political, economic and social conditions.

 

Most of our assets and operations are located in China. Accordingly, our business, financial condition, results of operations and prospects may be influenced to a significant degree by political, economic and social conditions in China generally and by continued economic growth in China as a whole.

 

The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition, the Chinese government continues to play a significant role in regulating industrial development by imposing industrial policies. The Chinese government also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies.

 

While the Chinese economy has experienced significant growth over the past decade, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall Chinese economy but may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations. In the past, the Chinese government has implemented certain measures, including interest rate increases, to control the pace of economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and operating results. Any significant increase in China’s inflation rate could increase our costs and have a negative impact on our operating margins. In addition, any sudden changes to China’s political system or the occurrence of widespread social unrest could have negative effects on our business and results of operations.

 

Under the EIT Law, we may be classified as a “resident enterprise” of China. Such classification would likely result in unfavorable tax consequences to us.

 

Under the new enterprise income tax law, or the EIT Law, and its implementation rules, or the Implementation Rules, both of which became effective on January 1, 2008, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a resident enterprise and is subject to enterprise income tax, or EIT, at the rate of 25% on its global income. The Implementation Rules define the term “de facto management bodies” as “establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise.” The State Administration of Taxation issued the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, on April 22, 2009. Circular 82 provides that a foreign enterprise controlled by a PRC company or a PRC company group will be classified as a “resident enterprise” with its “de facto management bodies” located within China if the following criteria are satisfied: (i) the place where the senior management and core management departments that are in charge of its daily operations perform their duties is mainly located in the PRC; (ii) its financial and human resources decisions are made by or are subject to approval by persons or bodies in the PRC; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (iv) more than half of the enterprise’s directors or senior management with voting rights frequently reside in the PRC. Although Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those invested in by PRC individuals, like our company, the determining criteria set forth in Circular 82 may reflect the State Administration of Taxation’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises or controlled by or invested in by PRC individuals. We do not believe that any of 500.com Limited, Fine Brand Limited and 500wan HK Limited meets all of the criteria above. Although we conduct our business principally through contractual arrangements among our wholly-owned PRC subsidiary and our consolidated affiliated entities in the PRC, and decisions relating to our financial and human resource matters are made by personnel of our wholly-owned PRC subsidiary and our consolidated affiliated entities in the PRC, each of 500.com Limited, Fine Brand Limited and 500wan HK Limited is a company incorporated outside the PRC. As holding companies, these three entities’ key assets and records, including the resolutions of their respective board of directors and the resolutions of their respective shareholders, are located and maintained outside the PRC. While we do not believe we would be considered a resident enterprise, if the PRC authorities were to subsequently determine that we should be so treated, a 25% EIT on our global income could significantly increase our tax burden and materially and adversely affect our financial condition and results of operations.

 

  27  

 

 

Pursuant to the EIT Law, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise in China to its foreign investors will be subject to a 10% withholding tax, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement and provided that relevant tax authorities approved the foreign investors as the beneficial owners of such dividends under applicable tax regulations. We are a Cayman Islands holding company and substantially all of our income may come from dividends from our PRC subsidiary, E-Sun Sky Computer and Qufan Information Technology (prior to its disposal in February 2018), through our Hong Kong holding company. The Cayman Islands do not have such a tax treaty with China. According to the Mainland and Hong Kong Special Administrative Region Arrangement on Avoiding Double Taxation or Evasion of Taxation on Income between China and Hong Kong entered into in August 2006, or the Double Tax Avoidance Arrangement, and other applicable PRC laws, if a Hong Kong resident enterprise is determined by the relevant PRC tax authority to have satisfied the relevant conditions and requirements under the Double Tax Avoidance Arrangement and other applicable laws, the 10% withholding tax on the dividends the Hong Kong resident enterprise receives from a PRC resident enterprise may be reduced to 5%. To the extent dividends paid by our PRC subsidiary to our Hong Kong holding company are subject to withholding tax, the amount of funds available to us to meet our cash requirements, including the payment of dividends to our shareholders and ADS holders, will be reduced.

 

Furthermore, the State Administration of Taxation promulgated the Notice on How to Understand and Determine the Beneficial Owners in Tax Agreement in October 2009, or Circular 601, which provides guidance for determining whether a resident of a contracting state is the “beneficial owner” of an item of income under China’s tax treaties and tax arrangements. According to Circular 601, a beneficial owner generally must be engaged in substantive business activities. An agent or conduit company will not be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits. The conduit company normally refers to a company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits. If we and our Hong Kong holding company are not considered resident enterprises, we cannot assure you that any dividends distributed to our Hong Kong holding company will be eligible for a reduced withholding tax rate under the applicable treaty.

 

Dividends payable to our foreign investors and gains on the sale of our ADSs or ordinary shares by our foreign investors may become subject to taxes under PRC tax laws.

 

Under the EIT Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to dividends payable to investors that are non-resident enterprises, which do not have an establishment or place of business in the PRC or which have such establishment or place of business but the dividends are not effectively connected with such establishment or place of business, to the extent such dividends are derived from sources within the PRC. Similarly, any gain realized on the transfer of ADSs or ordinary shares by such investors is also subject to PRC tax at a rate of 10%, subject to any reduction or exemption set forth in relevant tax treaties, if such gain is regarded as income derived from sources within the PRC. If we are deemed a PRC resident enterprise, dividends paid on our ordinary shares or ADSs, and any gain realized from the transfer of our ordinary shares or ADSs, would be treated as income derived from sources within the PRC and would as a result be subject to PRC taxation. See “Item 4. Information on the Company—Regulations Regarding the Enterprise Income Tax, Individual Income Tax and Withholding Tax.” Furthermore, if we are deemed a PRC resident enterprise, dividends payable to investors that are non-PRC individual investors and any gain realized on the transfer of ADSs or ordinary shares by such investors may be subject to PRC tax at a rate of 20%, subject to any reduction or exemption set forth in applicable tax treaties. It is unclear whether, if we are considered a PRC resident enterprise, holders of our ADSs or ordinary shares would be able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas (although we do not expect to withhold at treaty rates if any withholding is required). If dividends payable to our non-PRC investors, or gains from the transfer of our ordinary shares or ADSs by such investors are subject to PRC tax, the value of your investment in our ordinary shares or ADSs may be adversely affected.

 

  28  

 

 

We face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

 

Pursuant to the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or SAT Circular 698, issued by the State Administration of Taxation, or the SAT, on December 10, 2009 with retroactive effect from January 1, 2008, where a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly via disposing the equity interests of an overseas holding company, or an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that (i) has an effective tax of rate less than 12.5% or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the relevant tax authority of the PRC resident enterprise such Indirect Transfer. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. SAT Circular 698 also provides that, where a non-PRC resident enterprise transfers its equity interests in a PRC resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.

 

There is uncertainty as to the application of SAT Circular 698. For example, while the term “Indirect Transfer” is not clearly defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax rates in foreign tax jurisdictions, and the process and format for reporting an Indirect Transfer to the relevant tax authority of the PRC resident enterprise. In addition, there are no formal declarations with regard to how to determine whether a foreign investor has adopted an abusive arrangement in order to reduce, avoid or defer PRC tax. SAT Circular 698 may be determined by the tax authorities to be applicable to our offshore restructuring transactions, if any of such transactions were to be determined by the tax authorities to lack reasonable commercial purpose. As a result, we and our non-resident investors in such transactions may be at risk of being taxed under SAT Circular 698 and we may be required to expend valuable resources to comply with SAT Circular 698 or to establish that we should not be taxed under the general anti-avoidance rule of the EIT Law, which may have a material adverse effect on our financial condition and results of operations or such nonresident investors’ investments in us.

 

The PRC legal system embodies uncertainties which could limit the legal protections available to you and us.

 

As our main operating entities and a substantial majority of our assets are located in China, PRC laws and the PRC legal system in general may have a significant impact on our business operations. Although China’s legal system has developed over the last several decades, PRC laws, regulations and legal requirements remain underdeveloped relative to the United States. Moreover, PRC laws and regulations change frequently and their interpretation and enforcement involve uncertainties. For example, the interpretation or enforcement of PRC laws and regulations may be subject to government rules or policies, some of which are not published on a timely basis or at all. In addition, the relative inexperience of China’s judiciary in some cases may create uncertainty as to the outcome of litigation. These uncertainties could limit our ability to enforce our legal or contractual rights or otherwise adversely affect our business and operations. Furthermore, due to the existence of unpublished rules and policies, and since newly issued PRC laws and regulations may have retroactive effect, we may not be aware of our violation of certain PRC laws, regulations, policies or rules until after the fact.

 

  29  

 

 

A failure by our shareholders or beneficial owners who are PRC citizens or residents in China to comply with certain PRC foreign exchange regulations could restrict our ability to distribute profits, restrict our overseas and cross-border investment activities or subject us to liability under PRC laws, which could adversely affect our business and financial condition.

 

In July 2014, SAFE, issued the Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents Engaging in Overseas Investment Financing and Roundtrip Investments via Overseas Special Purpose Companies, or SAFE Circular 37, which annulled the previously applicable Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents Engaging in Financing and Roundtrip Investments via Overseas Special Purpose Vehicles, or SAFE Circular 75. SAFE Circular 37 states that the PRC institutes, citizens or residents must register with the relevant local SAFE branch or central SAFE in connection with their direct establishment or indirect control of an offshore entity established with their domestic enterprise’s legal assets or equity or overseas legal assets or equity for the purpose of investment and financing, and in connection with a roundtrip investment, whereby the PRC institutes, citizens or residents engage in direct investment activities domestically through the offshore entity directly or indirectly, that is establishment of foreign investment enterprises or projects domestically through setting up new enterprise or merger and acquisition and obtain the ownership, right of control and right of operation and management and other rights and interests. In addition, such PRC institutes, citizens or residents must apply for the registration of the overseas investment foreign exchanges before they invest in the special purpose companies with their domestic legal assets and interests, and amend their SAFE registrations when the offshore special purpose companies undergo material events, such as the change of their shareholders, names, operation period and other basic information, or their increases or decreases in investment amount, transfers or exchanges of shares, mergers or divisions, or other material events, or offering equity incentive to the directors, supervisors, senior management and other employees with the equity or option of the non-listed special purpose companies, or obtaining the profit, dividend from the special purpose companies or no-longer holding the rights and interests of the special purpose companies due to share transfer, bankruptcy, dissolution, liquidation, expiration of the operation period, change of identity and other reasons or transferring the financing fund back inland after the special purpose companies have completed the overseas financing.

 

We are committed to complying, and to ensuring that our shareholders and beneficial owners who are PRC citizens or residents comply, with SAFE Circular 37 requirements. We have requested our beneficial owners who are PRC residents to complete the registration under SAFE Circular 37, if applicable. As of the date of this annual report, our beneficial owners who are subject to SAFE Circular 37 registrations are in the process of updating their registrations with the Shenzhen Branch of SAFE. However, we may not be fully informed of the identities of all our beneficial owners who are PRC citizens or residents, and we cannot compel our beneficial owners to comply with SAFE Circular 37 requirements. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC citizens or residents have complied with, and will in the future make or obtain any applicable registrations or approvals required by, SAFE Circular 37 or other related regulations. Failure by such shareholders or beneficial owners to comply with SAFE Circular 37, or failure by us to amend the foreign exchange registrations of our PRC subsidiary, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

 

Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by Public Company Accounting Oversight Board, and as such, investors may be deprived of the benefits of such inspection.

 

Our independent registered public accounting firm issued the audit report included in this annual report. Generally, an auditor of companies that are traded publicly in the United States is registered with the Public Company Accounting Oversight Board (United States), or PCAOB, and is required by the laws of the United States to undergo regular inspections by PCAOB to assess its compliance with the laws of the United States and professional standards. However, as our former auditor is located in China, a jurisdiction where PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, our former auditor, like other independent registered public accounting firms operating in China, is not inspected by PCAOB.

 

Inspections of other firms outside of China conducted by PCAOB have identified deficiencies in those firms’ audit procedures and quality control procedures. The inability of PCAOB to conduct inspections of independent registered public accounting firms operating in China makes it more difficult to evaluate the effectiveness of our former auditor’s audit procedures or quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

  30  

 

 

We may be adversely affected by the initial decision issued by the administrative law judge against the Chinese affiliates of the Big Four accounting firms.

 

In December 2012, the SEC brought administrative proceedings against five accounting firms in China, alleging that the accounting firms refused to produce audit papers and other documents related to certain China-based companies that were under investigation by the SEC for potential accounting fraud. On January 22, 2014, an initial administrative law decision was issued, sanctioning the Chinese affiliates of the Big Four accounting firms and suspending them from practicing before the SEC for a period of six months. The sanction will not take effect until there is an order of effectiveness issued by the SEC. On February 12, 2014, four of these PRC-based accounting firms appealed to the SEC against this decision. In February 2015, each of the four PRC-based accounting firms agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC. The settlement requires the firms to follow detailed procedures to seek to provide the SEC with access to Chinese firms’ audit documents via the CSRC. If the firms do not follow these procedures, the SEC could impose penalties such as suspensions, or it could restart the administrative proceedings. The accounting firms involved have appealed the initial decision to the SEC, and may appeal to the federal appeal court if necessary. The former independent registered public accounting firm that issued the audit reports included in this annual report is one of the accounting firms named in the SEC’s proceedings, and we may be adversely affected by the outcome of the proceedings. In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about the proceedings against these audit firms may cause investor uncertainty regarding China-based, United States-listed companies and the market price of our ADSs may be adversely affected.

 

If our former independent registered public accounting firm were denied, even temporarily, the ability to practice before the SEC, our financial statements could be determined to not be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delisting of our ADSs from the NYSE or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States, result in a sharp decline of our market capitalization and materially and adversely affect the value of your investment in our ADSs.

 

A failure to comply with PRC regulations regarding the registration of shares and share options held by our employees who are PRC citizens may subject such employees or us to fines and legal or administrative sanctions.

 

On February 15, 2012, SAFE promulgated the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Share Incentive Plans of Overseas Publicly-Listed Companies, or the Share Option Rules, which replaced the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Share Ownership Plans or Share Option Plans of Overseas Publicly-Listed Companies issued by SAFE on March 28, 2007. Under the Share Option Rules and other relevant rules and regulations, PRC residents who participate in share incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches and complete certain other procedures. Participants of a share incentive plan who are PRC residents must retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly listed company or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the share incentive plan on behalf of its participants. Such participants must also retain an overseas entrusted institution to handle matters in connection with their exercise of share options, the purchase and sale of corresponding shares or interests and fund transfers. In addition, the PRC agent is required to amend the SAFE registration with respect to the share incentive plan if there is any material change to the share incentive plan, the PRC agent or the overseas entrusted institution or other material changes. As of the date of this annual report, we and our PRC citizen employees who have been granted share options are applying for registration with the Shenzhen branch of SAFE pursuant to the Share Option Rules. See “Item 4B. Business Overview—Regulations on our Industry—Regulations on Foreign Exchange.”

 

Risks Related to Our ADSs

 

The trading price of our ADSs may be volatile, which could result in substantial losses to investors.

 

The trading price of our ADSs may be volatile and could fluctuate widely in response to factors relating to our business as well as external factors beyond our control. Factors such as variations in our financial results, announcements of new business initiatives by us or by our competitors, recruitment or departure of key personnel, changes in the estimates of our financial results or changes in the recommendations of any securities analysts electing to follow our securities or the securities of our competitors could cause the market price for our ADSs to change substantially. At the same time, securities markets may from time to time experience significant price and volume fluctuations that are not related to the operating performance of particular companies. For example, in late 2008 and early 2009, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may also have a material adverse effect on the market price of our ordinary shares.

 

  31  

 

 

In addition, the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes for our ADSs. In recent years, some of PRC companies having listing their securities on U.S. stock markets have experienced significant volatility, including significant price declines in connection with their initial public offerings. The trading performances of these PRC companies’ securities at the time of or after their offerings may affect the overall investor sentiment towards PRC companies listed in the United States and consequently may impact the trading performance of our ADSs. These broad market and industry factors may significantly affect the market price and volatility of our ADSs, regardless of our actual operating performance. Any of these factors may result in large and sudden changes in the trading volume and price for our ADSs.

 

The price at which the ADSs are traded may decline below the offering price, meaning that you may experience a decrease in the value of your ADSs regardless of our operating performance or prospects. In the past, following periods of volatility in the market price of a company’s securities, shareholders have often instituted securities class action litigation against that company. If we were involved in a class action suit, it could divert the attention of senior management, and, if adversely determined, could have a material adverse effect on our results of operations.

 

Future sales or perceived sales of our ADSs or ordinary shares by existing shareholders could cause our ADSs price to decline.

 

If our existing shareholders sell, indicate an intention to sell, or are perceived to intend to sell, substantial amounts of our ordinary shares in the public market after the 90-day contractual lock-up period and the lapse of other legal restrictions on resale discussed in this annual report, the trading price of our ADSs could decline. All ADSs sold in our initial public offering are freely tradable, without restriction, in the public market. The representatives of the underwriters may, in their sole discretion, permit any party subject to lock-up agreements to sell shares prior to the expiration of the lock-up agreements. After the lock-up agreements pertaining to our initial public offering expire (90 days or more from the date of this annual report), all of our outstanding shares will be eligible for sale in the public market, but they will be subject to volume limitations and other restrictions under Rule 144 under the Securities Act. In addition, ordinary shares subject to outstanding options under our share incentive plan will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the lock-up agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold in the public market, the trading price of our ordinary shares could decline.

 

Future issuance of share options or restricted shares may have a diluting effect on existing and future shareholders.

 

The grant and exercise of share options or restricted shares to be issued in the future will likely result in a dilution of the value of our ordinary shares for all shareholders. We established a 2011 Share Incentive Plan under which we are able to issue up to 12% share options or up to 3% restricted shares of our issued and outstanding ordinary shares from time to time. We subsequently adjusted the exercise prices and period of certain options granted in June 2012 and June 2014. For more details, see “Item 6B. Compensation—Share Incentive Plans.” We may in the future issue additional share options and other share-based awards under the plan, which may dilute the interest of the existing and future shareholders. Moreover, we may seek authorization to increase the number of shares subject to our 2011 Share Incentive Plan, or sell additional securities and/or rights to purchase such securities at any time in the future. Dilution of the value of the ordinary shares will likely result from such sales, which in turn could adversely affect the market price of our ordinary shares and ADSs.

 

  32  

 

 

We may become a passive foreign investment company, or PFIC, which could result in adverse United States tax consequences to United States investors.

 

Based on our financial statements and the composition of our income and assets and the valuation of our assets, we do not believe that we were a passive foreign investment company, or PFIC, for United States federal income tax purposes for 2018, although there can be no assurances in this regard. Additionally, it is possible that we may be a PFIC in 2019 or future taxable years. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets and the valuation of our assets from time to time. Specifically, for any taxable year we will be classified as a PFIC for United States federal income tax purposes if either (i) 75% or more of our gross income in that taxable year is passive income or (ii) the average percentage of our assets (which includes cash) by value in that taxable year which produce or are held for the production of passive income is at least 50%. The calculation of the value of our assets will be based, in part, on the quarterly market value of our ADSs, which is subject to change.

 

In addition, there is uncertainty as to the treatment of our corporate structure and ownership of our consolidated affiliated entities for United States federal income tax purposes. If it is determined that we do not own the stock of our consolidated affiliated entities for United States federal income tax purposes (for instance, because the relevant PRC authorities do not respect these arrangements), we would likely be treated as a PFIC.

 

If we are a PFIC for any taxable year during which you hold our ADSs or ordinary shares, such characterization could result in adverse United States federal income tax consequences to you if you are a United States Holder, as defined under “Item 10E. Taxation—United States Federal Income Taxation.” For example, if we are or become a PFIC, you may become subject to increased tax liabilities under United States federal income tax laws and regulations, and will become subject to burdensome reporting requirements. See “Item 10E. Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.” We cannot assure you that we will not be a PFIC for 2019 or any future taxable year.

 

You may not be able to participate in rights offerings and may experience dilution of your holdings in relation to any such offerings.

 

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

In addition, the depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property and you will not receive such distribution.

 

  33  

 

 

Holders of our Class B ordinary shares will control the outcome of shareholder actions in our company.

 

Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are entitled to 10 votes per share. Holders of our Class B ordinary shares hold 74,400,299 Class B ordinary shares, or 17.5 % of the combined total outstanding ordinary shares (representing 68.0 % of the total voting rights) in our company as of December 31, 2018. Their shareholding, in particular the greater voting rights of the Class B ordinary shares, gives Class B ordinary shareholders the power to control any actions that require shareholder approval under Cayman Islands law, our amended and restated memorandum and articles of association and the NYSE requirements, including the election and removal of any member of our board of directors, mergers, consolidations and other business combinations, changes to our amended and restated memorandum and articles of association, the number of shares available for issuance under share incentive plans and the issuance of the significant amounts of our ordinary shares in private placements. Due to the disparate voting rights attached to the two classes of our ordinary shares, holders of our Class B ordinary shares could have sufficient voting rights to determine the outcome of all matters requiring shareholder approval even if it should, at some point in the future, hold considerably less than a majority of the combined total of our outstanding Class A and Class B ordinary shares.

 

As a result of their ownership of Class B ordinary shares, the voting power of holders of our Class B ordinary shares may cause transactions to occur that might not be beneficial to you as a holder of ADSs and may prevent transactions that would be beneficial to you. For example, their voting power may prevent a transaction involving a change of control of us, including transactions in which you as a holder of our ADSs might otherwise receive a premium for your securities over the then-current market price. Similarly, they may approve a merger or consolidation of our company that may result in you receiving a stake (either in the form of shares, debt obligations or other securities) in the surviving or new consolidated company, which may not operate our current business model and dissenter rights may not be available to you in such an event. In addition, holders of our Class B ordinary shares are not prohibited from selling a controlling interest in us to a third party and may do so without your approval. If they sell a controlling interest in us to a third party or otherwise undergo a change of control, any acquirer or successor will be entitled to exercise the voting control and may do so in a manner that could vary significantly from that of our current holders of Class B ordinary shares.

 

In addition, due to the disparate voting rights attached to these two classes, our Class B ordinary shareholders will have significant voting rights over matters requiring shareholder approval, including the election and removal of directors and certain corporate transactions, such as mergers, consolidations and other business combinations. This concentrated control could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A ordinary shares and ADSs may view as beneficial.

 

Anti-takeover provisions in our charter documents may discourage a third party from acquiring us, which could limit our shareholders’ opportunities to sell their shares at a premium.

 

Our amended and restated memorandum and articles of association include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change-of-control transactions. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix the powers and rights of these shares, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares. Preferred shares could thus be issued quickly with terms calculated to delay or prevent a change in control or make removal of management more difficult. In addition, if our board of directors issues preferred shares, the market price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares may be adversely affected. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of us in a tender offer or similar transaction.

 

  34  

 

 

We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

 

Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Cayman Islands Companies Law and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by noncontrolling shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States and provides significantly less protection to investors. In addition, some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands.

 

There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although a judgment obtained in the United States will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (a) is given by a foreign court of competent jurisdiction; (b) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given; (c) is final; (d) is not in respect of taxes, a fine or a penalty; and (e) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

 

You will have limited ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, because we are incorporated in the Cayman Islands, because we conduct our operations exclusively in China and most of our directors and officers reside outside the United States.

 

We are incorporated in the Cayman Islands and conduct our operations exclusively in China. All of our assets are located outside the United States. Most of our directors and officers reside outside the United States and a substantial portion of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the applicable securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state, and it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons predicated upon the securities laws of the United States or any state.

 

Shareholders of Cayman Islands exempted companies such as ourselves have no general rights under Cayman Islands law to inspect corporate records and accounts or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our amended and restated articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

 

As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a U.S. company.

 

Your ability to protect your rights as shareholders through the U.S. federal courts may be limited because we are incorporated under Cayman Islands law.

 

Cayman Islands companies may not have standing to initiate a derivative action in a federal court of the United States. As a result, your ability to protect your interests if you are harmed in a manner that would otherwise enable you to sue in a United States federal court may be limited to direct shareholder lawsuits.

 

  35  

 

 

The voting rights of holders of ADSs are limited in several significant ways by the terms of the deposit agreement.

 

Holders of our ADSs may only exercise their voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions from a holder of ADSs in the manner set forth in the deposit agreement, the depositary will endeavor to vote the underlying ordinary shares in accordance with these instructions. Under our amended and restated memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is five days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter at the meeting. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested.

 

The depositary of our ADSs, except in limited circumstances, grants to us a discretionary proxy to vote the ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, which could adversely affect your interests and the ability of our shareholders as a group to influence the management of our company.

 

Under the deposit agreement for the ADSs, the depositary gives us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings if you do not vote, unless:

 

· we have failed to timely provide the depositary with our notice of meeting and related voting materials;

 

· we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

· we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;

 

· a matter to be voted on at the meeting would have a material adverse impact on shareholders; or

 

· voting at the meeting is made on a show of hands.

 

The effect of this discretionary proxy is that you cannot prevent our ordinary shares underlying your ADSs from being voted, absent the situations described above, and it may make it more difficult for holders of ADSs to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

 

You may not receive distributions on our ordinary shares or any value for them if it is unlawful or impractical for us to make them available to you.

 

The depositary of our ADSs has agreed to pay you the cash dividends or other distributions it or the custodian for our ADSs receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of our ordinary shares your ADSs represent. However, the depositary is not responsible if it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed pursuant to an applicable exemption from registration. The depositary is not responsible for making a distribution available to any holders of ADSs if any government approval or registration is required for such distribution. We have no obligation to take any other action to permit the distribution of our ADSs, ordinary shares, rights or anything else to holders of our ADSs. This means that you may not receive the distributions we make on our ordinary shares or any value for them if it is unlawful or impractical for us to make them available to you. These restrictions may have a material and adverse effect on the value of your ADSs.

 

  36  

 

 

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

 

Your ADSs, represented by ADRs, are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our books or the books of the depositary are closed, or at any time if we think or the depositary thinks it is necessary or advisable to do so in connection with the performance of its duty under the deposit agreement, including due to any requirement of law or any government or governmental body, or under any provision of the deposit agreement.

 

We incurred, and will continue to incur increased costs as a result of being a public company.

 

As a public company, we have incurred significant accounting, legal and other expenses that we did not incur when we were a private company, including additional costs associated with our public company reporting obligations. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC, and NYSE, impose various requirements on the corporate governance practices of public companies.

 

We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. Since we are no longer an “emerging growth company,” we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the other rules and regulations of the SEC. For example, as a result of becoming a public company, we need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. Operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

 

In the past, shareholders of a public company often brought securities class action suits against the company following periods of instability in the market price of that company’s securities. On February 27, 2015, a purported stockholder class action lawsuit consisting of purchasers of our ADSs during the period between November 22, 2013 and February 25, 2015. For further details on this class action lawsuit, see “Item 4B. Business Overview— Legal and Administrative Proceedings.” When we are involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations, which could harm our results of operations and require us to incur significant expenses to defend the suit. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

We began operations in the online lottery service industry in 2001 through one of our consolidated affiliated entities, E-Sun Network Co., Ltd., or E-Sun Network, in Shenzhen, China. In May 2006, E-Sun Network established its wholly-owned subsidiary, E-Sun Sky Network Technology Co., Ltd., or E-Sun Sky Network, which became our major operation entity for our online lottery services business. We have voluntarily suspended our online sports lottery sales services in response to the promulgation of the Self-Inspection Notice and the Public Announcement since April 4, 2015.

 

  37  

 

 

In December 2015, we acquired a 63% equity interest in Sumpay.cn and its wholly-owned subsidiaries, which provide third-party payment services in China, with a cash consideration of RMB233.1 million. We disposed of our interest in Sumpay.cn for RMB359.1 million in cash in May 2016.

 

In July 2016, we acquired a 100% equity interest in Shenzhen Caiyu, a provider of sports information services in China, with a cash consideration of RMB1.0 million. In October 2017, we entered into a share transfer agreement for the disposal of our 100% equity interest in Shenzhen Caiyu for a cash consideration of RMB3.8 million and the transaction was completed in November 2017.

 

In October 2016, we acquired a 51% equity interest in Shenzhen Kaisheng, a provider of online spot commodity trading services in China.

 

In November 2016, we acquired a 51% equity interest in Qufan Internet Technology Inc., and Shenzhen Qufan Network Technology Co., Ltd. with a cash consideration and contingent consideration of RMB110.5 million, to provide mobile poker games services in China. In February 2018, we entered into a share transfer agreement for the disposal of our 51% equity interest in Qufan Internet Technology Inc., and Shenzhen Qufan Network Technology Co., Ltd. for a cash consideration of RMB122.0 million.

 

In June 2017, we acquired a 40.65% equity interest in Loto Interactive Limited, or Loto Interactive, a company listed on the Hong Kong Stock Exchange (Stock Code: 8198), for a total consideration of approximately HK$322.2 million (US$41.3 million). Loto Interactive is principally engaged in the distribution of mobile gaming and provision of lottery-related technologies, systems and solutions to two state-run lottery operators in China, namely the China Welfare Lottery Issuance Centre and the Sports Lottery Centre. Loto Interactive is a distributor of high quality, versatile lottery terminals and parts for the Sports Lottery Center. Loto Interactive provides game upgrading technology and system maintenance service for the rapid-draw game “Shi Shi Cai” in Chongqing Municipality. We accounted for the purchase as an equity method investment.

 

In July 2017, we acquired a 93% equity interest in TMG for a total consideration of approximately EUR49.8 Million (US$56.0 million) in cash. TMG holds licenses to operate online gaming sites from Curacao, Malta, the United Kingdom, Ireland and Sweden. Headquartered in Malta, TMG operates Multilotto.com, or Multilotto.net, which is considered one of the top online lottery betting and online casino platforms in the Nordic countries where it holds substantial market share. Operating under a Curacao e-Gaming license, Multilotto offers players the ability to bet on the outcomes of 24 of the world’s largest lotteries, and has a strong and balanced customer portfolio that has created a solid foundation for its expansion across Europe. Sweden is TMG’s top European market (generating approximately 70% and 71% of TMG’s total revenue in 2017 and 2018, respectively), and we acquired an online gaming license of Sweden on December 20, 2018 through Multi Brand Gaming, a subsidiary of TMG.

 

In March 2018, we entered into a framework agreement with the China Sports Lottery Administration Center, or the Sports Lottery Center, pursuant to which we will cooperate with the Sports Lottery Center to develop physical channels to sell sports lottery tickets. The Sports Lottery Center is the sports lottery issuance agency established by the General Administration of Sports in accordance with relevant laws, and it is the government authority in the PRC in charge of the issuance and organizing sales of sports lottery products in China. As of the date of this annual report, we had entered into framework agreements with Tianjin, Hunan and several other provincial (including regional and municipal) sports lottery centers and started trial operations in Tianjin, Hunan, Hubei, Guangxi and several other provinces and cities in China.

 

See “Item 4C. Organizational Structure” for a diagram illustrating our corporate structure as of December 31, 2018.

 

Our company was incorporated under the laws of the Cayman Islands on April 20, 2007 under the name Fine Success Limited, which was changed to 500wan.com on May 9, 2011 and further changed to the current name 500.com Limited on October 9, 2013.

 

  38  

 

 

On November 22, 2013, our ADSs began trading on the New York Stock Exchange under the ticker symbol “WBAI.” We issued and sold a total of 6,653,900 ADSs, representing 66,539,000 Class A ordinary shares, at an initial offering price of $13.00 per ADS.

 

In June 2015, Tsinghua Unigroup International Co., Ltd. purchased 6,350,050 newly issued ADSs, representing 63,500,500 Class A ordinary shares of the Company for a total purchase price of approximately US$123.8 million in cash. The per share purchase price was US$1.95 (corresponding to US$19.50 per ADS).

 

Our principal executive offices are located at 12F, West Side, Block B, Building No.7, Shenzhen Bay Eco-Technology Park, Nanshan District, Shenzhen, 518115, People’s Republic of China. Our telephone number at this address is +(86) 755 88352500 and our fax number is +(86) 755 83796070. Our registered office in the Cayman Islands is at PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our websites are www.500.com and www.500wan.com. Our agent for service of process in the United States is Law Debenture Corporate Services Inc. located at 400 Madison Avenue, 4th Floor, New York, New York 10017.

 

B. Business Overview

 

Overview

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, we were a leading online sports lottery service provider in China. We acted as an aggregator and processor of lottery purchase orders from our registered user and offered a comprehensive and integrated suite of online lottery services, information, user tools and virtual community venues to our users.

 

We were among the first companies to provide online lottery services in China, and we are one of the two entities that are authorized by the MOF to provide online lottery sales services on behalf of the China Sports Lottery Administration Center, the government authority in charge of the issuance and sale of sports lottery products in China.

 

Through continued and significant investments in the past 18 years, we have built a prominent brand, 500wan, which means “five million” in Chinese and is the typical amount of top prizes of most lottery products in China. We believe our brand is known in the industry and by our users for its credibility and reliability.

 

Due to the voluntary suspension of our online sports lottery sales services and the uncertainty about when such services can be resumed, we continue to strive for diversification across our business lines. We currently offer several different lines of services, including (i) online gaming services through our newly acquired subsidiary, TMG; (ii) financial technology services through our controlled subsidiary, Shenzhen Kaisheng; and (iii) physical channels for selling sports lottery tickets.

 

Our Services

 

Our current and certain past service offerings are summarized as below:

 

Online Gaming Services

 

Licenses

 

In July 2017, we acquired a 93% equity interest in TMG. TMG holds licenses from Malta, the United Kingdom, Ireland, Curacao and Sweden to operate online gaming sites. Through these licenses, TMG provides gaming services in close to 200 countries worldwide. On December 20, 2018, TMG acquired a license in Sweden through its subsidiary in response to a new license requirement effective January 1, 2019. Sweden is currently TMG’s top European market (generating approximately 70% and 71% of TMG’s total revenue in 2017 and 2018, respectively).

 

  39  

 

 

Users

 

Headquartered in Malta, TMG serviced, in 2018, (i) approximately 11,000 monthly users in Germany and Malta (through its Malta remote gambling license) at multilotto.net; (ii) approximately 5,000 monthly users in the UK (through its UK remote operating license) at multilotto.co.uk; (iii) approximately 500 monthly users in Ireland (through its Irish remote bookmaker’s license) at multilotto.ie; and (iv) approximately 36,000 monthly users in close to 200 additional jurisdictions, including key markets in the Nordic countries, as well as other parts of Europe where online gaming is not prohibited, Africa, South America and North America (through its Curacao e-Gaming license) at Multilotto.com.

 

Services

 

TMG provides betting on the outcome services also known as Secondary Lottery Services and remote casino services to its users.

 

Through its Secondary Lottery Services, TMG offers users the ability to bet on the outcomes of some of the world’s largest lotteries (including Powerball, Mega Million and EuroMillions), and has a strong and balanced customer portfolio that has created a solid foundation for its expansion across Europe. In 2018, TMG’s Secondary Lottery Services generated (based on gross gaming revenue): (i) approximately 45,000 euros per month, under the Malta remote gambling license; (ii) approximately 17,000 euros per month, under the UK remote operating license; (iii) approximately 4,500 euros per month, under the Irish remote bookmaker’s license; and (iv) approximately 820,000 euros per month under the Curacao e-Gaming license.

 

Through its remote casino services, TMG offers users several different casino services, including online slot machines and online table games. All online casino games are games of chance, and are provided and developed by third parties. Third-party developers are responsible for obtaining approvals from government authorities for legality and chances of winning. In 2018, TMG’s remote casino services generated (based on gross gaming revenue): (i) approximately 92,000 euros per month, under the Malta remote gambling license; (ii) approximately 99,000 euros per month, under the UK remote operating license; (iii) approximately 2,600 euros per month, under the Irish remote bookmaker’s license; and (iv) approximately 540,000 euros per month under the Curacao e-Gaming license.

 

Revenues provided by Online Gaming Services from TMG during the consolidating period of 2018 were RMB105.5 million (US$15.3 million).

 

  40  

 

 

Anti-Fraud Procedures

 

In order to combat e-commerce fraud, a common issue for remote gaming operators, TMG has implemented a stringent set of anti-fraud procedures through technical and procedural controls. Specifically, to ensure only players within the jurisdictions where TMG operates can participate in the lottery and casino services, identification information (including full name, date of birth, address, e-mail address and mobile number) is required upon registration. Registrations from IP addresses outside of the licensed jurisdictions are blocked. Players under 18 years of age are not permitted to open accounts. If the player’s IP address does not match the state and country in which the player resides, the player’s account is locked out.

 

Whenever a player reaches the threshold of 2000 euros in cumulative deposits, he/she will be subject to TMG’s Know Your Customer, or KYC, procedure. This can also be done prior to a player reaching such threshold, at the discretion of TMG’s fraud team. At such point, the player will be required to provide personal identity information including a photograph, proof of address (bank statement less than three months old, utility bill, or tax card/return), proof of account funding (copy of credit card, credit card statement, or bank statement). In addition, in cases of suspected fraud, the user is required to provide a photograph in which both the user’s face and identity card are legible.

 

In comparison to competitors, TMG’s wagering limits are set relatively low, making it impractical for money launderers to join the gaming service. All withdrawal requests are initially checked, and all withdrawal requests are monitored in order to detect suspicious transactions (based on any suspected fraudulent background).

 

In addition, all transactions/customer accounts are checked by TMG’s Fraud and Payments team prior to the player’s first withdrawal. This includes checks for multiple accounts, individuals which may have been blacklisted by any relevant organization or company, transaction and betting behavior, handled amounts, deposit/withdrawal methods and any other factors that may lead to any suspicious activity based on the experience of TMG’s risk management team. If no such issues are encountered, the finding will be forwarded to the accounting department for a final review before payout. This process is generally completed within one working day.

 

In any cases where TMG encounters and verifies that any form of anti-money laundering is taking place or being attempted, such activity will be reported to the relevant gaming authorities, as required.

 

No cash deposits or cash withdrawals are permitted. Deposits and withdrawals can only be made through electronic payment methods and through banking/financial institutions

 

  41  

 

 

Physical Sales of Sports Lottery Tickets

 

In March 2018, we entered into a framework agreement with the China Sports Lottery Administration Center, or the Sports Lottery Center, pursuant to which we will cooperate with the Sports Lottery Center to develop physical channels to sell sports lottery tickets. The Sports Lottery Center is the sports lottery issuance agency established by the General Administration of Sports in accordance with relevant laws, and it is the government authority in the PRC in charge of the issuance and organizing sales of sports lottery products in China.

 

The term of the framework agreement is three years, with an option to extend the agreement for an additional three years.

 

Under the framework agreement, we are responsible for negotiating, and entering into, cooperation agreements with provincial (including regional and municipal) sports lottery centers to install sports lottery terminals and provide relevant maintenance and operational services in accordance with local development plans.

 

We worked with the Sports Lottery Center to explore new physical sales channels and establish terminals in areas that existing and/or traditional lottery centers are not located. This may include establishing terminals in convenience stores, restaurants, bars, movie theaters, and other physical locations (particularly areas with high real estate costs) without access to lottery services at this time. Through the installation of terminals, we aim to provide users with physical access to sports lottery services 24 hours per day.

 

The installation of the sports lottery terminals aims to enhance the convenience of sports lottery ticket purchases, enlarge our customer base and optimize the user experience for lottery purchasers.

 

As of the date of this annual report, we had entered into framework agreements with Tianjin, Hunan and several other provincial (including regional and municipal) sports lottery centers and started trial operations in Tianjin, Hunan, Hubei, Guangxi and several other provinces and cities in China. Beginning in 2018, we began to generate a small amount of revenue from physical sales of sports lottery tickets.

 

Sports Information Services

 

Following our acquisition of Shenzhen Caiyu, a provider of sports information services in China, in July 2016, we began to offer a comprehensive sports information portal via a designated mobile application, which covers (i) real-time soccer match information; and (ii) data-driven soccer match predictions generated by our proprietary analysis engine. In addition, users can post free or pay-per-view contents such as proprietary observations and analyses on our sports information portal. We disposed of Caiyu in November 2017, and continue to provide this information through our own service offerings named “Cai Xun Hao,” which was further ceased in March 2019.

 

In November 2016, we added a pay-service, which offers our users the ability to connect with independent sports experts to obtain more detailed information on specific sporting matches. In connection with the pay-service, revenues are split equally between us and the experts.

 

Revenues provided by sports information during the consolidating period of 2018 were RMB16.0 million (US$2.3 million).

 

Financial Technology

 

With the increasing demand for more diversified financial and investment instruments in China, the precious metals trading market has expanded very quickly over the past few years. We entered the precious metals trading industry, leveraging our existing customer base to build an online gold trading platform.

 

Through our holding of a 51% interest in Shenzhen Kaisheng, we have developed a platform to provide our customers with reliable online spot commodity trading for gold trade and delay products across PC and mobile devices. Beginning in 2017, we began to generate a small amount of revenue from trading commissions on the online spot commodity trading executed on our websites and mobile applications. Shenzhen Kaisheng processed its customer orders through a commercial bank, which is a member of Shanghai Gold Exchange in the past, and formed a joint venture with another member of such exchange in the second quarter of 2018 to process its customer orders.

 

  42  

 

 

Sports Lottery Sales Services in China

 

We previously provided registered users with certain sports lottery sales services, which have been suspended since April 2015:

 

Individual Lottery Purchase . We provided our users with online purchase services to sports lottery products. Users place purchase orders for sports lottery products through our websites after registering, opening and funding an online account.

 

Lottery Pool Purchase. Lottery pools enabled individual users to purchase a share in a pooled lottery outcome or group of outcomes with other users. Lottery pool purchase was a service developed and first offered by us in China utilizing the unique advantages of the Internet, and it has become a standard feature on all websites that offer online lottery services.

 

Automatic Tag-along Purchase. Automatic tag-along purchase was another service we provided that distinguished us from traditional offline lottery agents. Through this service, a user can choose to automatically and periodically join a lottery pool initiated by another user. A user can customize the automatic tag-along feature by specifying the pools he wishes to automatically join, the commitment to be put down for each automatic pool and other specifications. Users may also use the “following” feature to be notified of the pooling activities initiated by certain users without automatically tagging-along. We placed the option to automatically join or follow a user’s pool on such user’s profile page. A profile page also contains a user’s basic information, such as winning record, number of pools initiated and consummated, number of followers and date of registration, to allow other users to judge whether to follow or join pools initiated by this particular user.

 

Recurring Purchase. Recurring purchase service enabled our users to repeatedly purchase a particular number or a combination of numbers. The user sets the combination once and specifies the type and number of rounds or dates of lotteries he wants to purchase with the selected combination. We processed the purchase orders automatically. Users might cancel a recurring purchase prior to the date of any particular lottery. We also offered a filtering tool that helps users set certain parameters in choosing the combination of numbers.

 

Locked-in Lottery Number Purchase. Locked-in lottery number purchase service enabled users for number-based lottery products to lock in certain numbers for each of their purchases. For instance, a user may prefer the number “8” to occur somewhere in their selected combination. The number locked-in service let users specify numbers they want and randomly generate the remaining to form a lottery pick.

 

Mobile Gaming

 

Between the fourth quarter of 2016 and the first quarter of 2018 when we owned a 51% interest in Qufan, we offered two mobile games, namely Night of Texas Hold’em Poker and Paiyou for Texas Hold’em Poker. Both games are based on the real-world counterpart that dates back to the early 1900s.

 

The Night of Texas Hold’em Poker. Our Night of Texas Hold’em is open for all the registered users. Two to nine players can compete with each other in a virtual public poker room to win the virtual tokens contributed by all the playing parties.

 

Paiyou for Texas Hold’em Poker . Our Paiyou for Texas Hold’em is designed for friends and acquaintances. Registered users can open a virtual private poker room and invite friends and acquaintances to participate in the poker games. In addition to the traditional Texas Hold’em poker game, our Paiyou for Texas Hold’em is equipped with a number of appealing creative features such as poker room customization, social sharing and analytic tools.

 

  43  

 

 

Revenues generated from these games in 2018 were RMB7.4 million (US$1.1 million). As a result of the disposal of Qufan, we no longer generate revenues from these games (effective since February 9, 2018). Our revenue from these games in 2018 was significantly less than that of 2017.

 

Independent of Qufan, we offered a mobile game in 2017 called Quiz . In the game, users aim to win virtual tokens, which can be used in a subsequent draw to win certain prizes (including iPhones and iPads). We ceased operations on Quiz in the first quarter of 2018.

 

Revenues provided by Quiz in 2018 were RMB4.0 million (US$0.6 million).

 

Payment Processing and Complementary Services

 

When we owned the 63.0% equity interest in Sumpay.cn and its wholly-owned subsidiaries between December 2015 and March 2016, we provided certain online payment services and prepaid card services in the PRC.

 

Our Revenue Model

 

Online Gaming Services

 

We generate revenue from online gaming services through our users’ gaming losses.

 

Revenues from our online gaming services are determined by calculating (i) the aggregate net difference between our users’ real money gaming wins and real money gaming losses plus (ii) the aggregate net difference between our users’ “bonus” gaming bets (relating to promotions and loyalty programs) and “bonus” gaming wins.

 

Funds deposited by customers in advance are recognized as a liability before  gaming play occurs.

 

Physical Sales of Sports Lottery Tickets

 

As of the date of this annual report, we had entered into cooperation agreements with Tianjin, Hunan and several other provincial (including regional and municipal) sports lottery centers and started trial operations in Tianjin, Hunan, Hubei, Guangxi and several other provinces and cities in China.

 

Under this line of service, we generate net revenues from service fees paid to us by provincial sports lottery centers for physical purchase orders of lottery products we direct to them from the lottery terminals. Each provincial lottery administration center pays us a fixed percentage of the total purchase amount received from us as a service fee.

 

Sports Information Services

 

Our sports information portal is free to use, and our users can view basic content such as real-time soccer match information and part of the user-generated contents. We generate revenue from our sports information portal through (i) monthly subscription of premium content, primarily our data-driven soccer match predictions; and (ii) a fixed percentage of fee on the fee received by other users for the pay-per-view content they posted, including proprietary analyses and observations.

 

In 2017, we added a pay-service, which offers our users the ability to connect with independent sports experts to obtain more detailed information on specific sporting matches. In connection with the pay-service, revenues are split equally between us and the experts.

 

We have ceased offering this service in March 2019.

 

  44  

 

 

Financial Technology

 

Through our interest in Shenzhen Kaisheng, we generate revenue from financial technology services through trading commissions on each online spot commodity trade executed on our websites and mobile applications.

 

Sports Lottery Sales Services in China

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, most of our net revenues came from service fees paid to us by provincial lottery administration centers for purchase orders of national and provincial lottery products we direct to them.

 

We have entered into service agreements with a number of provincial lottery administration centers. Pursuant to these service agreements, each provincial lottery administration center generally pays us a fixed percentage of the total purchase amount received from us as a service fee.

 

Aside from our operating websites, namely, www.500wan.com and www.500.com, we also offered our services in a number of other service channels. We provided content to third-party websites that offer lottery information services to their users prior to the voluntary suspension of our online sports lottery sales services in April 2015. Such third-party websites offer their users an option to submit lottery purchase order through us by redirecting such users to our websites. We paid the third-party websites a pre-determined fixed percentage of the total purchase amount provided by such redirected orders with third-party websites pursuant to agreed-upon allocations ratios.

 

The residual amount of lottery pool purchases we contributed was recognized as a reduction of revenue. We would distribute the prize money to the pool participants based on the predetermined payout ratio if the lottery pool wins a prize, and the residual amount after the distribution is received by us and recorded as other operating income.

 

Mobile Gaming Services

 

For these services, we generated all of our revenue from the sales of in-game virtual items, including virtual tokens and other virtual items, to our paying players. We offered a limited amount of free virtual tokens to our players to allow them to enter and play our games. Players may purchase and earn virtual tokens and other virtual items that can only be used in our games, cannot be cashed out and have no monetary value outside our games. Our mobile gaming revenue significantly reduced in 2018 as a result of our disposal of Qufan and cessation of Quiz in early 2018.

 

User Support Operations

 

Our support team is divided into two groups: (i) customer service department; and (ii) online security (Fraud & Payments).

 

The customer service department receives a significant number of incoming emails and aims to identify and assess customers’ needs to achieve satisfaction, as well as build sustainable relationships and trust with customer accounts through open and interactive communication. The customer service department strives to provide accurate information, appropriate solutions and suitable alternatives within the applicable time constraints. In addition, the customer service department performs Know Your Customer checks regularly and applies enhanced due diligence accordingly.

 

The Fraud & Payments team processes and monitors all customers withdrawals in accordance with the procedures we have established and reviews player accounts and financial activity to minimize risk. In addition, they perform investigations and report suspicious customer account activity to our Money Laundering Reporting Officer. The Fraud & Payments team also assists customer service in handling user inquiries relating to payments, disputes and complaints filed with alternative dispute resolution centers.

 

  45  

 

 

Sales, Marketing and Branding

 

We were among the first companies to offer online lottery services in China and have built a strong brand name and reputation.

 

Our approach to marketing and sales incorporates all available online marketing activities, utilizing both in-house and externally available resources. Apart from online marketing, we also pursue traditional advertising opportunities in offline marketing, while ensuring the use of a range of promotional messages across different channels.

 

Our marketing activities are aimed at targeting a specific audience in the local markets where such promotional messages are time sensitive, seasonal, on-going and live.

 

We place great importance on the reputation of our brand, and are focused on increasing brand visibility steadily in other markets.

 

Competition

 

We experience intense competition in our industry.

 

The lottery segment of our business is extremely competitive. Our main competitors include TheLotter, LottoLand and 25Lotto.

 

In the online and live casino segment of our business, our main competitors include Betsson, LeoVegas, 

Casumo and Mr. Green.

 

Product Development

 

We had a technology and product development team of 108 employees as of December 31, 2018, representing 38.3% of our total number of employees. The members of the core development team all have previous experience in major Chinese Internet enterprises, some of whom are the first-generation Internet professionals in China. We are dedicated to expanding our product development team and attracting highly experienced professionals. We provide our team members with frequent and up-to-date training to ensure that they are fully updated on industry trends and developments, and are capable of and efficient in handling any technical challenges we might face in our operations. Our current focus is on the development of new functions and improvement of existing technologies in a number of crucial areas, such as server capacity, user interface, client-side software, mobile site and mobile client-side software, infrastructure optimization and user data mining. The product development department has subgroups that focus on various areas of research and development, such as product design, user interface design, product operation and product support. The product design group focuses on enhancing existing services and researching and developing new lottery services. The product operation and support groups are dedicated to building a safe, stable and highly efficient operating environment to handle our high volume of user traffic and data transmission. As a result, we operate an online lottery service platform that is stable, secure and fast. We plan to develop and improve our systems and technologies, and co-develop new lottery products in cooperation with lottery administration centers, which we believe will help to distinguish us from our competitors.

 

Legal and Administrative Proceedings

 

On September 12, 2016, we entered into a settlement agreement with certain plaintiffs who brought a stockholder class action lawsuit in the U.S. District Court for the Central District of California, shareholders’ litigation in February 2015. In 2016, we paid US$1.5 million for the settlement, and the remaining US$1.0 million was covered by the insurance company.

 

  46  

 

 

In connection with our acquisition of a 93% equity interest in TMG in 2017, we entered into a shareholders’ agreement with Helmet Limited, or Helmet, which owns the remaining 7% equity interest (post-acquisition) in TMG. Pursuant to this shareholders’ agreement, if Thomas Biro resigns from his employment with TMG, or his employment is terminated for whatever reason, Helmet has the right to request that we, on one occasion, purchase all or some of the TMG shares then held by Helmet. This right is exercisable within one year from the aforementioned resignation. However, such right is not exercisable if Mr. Biro resigns before December 31, 2018. When the notice to exercise such right is delivered, we and Helmet shall, within 30 business days, establish a fair market value as the purchase price for the TMG shares subject to sale. If both parties fail to reach an agreement during such period, the fair market value of those TMG shares will be decided by an independent valuation expert appointed by both parties. If the parties are not able to decide on an independent valuation expert, such expert shall be appointed in accordance with the dispute resolution provisions under the shareholders’ agreement.

 

In early 2019, we received a redemption notice from Helmet, requesting us to purchase the 7% equity interest in TMG held by Helmet at a redemption price of EUR3,745,000. We and Helmet failed to reach an agreement as to the purchase price for the TMG shares within 30 business days of the notice. Helmet has referred the dispute to arbitration by a local court in Malta, and we have engaged attorneys to represent us in the arbitration. The worst-case scenario is that we ultimately may be required to purchase the TMG shares held by Helmet at the redemption price of EUR3,745,000. Accordingly, after receiving the redemption notice we adjusted the carrying amount of the 7% redeemable noncontrolling interest to equal to the redemption amount of EUR3,745,000 as of December 31, 2018. Other than this adjustment as reflected and disclosed in our consolidated financial statements for 2018, we do not expect to incur other liabilities in connection with the aforementioned arbitration.

 

Regulation of Our Industry

 

This section sets forth a summary of the most significant regulations or requirements that affect our business activities in China or our shareholders’ rights to receive dividends and other distributions from us.

 

As regulations on our industry are developing and evolving in China and in Europe, authorities may adopt from time to time new laws and regulations that will address new issues or require us to obtain licenses and permits in addition to those that we currently have. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future Chinese laws and regulations applicable to the online lottery services industry. See “Item 3D. Risk Factors—Risks Related to Our Business and Industry—The rules and regulations on our industry are relatively new and interpretations and implementation thereof have changed substantially on a number of occasions, and their further interpretations and implementation involve uncertainty.”

 

We maintain policies and procedures to ensure that orders for lottery products from IP addresses from the United States will not be accepted through our websites. Accordingly, we do not believe our operations are subject to the regulatory authority of the United States.

 

Regulations on Online Gaming in Europe

 

Through TMG, we hold licenses to operate online gaming sites from Curacao, Malta, the United Kingdom, Ireland and Sweden, and are required to renew them periodically. Some European jurisdictions have introduced regulations attempting to restrict or prohibit online gaming, while other jurisdictions have taken the position that online gaming is legal and have adopted or are in the process of considering legislation to regulate online gaming.

 

Sweden represents our top European market (generating approximately 71% of TMG’s total revenue in 2018), but did not have a license requirement until January 2019. The Swedish government submitted a legislative proposal to the European Commission in late 2017, and by making this legislative proposal, the legislation entered a three-month period of standstill that ended on March 31, 2018, during which European Union authorities reviewed the proposal. The Swedish government began accepting license applications from interested operators in mid-2018, and the new regulatory framework took effect on January 1, 2019. We operated in Sweden under the Curacao license before we obtained the Swedish license on December 20, 2018.

 

  47  

 

 

While certain European countries are adopting a regulated online gaming approach, there are some opposing views. Some countries, where there are state-owned monopolies, are taking action aimed at banning foreign online gaming operators. Any decision of the European Court of Justice or legislation promulgated by the European Commission that effectively prohibits online gaming in European Union member states could have a severe material adverse effect on our business, revenues, operating results and financial condition.

 

Regulations on Lottery Services Industry and Online Lottery Sales

 

Since 1991, the Chinese government has promulgated a series of rules and regulations to regulate the lottery industry in China. The major rules and regulations currently in effect and applicable to our online lottery services include Regulation on Administration of Lottery, promulgated by the State Council on May 4, 2009 and effective as of July 1, 2009, or the Lottery Regulation, and the Interim Measures for the Administration of Online Sales of Lottery, promulgated by the MOF on September 26, 2010, or the Lottery Measures, and effective upon the promulgation. On January 18, 2012, the MOF, the Ministry of Civil Affairs and the General Administration of Sports of China jointly promulgated the Implementing Rules, which became effective on March 1, 2012. On February 28, 2012, General Administration of Sports of China promulgated the Urgent Notice. Under currently effective rules and regulations, only qualified service providers approved by the MOF may engage in online lottery sales. Such qualified service providers will act as agencies for the relevant lottery administration centers and must obtain a Lottery Agency License from and enter into lottery agency agreements with the competent lottery administration centers before engaging in lottery sales on their behalf.

 

Certain rules and regulations previously promulgated by the MOF and other regulatory authorities had previously prohibited the sales of lotteries through the Internet, but after the promulgation of the Lottery Measures those rules and regulations have ceased to have legal effect.

 

Online Lottery Sales

 

The Lottery Measures set forth detailed requirements for the administration of online lottery sales as well as the requirements for qualified online lottery service providers. According to the Lottery Measures, the MOF is the supervisory and regulatory body of online lottery sales in the PRC, and the China Welfare Lottery Issuance and Administration Center and the China Sports Lottery Administration Center (collectively, “Lottery Issuance Agencies”) are responsible for the overall planning and management of online lottery sales for welfare lottery and sports lottery, respectively. The Lottery Issuance Agencies may collaborate with other entities or authorize relevant lottery sales agencies to conduct online lottery sales, or appoint qualified entities as their online lottery sales agents. The Lottery Measures require qualified online lottery service providers to meet certain criteria, including, among others, that (i) they have a minimum registered capital of RMB50 million, (ii) they maintain adequate organizational, internal control and risk management systems, (iii) they and their senior management have a clean criminal and credit history for the past five years, and (iv) they have obtained an Internet content provider license. The Lottery Issuance Agencies are required to selectively submit to the MOF information on the online lottery service providers that apply to become qualified to engage in online lottery business under the Lottery Measures. Jiangxi Sports Lottery Administration Center notified us that it submitted an application for qualification and approval for the online lottery sales services for sports lottery products that we provided on our websites to the China Sports Lottery Administration Center in January 2011, and that this application would be further submitted by the China Sports Lottery Administration Center to the MOF for approval. In October 2012, we were notified by the China Sports Lottery Administration Center that we were approved by the MOF to provide online sales services for sports lottery products on its behalf. Since the relevant regulations do not set forth a specific time limit for the MOF to issue such approval, it is not clear when we will be able to obtain the MOF’s approval, or at all.

 

On January 15, 2015, the MOF, the Ministry of Civil Affairs and the General Administration of Sports of the People’s Republic of China jointly promulgated the Self-Inspection Notice, which requires provincial and municipal government branches, including financial, civil affairs and sports bureaus, to conduct inspections and take remedial measures for unauthorized online lottery sales within their respective jurisdictions. The scope of inspection includes, among other things, commercial contract arrangements, online lottery products, lottery sales data exchange, online lottery sales channels, and sales commission fees in connection with unauthorized engagements of online sales agents by lottery administration centers. The Notice further requires a formal report on the result of the self-inspection and self-remedy be submitted by each provincial or municipal government to the Ministry of Finance, the Ministry of Civil Affairs and the General Administration of Sports of the People’s Republic of China by March 1, 2015.

 

  48  

 

 

On April 3, 2015, the Public Announcement was jointly released by eight competent government authorities, namely, the MOF, the Ministry of Public Security, the State Administration for Industry & Commerce, the Ministry of Industry and Information Technology, the Ministry of Civil Affairs, the People’s Bank of China, the General Administration of Sports of China and the China Banking Regulatory Commission. The Public Announcement mandates, among other things, that (i) all lottery institutions, internet companies, and other institutions or individuals which provide unauthorized online lottery sales services, either directly or through agents, shall immediately cease such services. The local governmental authorities of finance, civil affairs and sports shall investigate and sanction unauthorized online lottery sales in their respective jurisdictions according to relevant laws and regulations; (ii) the local government authorities of public security and industry & commerce shall investigate any issuance or sales of illegal lottery within their respective jurisdictions, with necessary assistance from local government authorities of finance, communication, banking regulatory commission, civil affairs, sports and local branches of the People’s Bank of China, and report any criminal activities to the judicial authority for prosecution; and (iii) the lottery issuance authorities that plan to sell lottery products online shall obtain the approval from the Ministry of Civil Affairs or the General Administration of Sports of China by submitting an application to the Ministry of Finance for written approval. Any entity shall not provide online lottery sales services without the approval by the Ministry of Finance.

 

We were one of the two entities approved by the Ministry of Finance in 2012 to provide online lottery sales services on behalf of the China Sports Lottery Administration Center. To the best of our knowledge, the approval by the MOF for us to provide online lottery sales services on behalf of the China Sports Lottery Administration Center is valid and has not been revoked or amended as of the date of this annual report.

 

Lottery Regulatory Authorities

 

Under the current regulations and provisions, the State Council is vested with the power to authorize the issuance of welfare lottery and sports lottery, and is also the highest authority for granting the right to issue lotteries. The MOF is responsible for administering, regulating and supervising the national lottery industry. The Ministry of Civil Affairs and the General Administration of Sport of China are responsible for administering and regulating welfare lottery and sports lottery, respectively, and have established the China Welfare Lottery Issuance and Administration Center and the China Sports Lottery Administration Center, respectively, pursuant to regulations for the issuance and sales of welfare lottery and sports lottery. The civil affairs departments and sports administration departments of provincial governments are responsible for the administration of welfare lotteries and sports lotteries within their respective administrative regions. The following organization chart illustrates the overall governmental administrative authority in the China lottery operation:

 

 

 

  49  

 

 

Regulations on Lottery Administration

 

On May 4, 2009, the State Council promulgated the Lottery Regulation, which sets forth general provisions for the issuance, sales and administration of lottery products. According to the Lottery Regulation, the welfare and sports lotteries sold in China must be issued by the lottery issuance authorities, established by the civil affairs’ department and sports administration department of the PRC State Council, or the Lottery Issuance Agencies, and must be sold through Lottery Issuance Agencies or lottery sales offices established by the civil affairs’ departments and sports administration departments of the people’s government at the provincial level (“Lottery Sales Agencies”). Lottery Issuance Agencies and Lottery Sales Agencies may, by entering into agency agreements, appoint other entities or individuals as their agents in distributing lotteries. The Lottery Regulation also listed circumstances where the Lottery Issuance Agencies and Lottery Sales Agencies may terminate such agency agreements, including situations where the agent subcontracts the sales of the lottery products to any other persons or entities or sells lottery products to underage buyers.

 

The Lottery Regulation prohibits the Lottery Issuance Agencies, the Lottery Sales Agencies and their sales agents from (i) advertising false or misleading information, (ii) competing unfairly by discrediting others in the same industry, (iii) selling lottery or paying lottery prizes to underage purchasers and (iv) selling lottery on credit. If the Lottery Issuance Agencies or the Lottery Sales Agencies fail to comply with these requirements, the MOF or its relevant branches will have the power to (i) require the Lottery Issuance Agencies or the Lottery Sales Agencies to correct or cease their operations; (ii) confiscate the illegal income received by the Lottery Issuance Agencies or the Lottery Sales Agencies and impose fines; and/or (iii) impose administrative sanctions against persons that are responsible. If any lottery sales agent sells lotteries to the underage buyers, its relevant income may be confiscated and it may be subject to administrative fines up to RMB10,000, and the Lottery Issuance Agencies or the Lottery Sales Agencies may have the right to terminate the agency agreement with the lottery sales agent. In addition, the Lottery Measures prohibits the opening of online lottery accounts for or the granting of lottery prizes to underage buyers.

 

Prior to the promulgation of the Lottery Regulation, the issuance and sales of the lottery products were governed by the Interim Provisions for the Administration of the Lottery Issuance and Sales, or the Interim Provisions, promulgated by the MOF on March 1, 2002. The Interim Provisions were replaced by the Administrative Measures for Lottery Issuance and Sales promulgated by the MOF on December 28, 2012. The Administrative Measures for Lottery Issuance and Sales provided that any Lottery Issuance Agency, which wishes to apply to create, change or abolish a specific type of welfare or sports lottery, is required to apply to the Ministry of Civil Affairs or the General Administration of Sport of China for creating, changing or abolishing a specific type of welfare or sports lottery. If the application has been approved by the Ministry of Civil Affairs or the General Administration of Sport of China, such application will be further submitted to the MOF for the MOF’s examination and approval before the implementation. After the creation or change of specific type of welfare or sports lottery has been approved by the MOF, the Lottery Issuance Agency receiving MOF approval or its related Lottery Sales Agencies shall submit sales implementation plans to the MOF or its provincial counterparts for approval prior to the sales of the specific type of lottery. The sales implementation plan shall include, among other things, the proposed sales commencement date, promotion plans and risk control measures. In order to sell the specific type of welfare or sports lottery so created or changed, the Lottery Issuance Agencies or the Lottery Sales Agencies may engage specific sales agents by entering into lottery sales agency agreements with such sales agents.

 

Regulation of Telecommunication Services

 

The telecommunication industry, including the Internet sector, is highly-regulated in China. Regulations issued or implemented by the State Council of China, the MIIT, and other relevant government authorities cover many aspects of the operation of telecommunication and the Internet information services, including access to the telecommunication industry, the scope of permissible business activities, and licenses and permits required for various business activities and foreign investment.

 

The principal regulations governing telecommunication and Internet information services include:

 

· the Telecommunication Regulations promulgated by the State Council on September 25, 2000;

 

  50  

 

 

· the Administrative Measures for Telecommunications Business Operating License promulgated by the MIIT on March 5, 2009; and

 

· the Catalogue of Classes of Telecommunications Businesses promulgated by the Ministry of Information Industry, former of MIIT, also as MIIT on February 21, 2003.

 

Under these regulations, telecommunication services in China are categorized as either basic telecommunication services or value-added telecommunication services, both of which require relevant operating licenses.

 

Regulations on Value-Added Telecommunication and Internet Information Services

 

On September 25, 2000, the State Council promulgated the Telecommunication Regulations, or the Telecom Regulations. The Telecom Regulations categorize all telecommunication businesses in the PRC as either basic or value-added. Value-added telecommunication services are defined as telecommunication and information services provided through public network infrastructure. The “Catalog of Classes of Telecommunication Business,” an attachment to the Telecom Regulations and updated by the MII’s Notice on Adjusting the Catalog of the Class of Telecommunication Business, effective from April 1, 2003, categorizes various types of telecommunication and telecommunication-related activities into basic or value-added telecommunication services, according to which, Internet content provision services, or ICP services, are classified as value-added telecommunication businesses, or VAS business. Under the Telecom Regulations, commercial operators of value-added telecommunication services must first obtain an operating license for value-added telecommunication services, or the VAS license, from the MIIT or its provincial level counterparts before commencing any operations.

 

The State Council issued the Administrative Measures on Internet Information Services, or the Internet Measures, on September 25, 2000, and subsequently amended the Internet Measures on January 8, 2011. According to the Internet Measures, a commercial ICP service operator must obtain a VAS license from the relevant government authorities before providing any commercial ICP service within the PRC. When the ICP service involves regulated industries, such as news, publication, education, medicine, health, pharmaceuticals and medical equipment, prior approval from the respective regulating authorities must be obtained prior to applying for the VAS license from MIIT or its local branch at the provincial level. Moreover, an ICP service operator must display its VAS license number in a conspicuous location on its website and must monitor its website to remove categories of harmful content that are broadly defined.

 

On December 26, 2001, the MIIT promulgated the Administrative Measures for Telecommunication Business Operating License, or the Telecom License Measures. On March 5, 2009, the MIIT issued amended Telecom License Measures, which took effect on April 10, 2009. The Telecom License Measures set forth more specific provisions regarding the types of licenses required to operate value-added telecommunication services, the qualifications and procedures for obtaining such licenses and the administration and supervision of such licenses. For example, the appendix to the VAS license is to detail the permitted activities to be conducted by the VAS operator and the VAS operator must conduct its business in accordance with the specifications recorded on its VAS license. The VAS license is subject to annual review and results of the annual review is to be recorded as an appendix to the VAS license, published to the public and notified to the Administration for Industry and Commerce.

 

Currently, E-Sun Sky Network holds a value-added telecommunication business operating license issued by MIIT, which is effective until September 5, 2022, for providing Internet information services. We intend to renew this license upon its expiration.

 

Regulations on Internet Content Services

 

Under various laws and regulations governing ICP services, ICP services operators are required to monitor and censor the content on their websites. They may not produce, duplicate, post or disseminate, and must remove from their websites, any content that falls within the prohibited categories, including any content that: (i) opposes the fundamental principles determined in the PRC constitution; (ii) compromises state security, divulges state secrets, subverts state power or damages national unity; (iii) harms the dignity or interests of the State, incites ethnic hatred or racial discrimination or damages inter-ethnic unity; (iv) sabotages China’s religious policy or propagates heretical teachings or feudal superstitions; (v) disseminates rumors, disturbs social order or disrupts social stability; (vi) propagates obscenity, pornography, gambling, violence, murder or fear or incites the commission of crimes; (vii) insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or (viii) or includes other content prohibited by laws or administrative regulations.

 

  51  

 

 

The PRC government may shut down the websites of VAS license holders that violate any of the content restrictions and requirements, revoke their VAS licenses or impose other penalties pursuant to the applicable laws and regulations.

 

Regulations on Foreign Investment in Lottery and Value-Added Telecommunications Services.

 

According to the Catalogue for the Guidance of Foreign Investment Industries (the “Guidance Catalogue”) jointly promulgated by the National Development & Reform Commission and the Ministry of Commerce on December 24, 2011 and effective from January 30, 2012, foreign investments are not allowed to operate in the lottery industry. As the development of the lottery industry is still in its early stage, there are no further regulations relating to foreign investment in the lottery industry.

 

Under the Guidance Catalogue, foreign ownership in value-added telecommunication services shall not exceed 50%. Aside from the Guidance Catalogue, the Regulations for Administration of Foreign-Invested Telecommunication Enterprises, or the FITE Regulations, promulgated by the State Council on December 11, 2001 and amended on September 10, 2008, set forth detailed requirements with respect to, among other things, capitalization, investor qualifications and application procedures in connection with the establishment of a foreign-invested telecommunication enterprise. Under the FITE Regulations, a foreign entity is prohibited from owning more than 50% of the total equity interest in any value-added telecommunication service providers in China and the major foreign investor in any value-added telecommunication service business in China is to have a good track record in the industry.

 

On July 13, 2006, the MIIT issued the Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunication Business. Under this circular, a domestic PRC company that holds a VAS license is prohibited from leasing, transferring or selling the VAS license to foreign investors in any form, and from providing any assistance, including resources, sites or facilities, to foreign investors that conduct value-added telecommunication business illegally in China. Further, the domain names and registered trademarks used by an operating company providing value-added telecommunication service is to be legally owned by a domestic PRC company and/or its shareholders. In addition, the company’s operation premises and equipment would have to comply with its approved VAS license, and the company should establish and improve its internal Internet and information security policies and standards and emergency management procedures.

 

We conduct our businesses in China primarily through contractual arrangements among our company, 500.com Limited, E-Sun Sky Computer, our consolidated affiliated entities and their respective shareholders. There is no explicit provision under the Guidance Catalogue, the FITE Regulations or the Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunication Business, which classifies the contractual arrangements between our PRC subsidiary and each of our consolidated affiliated entities, including, among others, the Equity Interests Pledge Agreements, either by each agreement itself or taken as a whole, as a transaction that is subject to the approval of relevant government authorities. E-Sun Sky Network currently holds a regional VAS business operating license.

 

Regulations on Intellectual Property

 

Trademark

 

The PRC Trademark Law, adopted on August 23, 1982 and amended in 1993, 2001 and 2013 respectively, protects the proprietary rights of registered trademarks. The Trademark Office handles trademark registrations and grants proprietary rights for an initial term of 10 years to registered trademarks. Upon the expiration of the initial term, the second term of 10 years may be granted upon renewal. Trademark licensing agreements must be filed with the Trademark Office or its regional offices. In addition, if a registered trademark is recognized as a well-known trademark in a specific case, proprietary rights of the trademark holder may be extended beyond the registered scope of products and services to which the trademark relates.

 

  52  

 

 

Software Products

 

On October 27, 2000, the MIIT issued the Administrative Measures on Software Products, or the Software Measures, to strengthen the regulation of software products and to encourage the development of the PRC software industry. On March 5, 2009, the MIIT issued amended Software Measures, which became effective on April 10, 2009. The Software Measures provide a registration and filing system with respect to software products made in or imported into China. These software products may be registered with competent local authorities in charge of software industry administration. Registered software products may enjoy preferential treatment status granted by relevant software industry regulations. Software products can be registered for five years and the registration is renewable upon expiration.

 

In order to further implement the Computer Software Protection Regulations, promulgated by the State Council on December 20, 2001 and amended on January 30, 2013, the National Copyright Administration of the PRC issued Computer Software Copyright Registration Procedures on February 20, 2002, which apply to the registration of the software copyright, licensing agreements and transfer agreements.

 

Domain Names

 

The Implementing Rules for Domain Name Registration, issued and amended by China Internet Network Information Center, or CNNIC, in September 2002 and May 2012, respectively, sets forth detailed rules for the registration of domain names. On November 5, 2004, the MIIT promulgated the Measures for Administration of Domain Names for the Chinese Internet, or the Domain Name Measures. The Domain Name Measures regulate the registration of domain names, such as the first-tier domain name “.cn.” The Measures on Domain Name Dispute Resolution and its implementing rules, issued and amended by CNNIC in February 2006 and May 2012, respectively, allows the CNNIC to authorize a domain name dispute resolution institution to resolve disputes.

 

Regulations on Foreign Exchange

 

Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents

 

In October 2005, SAFE issued the Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents Engaging in Financing and Roundtrip Investments via Overseas Special Purpose Vehicles, or SAFE Circular 75. SAFE Circular 75 states that PRC citizens or residents must register with the relevant local SAFE branch or central SAFE in connection with their establishment or control of an offshore entity established for the purpose of overseas equity financing involving a roundtrip investment whereby the offshore entity acquires or controls onshore assets or equity interests held by the PRC citizens or residents. In addition, such PRC citizens or residents must amend their SAFE registrations when the offshore special purpose companies undergo material events relating to increases or decreases in investment amount, transfers or exchanges of shares, mergers or divisions, long-term equity or debt investments, external guarantees, or other material events that do not involve roundtrip investments. Since May 2007, SAFE has issued guidance to its local branches regarding the operational procedures for such registration, which provides more specific and stringent requirements on the registration relating to SAFE Circular 75. The latest guidance was issued by SAFE on November 19, 2012 and took effect on December 17, 2012.

 

We conduct businesses in China primarily through our consolidated affiliated entities. We enter into contractual arrangements with our PRC consolidated affiliated entities and their respective shareholders, some of whom are PRC residents and also beneficial owners of our company. As of the date of this annual report, our beneficial owners who are subject to SAFE Circular 75 registrations are in the process of updating their registrations with the Shenzhen Branch of SAFE. However, we cannot assure you that our beneficial owners can successfully amend their foreign exchange registrations with SAFE in full compliance with Circular 75 for the development of our company. See “Item 3D. Risk Factors—Risks Related to Doing Business in China—A failure by our shareholders or beneficial owners who are PRC citizens or residents to comply with certain PRC foreign exchange regulations could restrict our ability to distribute profits, restrict our overseas and cross-border investment activities or subject us to liability under PRC laws, which could adversely affect our business and financial condition.”

 

  53  

 

 

Regulations on Employee Stock Option Granted by Offshore Listed Companies

 

In December 2006, the People’s Bank of China promulgated the Administrative Measures on Individual Foreign Exchange, or the Individual Foreign Exchange Regulations, setting forth the requirements for foreign exchange transactions by individuals (both PRC and non-PRC citizens) under the current account and the capital account. In January 2007, SAFE issued the implementation rules for the Individual Foreign Exchange Regulations, which, among other things, specified the approval and registration requirement for certain capital account transactions, such as a PRC citizen’s participation in employee share ownership and share option plans of overseas listed companies.

 

The Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Share Incentive Plans of Overseas Publicly-Listed Companies, or the Share Option Rules, promulgated by SAFE on February 15, 2012, replacing the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Share Ownership Plans, or Share Option Plans of Overseas Publicly-Listed Companies, issued by SAFE on March 28, 2007, require (i) PRC residents who are granted shares or share options by companies listed on overseas share exchanges based on share incentive plans to register with SAFE or its local branches, and (ii) PRC residents participating in the share incentive plans of an overseas publicly-listed companies to retain a qualified PRC agent, which could be a PRC subsidiary of the overseas publicly-listed company or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the share incentive plans on behalf of these participants.

 

Such participants must also retain an overseas entrusted institution to handle matters in connection with their exercise of share options, purchase and sale of corresponding shares or interests, and fund transfer. In addition, the PRC agents are required to amend the SAFE registration with respect to the share incentive plan if there is any material change to the share incentive plan, the PRC agents, or the overseas entrusted institution. The PRC agents shall, on behalf of the PRC residents who have the right to exercise the employee share options, apply to SAFE or its local branches for an annual quota for the payment of foreign currencies in connection with the PRC residents’ exercise of the employee share options. The foreign exchange proceeds received by the PRC residents from the sale of shares granted under the share incentive plans and dividends distributed by the overseas listed companies must be remitted into the bank accounts in the PRC opened by the PRC agents before distribution to such PRC residents. In addition, the PRC agents are to file the form for record-filing of information of the domestic individuals participating in the share incentive plans of overseas listed companies with SAFE or its local branches every quarter. We and our PRC citizen employees who have been granted share options are subject to these rules upon the listing and trading of our ADSs on the NYSE. As of the date of this annual report, we and our PRC citizen employees who have been granted share options are applying for registration with the Shenzhen branch of SAFE pursuant to the Share Option Rules.

 

M&A Regulations and Overseas Listings

 

On August 8, 2006, six PRC regulatory authorities, including the CSRC, promulgated the 2006 M&A Rules, which were later amended on June 22, 2009. Pursuant to the 2006 M&A Rules, an offshore special purpose vehicle, or SPV, refers to an overseas company controlled directly or indirectly by PRC domestic companies or individuals for purposes of overseas listing of equity interests in domestic companies (defined as enterprises in the PRC other than foreign-invested enterprises). If an SPV purchases, for the purpose of overseas listing, equity interests of any PRC company that are held by PRC companies or individuals controlling such SPV, then the overseas listing by the SPV must obtain the approval of the CSRC. The application of the 2006 M&A Rules remains unclear and there is currently no consensus among PRC law firms regarding the scope of CSRC’s jurisdiction. As of the date of this annual report, the CSRC has not issued any rules or written interpretation clarifying whether offerings like ours are subject to this new procedure.

 

Our then PRC counsel, Han Kun Law Offices, has advised us that the 2006 M&A Rules do not require us to obtain prior CSRC approval for the listing and trading of our ADSs on the NYSE, given that:

 

  54  

 

 

the CSRC approval requirement applies to SPVs that acquired equity interests of any PRC company that are held by PRC companies or individuals controlling such SPV and seek overseas listing; and

 

our PRC operating subsidiary was incorporated as a wholly foreign-owned enterprise by means of direct investment rather than by merger or acquisition by our company of the equity interest or assets of any “domestic company” as defined under the 2006 M&A Rules, and no provision in the 2006 M&A Rules classifies the contractual arrangements between our company, our PRC operating subsidiary and any of the affiliated consolidated entities, including, among others, the Equity Interests Pledge Agreements and the Shareholder’s Voting Power Assignment Agreement, either by each agreement itself or taken as a whole, as a type of acquisition transaction falling under the 2006 M&A Rules.

 

Regulations on Foreign Currency Exchange

 

Pursuant to applicable PRC regulations on foreign currency exchange, the Renminbi is freely convertible only to the extent that it relates to current account items, such as trade-related receipts and payments, interest and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment, require the prior approval from the SAFE or its local branch for conversion of Renminbi into a foreign currency, such as U.S. dollars. Payments for transactions that take place within the PRC must be made in Renminbi. Domestic companies or individuals can repatriate foreign currency payments received from abroad into the PRC, or deposit these payments abroad, subject to compliance with the requirements promulgated by the SAFE. Foreign currencies received for current account items can be either retained or sold to financial institutions that have foreign exchange settlement or sales business without prior approval from the SAFE, subject to certain regulations. Foreign exchange income under capital account can be retained or sold to financial institutions that have foreign exchange settlement and sales business, with prior approval from the SAFE, unless otherwise provided.

 

In addition, another notice issued by the SAFE, the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or SAF Circular 142, regulates the conversion by foreign-invested enterprises of foreign currency into Renminbi by restricting how the converted Renminbi may be used. On March 30, 2015, SAFE promulgated SAFE Circular 19, which came into force replacing SAFE Circular 142 on June 1, 2015. SAFE Circular 19 removed certain restrictions previously provided under Circular No. 142 for conversion by a foreign-invested enterprise of foreign currency registered capital into RMB and use of such RMB capital. However, SAFE Circular 19 continues to prohibit foreign-invested enterprises from, among other things, using RMB fund converted from its foreign exchange capitals for expenditure beyond its business scope, providing entrusted loans or repaying loans between non-financial enterprises. On November 9, 2011, SAFE issued the Notice on Further Clarifying and Standardizing Related Issues Concerning Foreign Exchange Administration for Part of Capital Account Items to further regulate the payment and settlement of foreign currency exchange of foreign-invested enterprises.

 

Regulations on Dividend Distribution

 

Under applicable PRC laws and regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign-invested enterprises in China are required to allocate at least 10% of their respective accumulated profits each year, if any, to fund statutory reserve funds, unless these reserves have reached 50% of the registered capital of the respective enterprises. These reserves are not distributable as cash dividends.

 

Regulations Regarding the Enterprise Income Tax, Individual Income Tax and Withholding Tax

 

The EIT Law, effective on January 1, 2008, imposes a uniform enterprise income tax at the rate of 25% on all domestic enterprises, including foreign-invested enterprises unless they qualify for certain exceptions, and terminates most of the tax exemptions, reductions and preferential treatments available under previous tax laws and regulations. Under the EIT Law and a notice issued by the PRC State Council on transition preferential policies, commencing January 1, 2008, (i) those enterprises that were established before March 16, 2007 and were formerly entitled to preferential policies of lower taxation will undergo a gradual transition to statutory tax rates within five years; and (ii) those enterprises that were established before March 16, 2007 and were formerly entitled to preferential income tax reduction policies, such as “two-years exempt and three-years halved” and “five-years exempt and five-years halved,” shall continue to enjoy such preferential policies as stipulated in the former taxation laws, administrative regulations and relevant documents until the end of the terms of these policies, provided however that for those enterprises not profitable enough to enjoy the aforementioned tax preferences, the preference time limits shall commence from 2008.

 

  55  

 

 

Pursuant to the EIT Law and its Implementation Rules, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise” for PRC EIT purposes. The term “de facto management body” is defined as the establishment that carries out substantial and overall management and control over the manufacturing and business operation, production, personnel, accounting and properties of an enterprise. Pursuant to Circular 82, a foreign enterprise controlled by a PRC company or a PRC company group will be classified as a “resident enterprise” with its “de facto management bodies” located within China if the following requirements are satisfied: (i) the place where the senior management and core management departments that are in charge of its daily operations perform their duties is mainly located in the PRC; (ii) its financial and human resources decisions are made by or are subject to approval by persons or bodies in the PRC; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (iv) more than half of the enterprise’s directors or senior management with voting rights frequently reside in the PRC. Although the circular only applies to offshore enterprises controlled by PRC enterprises and not those controlled by PRC individuals or foreigners, it is believed that the determining criteria set forth in the circular may reflect the State Administration of Taxation’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises, individuals or foreigners. However, given that the EIT Law contains ambiguous definitions, requirements and procedures, it remains uncertain how tax authorities will determine tax residency status based on the facts of each case.

 

Furthermore, the EIT Law and its Implementation Rules provide that the “non-resident enterprises” are subject to the EIT rate of 10% on their income derived from China, if such “non-resident enterprises” (i) do not have establishments or premises of business in China or (ii) have establishments or premises of business in China, but the relevant income does not have actual connection with their establishments or premises of business in China. Such income tax may be exempted or reduced by the PRC State Council or pursuant to a tax treaty with China that provides for a different withholding agreement between China and the jurisdictions in which the non-resident enterprise reside. The Cayman Islands, where we are incorporated, does not have such tax treaty with China.

 

Under the Foreign Invested Enterprise and Foreign Enterprise Income Tax Law, effective prior to January 1, 2008, dividends paid to foreign investors by foreign-invested enterprises were exempt from PRC withholding tax. Pursuant to the EIT Law, which became effective on January 1, 2008, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise in China to its foreign investors will be subject to a 10% withholding tax, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement and the foreign investor is approved by competent tax authorities as the beneficial owners of such dividends under applicable tax regulations.

 

Furthermore, the State Administration of Taxation issued the Notice on How to Understand and Determine the Beneficial Owners in Tax Agreement in October 2009, or Circular 601, which provides guidance for determining whether a resident of a contracting state is the “beneficial owner” of an item of income under China’s tax treaties and tax arrangements. According to Circular 601, a beneficial owner must generally be engaged in substantive business activities. An agent or conduit company will not be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits.

 

Moreover, non-resident individual investors may be required to pay PRC individual income tax at a rate of 20% on dividends payable to the investors or any capital gains realized from the transfer of ADSs or ordinary shares if such dividends or gains are deemed income derived from sources within the PRC. Under the PRC Individual Income Tax Law, or IIT Law, a “non-resident individual” refers to an individual who has no domicile in China and does not stay in the territory of China or who has no domicile in China and has stayed in the territory of China for less than one year. Pursuant to the IIT Law and its implementation rules, for purposes of the PRC capital gains tax, taxable income is the balance of the total income obtained from the transfer of the ADSs or ordinary shares minus all the costs and expenses that are permitted under PRC tax laws to be deducted from the income. Therefore, if we are considered a PRC “resident enterprise” and the relevant competent PRC tax authorities consider dividends we pay with respect to our ADSs or ordinary shares and the gains realized from the transfer of our ADSs or ordinary shares to be income derived from sources within the PRC, such gains earned by non-resident individuals may also be subject to PRC withholding tax at a rate of 20%. Furthermore, according to the IIT Law and its implementation rules, a “resident individual” refers to an individual who, by reason of his or her permanent residence, family or economic interests, habitually resides in the territory of China or who has no domicile but has stayed in the territory of China for one year or longer. A PRC resident individual shall file tax returns with the competent tax authority for the income he or she receives from outside the territory of China.

 

  56  

 

 

Such income includes, among others, gains realized from transfer of securities, which shall be subject to a tax rate of 20%.

 

If the PRC tax authorities determine that our Cayman Islands holding company is a “resident enterprise” for PRC EIT purposes, a number of unfavorable PRC tax consequences could follow: (i) we may be subject to EIT at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations; (ii) a 10% withholding tax may be imposed on dividends we pay to our shareholders who are nonresident enterprises and gains derived by them from transferring our shares or ADSs, if such income is considered as PRC-sourced income by relevant PRC authorities; and (iii) a potential 20% withholding tax may be imposed on dividends we pay to our shareholders who are non-resident individuals and gains derived by them from transferring our shares or ADSs, if such income is considered as PRC-sourced income by relevant PRC authorities.

 

Pursuant to SAT Circular 698, issued by the SAT, on December 10, 2009 with retroactive effect from January 1, 2008, where a non-resident enterprise transfers its equity interests in a PRC resident enterprise through an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the relevant tax authority of the PRC resident enterprise this Indirect Transfer. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. SAT Circular 698 also provides that, where a non-PRC resident enterprise transfers its equity interests in a PRC resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.

 

There is uncertainty as to the application of SAT Circular 698. For example, while the term “Indirect Transfer” is not clearly defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax rates in foreign tax jurisdictions, and the process and format of reporting an Indirect Transfer to the relevant tax authority of the PRC resident enterprise. In addition, there are no formal declarations with regard to how to determine whether a foreign investor has adopted an abusive arrangement in order to reduce, avoid or defer PRC tax.

 

PRC Business Tax and Value-added Tax

 

In November 2011, the PRC Ministry of Finance and the State Administration of Taxation jointly issued two circulars setting out the details of the pilot value-added tax, or VAT, reform program, which change the charge of sales tax from business tax to VAT for certain pilot industries. The pilot VAT reform program initially applied only to the pilot industries in Shanghai, and has been expanded to eight additional regions, including, among others, Shenzhen, in 2012. According to two circulars jointly issued by the PRC Ministry of Finance and the State Administration of Taxation in May and December 2013, the pilot program has been expanded nationwide.

 

Since November 2012, a 6% VAT, which replaced the original 5% business tax in Shenzhen as a result of the PRC government’s pilot VAT reform program, applies to certain services provided by E-Sun Sky Computer and E-Sun Sky Network. Since June 2014, a 6% VAT applies to all services provided by VIEs, except for Lhasa Yicai, Hainan Menghuanxingchen, Shenzhen Yicai, Hainan Jingli, Hainan Panfeng, Hangzhou E-Sun Sky Network, Youlanguang Technology, E-Sun Network and Baifengrun Technology, which are subject to a 3% VAT.

 

  57  

 

  

C. Organizational Structure

 

The following diagram illustrates our company’s organizational structure, and the place of formation, ownership interest and affiliation of each of our principal subsidiaries and affiliated entities as of the date of this annual report.

 

 

 

  58  

 

 

Contractual Arrangements with Our Consolidated Affiliated Entities

 

PRC laws and regulations currently restrict foreign ownership in companies providing value-added telecommunications services and do not allow foreign investments in the lottery industry. Because we are a Cayman Islands company, we are classified as a foreign enterprise under PRC laws and regulations and our PRC subsidiary, E-Sun Sky Computer is foreign-invested enterprises. To comply with PRC laws and regulations, we conduct our operations in China through a series of contractual arrangements with our consolidated affiliated entities and their respective shareholders.

 

In September 2007, our PRC subsidiary, E-Sun Sky Computer entered into a set of control agreements with E-Sun Sky Network and its shareholders, which include the Exclusive Technology Consultation and Service Agreement, the Business Operation Agreement, the Equity Interest Disposal Agreement, the Equity Pledge Agreement and the Power of Attorney, or the control agreements. The control agreements, including the Business Operation Agreement, the Equity Interest Disposal Agreement and the Equity Pledge Agreement, were further amended in January 2010 and December 2010, respectively.

 

Following the establishment of Youlanguang Technology and Guangtiandi Technology in December 2008, E-Sun Sky Computer entered into an identical set of control agreements with each of Youlanguang Technology and Guangtiandi Technology and their respective shareholders. The control agreements between E-Sun Sky Computer and Youlanguang Technology and its shareholders, including the Business Operation Agreement, the Equity Interest Disposal Agreement and the Equity Pledge Agreement, were further amended in August 2009 and September 2010. The control agreements between E-Sun Sky Computer and Guangtiandi Technology and its shareholders, including the Business Operation Agreement, the Equity Interest Disposal Agreement and the Equity Pledge Agreement, were amended in August 2009.

 

Following the establishment of Tongfu Technology in December 2015, E-Sun Sky Computer entered into an identical set of control agreements with Tongfu Technology and its shareholders.

 

As a result of the acquisition of Qufan Cayman, Qufan Information technology entered into an identical set of control agreements arrangements with Shenzhen Qufan.

 

We have been relying and expect to continue to rely on our consolidated affiliated entities to operate our online lottery service business in China as long as PRC laws and regulations do not allow us to directly operate such business in China. We revised our contractual arrangements with the consolidated affiliated entities and their respective shareholders on June 1, 2011, and amended our contractual arrangements on May 2, 2013, supplemented on December 28, 2013, further amended on November 18, 2015, and further supplemented on January 10, 2017 and further amended on July 3, 2017, respectively. These contractual arrangements continue to enable us to:

 

· exercise effective control over E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology and Shenzhen Qufan.;

 

· receive substantially all of the economic benefits and assume substantially all the losses of E-Sun Network, E-Sun Sky Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology and Shenzhen Qufan in consideration for the services provided by our PRC subsidiary;

 

· have an exclusive option to purchase all of the equity interest in E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology and Shenzhen Qufan to the extent permitted under PRC law; and

 

· provide appropriate funds to the consolidated affiliated entities through the respective shareholders of consolidated affiliated entities for major losses resulting from their business and operations if any are incurred.

 

  59  

 

 

Accordingly, under U.S. GAAP, we consolidate E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology, E-Sun Sky Network, Lhasa Yicai, Hainan Jingli, Hainan Panfeng, Hangzhou E-Sun Sky Network, Shenzhen Yicai, Baifengrun Technology and Shenzhen Kaisheng, as our “subsidiaries of variable interest entities” in our consolidated financial statements. We also consolidated Sumpay.cn, Shangmeng Services, and Hangzhou Laiqi before their disposals in May 2016, consolidated Shenzhen Caiyu before its disposal in November 2017, consolidated 500Fu, Shenzhen Qufan and Beijing Daguoxiaoxian before their disposals in February 2018 and consolidated Shenzhen Fenggu before its disposal in June 2018.

 

Our contractual arrangements with our consolidated affiliated entities and their shareholders are described in further detail as follows:

 

Agreements that Transfer Economic Benefits to Us

 

Exclusive Business Cooperation Agreements . The exclusive business cooperation agreements are entered into by E-Sun Sky Computer and each of E-Sun Network, Youlanguang Technology, Guangtiandi Technology and Tongfu Technology, respectively. Pursuant to these exclusive business cooperation agreements, E-Sun Sky Computer provides technical services, business consultations, marketing consultancy, product research and development to the affiliated consolidated entities, in exchange for a service fee. The service fee is payable at such time as agreed between E-Sun Sky Computer and the relevant consolidated affiliated entity and approved by the board of such consolidated affiliated entity. The term of each exclusive business cooperation agreement is 10 years from the effective date.

 

Agreements that Provide Us with Effective Control

 

Exclusive Option Agreement. The exclusive option agreements are entered into by E-Sun Sky Computer and each of E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology and Shenzhen Qufan, respectively, and each of their respective shareholders. Pursuant to these exclusive option agreements, the shareholders irrevocably granted E-Sun Sky Computer and Qufan Information Technology or their designated representative exclusive options to purchase, to the extent permitted under PRC law, all or part of their equity interest in the consolidated affiliated entities. E-Sun Sky Computer and Qufan Information Technology or their designated representatives have sole discretion as to when to exercise these options, whether in part or in full. These agreements are for terms of 10 years and are renewable at the discretion of E-Sun Sky Computer.

 

In November 2012, E-Sun Sky Computer, the consolidated affiliated entities (excluding E-Sun Sky Network) and each of their respective shareholders entered into certain supplementary agreements to exclusive option agreements; In January 2017, Qufan Information Technology, the consolidated affiliated entity and its shareholder entered into certain supplementary agreements to exclusive option agreements; pursuant to which the shareholders shall, in the manner permitted by PRC laws, transfer all the capital and assets (including but not limited to dividends, bonuses or any other rights and interests) they gain from the consolidated affiliated entities to E-Sun Sky Computer unconditionally per its request.

 

Equity Interests Pledge Agreements. The equity interests pledge agreements are entered into by E-Sun Sky Computer and each of E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology, also by Qufan Information Technology and Shenzhen Qufan, respectively and each of their respective shareholders. Pursuant to these equity interests pledge agreements, the shareholders have pledged their respective equity interests in the relevant consolidated affiliated entity to E-Sun Sky Computer and Qufan Information Technology to secure the obligations of such consolidated affiliated entity under its exclusive business cooperation agreement with E-Sun Sky Computer and Qufan Information Technology. In addition, except for the performance of the exclusive option agreement executed by them, the shareholders have agreed not to transfer, place or permit the existence of any security interest or other encumbrance on their respective equity interest, without the prior written consent of E-Sun Sky Computer.

 

  60  

 

 

Shareholder’s Voting Power Assignment Agreements . Each shareholder of E-Sun Network, Youlanguang Technology, Guangtiandi Technology, Tongfu Technology and Shenzhen Qufan executed an irrevocable power of attorney appointing E-Sun Sky Computer and Qufan Information Technology as his or her representative to attend shareholders’ meetings of the consolidated affiliated entities and to vote on his or her behalf on all matters requiring shareholder approval, including but not limited to, the sale, transfer, pledge, or disposition of his or her shareholding in the consolidated affiliated entities on June 1, 2011 and May 2, 2013 and January 10, 2017, respectively. Such irrevocable power of attorney was terminated by the shareholder’s voting power assignment agreements entered into among 500.com Limited, E-Sun Sky Computer, Qufan Information Technology and the nominee shareholders of the consolidated affiliated entities on December 28, 2013 and January 10, 2017. Pursuant to these shareholder’s voting power assignment agreements, the nominee shareholders of each consolidated affiliated entity assigned the rights to vote on all of the matters in each consolidated affiliated entity that require shareholders’ approval at the consolidated affiliated entities’ shareholders’ meetings to persons or entities designated by 500.com Limited as permitted by applicable laws. Unless terminated by 500.com limited or otherwise required by applicable laws, such shareholder’s voting power assignment agreements will remain valid and irrevocable from the date of their execution, so long as each shareholder remains the shareholder of the respective consolidated affiliated entities.

 

Guangzhou Shu Lian Information Investment Co., Ltd. and Xiaojun Xu, two former shareholders of E-Sun Network, jointly entered into a share transfer agreement with Bo Zou on November 15, 2012, pursuant to which Guangzhou Shu Lian Information Investment Co., Ltd. and Xiaojun Xu transferred all the equity interest they respectively held in E-Sun Network to Bo Zou. E-Sun Network completed registration with relevant branch of SAIC for the aforementioned share transfer on December 5, 2012. Shijie Zhang, a former shareholder of Guangtiandi Technology, entered into a share transfer agreement with Liangdong Yuan on October 31, 2012, pursuant to which Shijie Zhang transferred all the equity interest he held in Guangtiandi Technology to Liangdong Yuan. Guangtiandi Technology completed registration with relevant branch of SAIC for the aforementioned share transfer on March 27, 2013. Accordingly, we updated certain control agreements on May 2, 2013 entered into by and among E-Sun Sky Computer, E-Sun Network and Bo Zou, including the Equity Interests Pledge Agreement, the Exclusive Option Agreement, and its supplementary agreement to replace those entered into by and among E-Sun Sky Computer, E-Sun Network, Guangzhou Shu Lian Information Investment Co., Ltd. and Xiaojun Xu, respectively. We also updated the Irrevocable Power of Attorney executed by Bo Zou on May 2, 2013 to replace those executed by Guangzhou Shu Lian Information Investment Co., Ltd. and Xiaojun Xu, respectively. In addition, we superseded agreements entered into by and among E-Sun Sky Computer, Guangtiandi Technology and Shijie Zhang, including the Equity Interests Pledge Agreement, the Exclusive Option Agreement and its supplementary agreement with agreements entered into by and among E-Sun Sky Computer, Guangtiandi Technology and Liangdong Yuan respectively on May 2, 2013. We also superseded the Irrevocable Power of Attorney executed by Shijie Zhang with the Irrevocable Power of Attorney executed by Liangdong Yuan on May 2, 2013. Moreover, in May 2013, Bo Zou executed a confirmation letter, under which he agrees to succeed to and assume any and all the rights and obligations of Xiaojun Xu and Guangzhou Shu Lian Information Investment Co., Ltd. under the aforementioned supplementary agreements immediately after the share transfer among Bo Zou, Xiaojun Xu and Guangzhou Shu Lian Information Investment Co., Ltd. completed and Bo Zou was registered as E-Sun Network’s shareholder. On the same date, Liangdong Yuan executed an identical confirmation letter, pursuant to which Liangdong Yuan agrees to succeed to and assume any and all the rights and obligations of Shijie Zhang under the aforementioned supplementary agreements immediately after the share transfer between Liangdong Yuan and Shijie Zhang completed and Liangdong Yuan was registered as Guangtiandi Technology’s shareholder.

 

On December 28, 2013, 500.com Limited entered into a Financial Support Agreement with each of our consolidated affiliated entities, under which 500.com Limited agreed to provide unconditional financial support, through the nominee shareholders of each consolidated affiliated entity to each consolidated affiliated entity in manners permitted by PRC laws and regulations for each consolidated affiliated entity’s operations.

 

Jing Zhang and Jin Li, two former shareholders of Youlanguang Technology, entered into a share transfer agreement with Bo Yu and Zhiwei Yin on November 1, 2015, pursuant to which Jing Zhang and Jin Li transferred all the equity interest they respectively held in Youlanguang Technology to Bo Yu and Zhiwei Yin. Youlanguang Technology completed registration with relevant branch of SAIC for the aforementioned share transfer on November 18, 2015. Accordingly, we superseded agreements entered into by and among E-Sun Sky Computer, Youlanguang Technology, Jing Zhang and Jin Li, including the Equity Interests Pledge Agreement, the Exclusive Option Agreement, the Financial Support Agreement and its supplementary agreement with agreements entering into by and among E-Sun Sky Computer, Youlanguang Technology, Bo Yu and Zhiwei Yin respectively on November 18, 2015. We also superseded the Irrevocable Power of Attorney executed by Jing Zhang and Jin Li with the Irrevocable Power of Attorney executed by Bo Yu and Zhiwei Yin on November 18, 2015. On the same date, E-Sun Sky Computer executed a confirmation letter, to the effect that its exercise of the rights under the Irrevocable Power of Attorney executed by Bo Yu and Zhiwei Yin shall be subject to consent by 500wan HK Limited in manners allowed by the PRC laws and regulation and in accordance with the instructions of 500wan HK Limited.

 

  61  

 

 

Jiepin Fu, He Li, Xue Li, Ping Yuan, Bo Zou and Ying Zou, the former shareholders of E-Sun Network, jointly entered into a share transfer agreement with Bo Yu and Zhiwei Yin on November 1, 2015, pursuant to which Jiepin Fu, He Li, Xue Li, Ping Yuan, Bo Zou and Ying Zou transferred all the equity interest they respectively held in E-Sun Network to Bo Yu and Zhiwei Yin. E-Sun Network completed registration with relevant branch of SAIC for the aforementioned share transfer on November 18, 2015. Accordingly, we superseded agreements entered into by and among E-Sun Sky Computer, E-Sun Network, Jiepin Fu, He Li, Xue Li, Ping Yuan, Bo Zou and Ying Zou, including the Equity Interests Pledge Agreement, the Exclusive Option Agreement, the Financial Support Agreement and its supplementary agreement with agreements entering into by and among E-Sun Sky Computer, E-Sun Network and Bo Yu and Zhiwei Yin, respectively on November 18, 2015. We also superseded the Irrevocable Power of Attorney executed by Jiepin Fu, He Li, Xue Li, Ping Yuan, Bo Zou and Ying Zou, respectively, by the Irrevocable Power of Attorney executed by Bo Yu and Zhiwei Yin on November 18, 2015. On the same date, E-Sun Sky Computer executed a confirmation letter, to the effect that its exercise of the rights under the Irrevocable Power of Attorney executed by Zhiwei Yin and Bo Yu shall be subject to consent by 500wan HK Limited in manners allowed by the PRC laws and regulation and in accordance with the instructions of 500wan HK Limited.

 

On January 10, 2017, as a result of the acquisition of Qufan Cayman, we entered into similar contractual arrangements with Shenzhen Qufan through Qufan Information Technology, which obligates Qufan Information Technology to absorb a majority of the expected losses from the activities of Shenzhen Qufan’s activities, and entitles Qufan Information Technology to receive a majority of residual returns from Shenzhen Qufan. In February 2018, we disposed of Qufan due to a change in business strategy.

 

We have been advised by our PRC legal counsel, Grandall Law Firm, that the structure for operating our business in China (including our corporate structure and our contractual arrangements with our consolidated affiliated entities) complies with all applicable PRC laws, rules and regulations, and does not violate any applicable PRC laws, rules or regulations. However, there are uncertainties regarding the interpretation and application of PRC laws, rules and regulations that are relevant to our business operations. Accordingly, there can be no assurance that the PRC regulatory authorities will not take a view that is contrary to the opinion of our PRC legal counsel. Our PRC legal counsel has further advised us that if a PRC government authority determines that our corporate structure, the contractual arrangements or the reorganization to establish our current corporate structure violates any applicable PRC laws, rules or regulations, the contractual arrangements may become invalid or unenforceable, and we could be subject to severe penalties and required to obtain additional governmental approvals from the PRC regulatory authorities. See “Item 3D. Risk Factors—Risks Related to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in the Internet and the lottery business, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations” and “Item 3D. Risk Factors—The 2006 M&A Rules establish complex procedures for some acquisitions of Chinese Companies by foreign investors, which could make it difficult for us to pursue growth through acquisitions in China.”

 

D. Property, Plant and Equipment

 

Our principal executive offices are located at 12F, West Side, Block B, Building No.7, Shenzhen Bay Eco-Technology Park, Nanshan District, Shenzhen, China and occupy a total of 9,659 square meters. We also have representative offices in Beijing, Hong Kong, Japan, the United States of America and Malta. We lease our premises from unrelated third parties. Each of the lessors for the leased premises either has a valid title to the property or has proper authorization from the title owner to sublease the property.

 

In September 2016, we entered into a lease agreement with Shenzhen Harbor Technology Development Co., Ltd., to lease offices of 9,659 square meters in Nanshan District, Shenzhen, with a total expenditure of RMB1.3 million (US$0.2 million) per month. We expect the rental expense to increase by 5% annually. We also expected the total leasehold improvement expenses to be RMB79.6 million (US$11.6 million), and we have paid RMB76.6 million (US$11.4 million) as of the annual report.

 

  62  

 

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. See “Item 5. Operating and Financial Review and Prospects—G. Safe Harbor.” Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3D. Risk Factors” or in other parts of this annual report.

 

A. Operating Results

 

Overview

 

Prior to the voluntary suspension of our online sports lottery sales services in April 2015, we were a leading online sports lottery service provider in China. We have not generated any revenue from sports lottery sales since this suspension, and our financial results are materially and adversely impacted during the suspension period. There were no net revenues provided by the sports lottery sales during 2016 and 2018.

 

We currently offer several different lines of services, including online gaming services in Europe and through our own platform of mobile gaming services, sports information services and online spot commodity trading services in the PRC.

 

We began to generate revenues from online gaming services in Europe in July 2017 after we acquired a 93% equity interest in TMG, which holds licenses from Curacao, Malta, the United Kingdom, Ireland and Sweden to operate online gaming sites. We generated revenues of RMB49.4 million and RMB105.5 million (US$15.3 million) from the provision of these services in 2017 and 2018.

 

We generated revenues from sports information services through Shenzhen Caiyu and our own service offerings named “Cai Xun Hao,” which accounted for RMB1.8 million, RMB13.2 million and RMB16.0 million (US$2.3million) in 2016, 2017 and 2018, respectively.

 

We generated RMB0.4 million and RMB0.4 million (US$0.1 million) in 2017 and 2018 from trading commissions on the online spot commodity trading executed on our websites and mobile applications through Shenzhen Kaisheng.

 

Between the fourth quarter of 2015 and the second quarter of 2016, we generated revenues from the payment processing and complementary services provided by Sumpay.cn, which we disposed of in May 2016. Net revenues generated from these services were RMB0.7 million and RMB3.5 million in 2015 and 2016, respectively.

 

Between the fourth quarter of 2016 and the first quarter of 2018, we generated revenues from mobile gaming services through Qufan. We acquired 51% equity interest of Qufan in November 2016 and disposed of in February 2018. Net revenues generated from these services accounted for RMB5.7 million, RMB59.5 million and RMB7.4 million (US$1.1 million) in 2016, 2017 and 2018, respectively. We deconsolidated Qufan as of February 2018 following our disposal of it. Accordingly, the consolidated statements of comprehensive loss for the full years ended December 31, 2016, 2017 and 2018 have been reclassified to reflect the Qufan business segment as a discontinued operation. Also, we generated revenues from mobile gaming services through Guangtiandi Technology, which accounted for nil, RMB8.9 million and RMB4.0 million (US$0.6 million) in 2016, 2017 and 2018, respectively.

 

  63  

 

 

Our net revenues from continuing operations were RMB5.3 million, RMB71.9 million and RMB126.1 million (US$18.3 million) in 2016, 2017 and 2018, respectively, representing an increase of 1,256.6% from 2016 to 2017 and an increase of 75.4% from 2017 to 2018, respectively. The Company acquired the TMG in July 2017, which contributed significantly to the net revenues.

 

Net loss from continuing operations attributable to 500.com Limited were RMB203.3 million in 2016, RMB324.7 million in 2017 and 462.9 million (US$67.3 million), representing an increase of 59.7% from 2016 to 2017, and an increase of 42.6% from 2017 to 2018, respectively. Net loss from continuing operations attributable to 500.com Limited in 2016, 2017 and 2018 were adversely impacted by share-based compensation expenses of RMB163.3 million, RMB91.1 million and RMB108.6 million (US$15.8 million) in 2018, respectively. Aside from the material adverse impact of our voluntary suspension of sports lottery sales starting from April 2015, our net loss in 2018 was adversely impacted by an impairment provision of RMB149.9 million (US$21.8 million) provided for long-term investment.

 

Description of Key Statement of Operations Items from Continuing Operation

 

Net revenues

 

In 2016, 2017 and 2018, we generated revenues from the following lines of businesses:

 

(i) Online gaming services in Europe and beyond, through TMG, a 93% equity interest of which was acquired by us in July 2017;

 

(ii) Sports information services mainly through Shenzhen Caiyu, which we disposed of in November 2017, and through our own service offerings “Cai Xun Hao,” which was ceased in March 2019.

 

(iii) Online sports lottery sales services, suspended in April 2015, through which we derived substantially all of our net revenues from service fees paid to us by the provincial lottery administration centers for orders we direct to such centers. As a result of the suspension, we did not generate any revenue from online sports lottery sales services in 2016 to 2018;

 

(iv) Payment processing and complementary services through our investment in Sumpay, between the fourth quarter of 2015 and the second quarter of 2016;

 

(v) Mobile gaming service between the fourth quarter of 2016 and the first quarter of 2018 through Guangtiandi Technology; and

 

(vi) Financial technology services through our investment in Shenzhen Kaisheng.

 

Our net revenues from continuing operations were RMB5.3 million, RMB71.9 million and RMB126.1 million (US$18.3 million) in 2016, 2017 and 2018, respectively, representing an increase of 1,256.6% from 2016 to 2017 and an increase of 75.4% from 2017 to 2018, respectively. The table below sets forth our net revenues in aggregate and derived from services specified therein for the periods indicated:

 

  64  

 

 

    Year ended December 31,  
    2016     2017     2018  
    RMB     RMB     RMB     US$  
    (in thousands)  
Payment processing and other services     3,459                    
Online gaming services in Europe and beyond           49,370       105,511       15,346  
Mobile gaming     8       8,906       3,954       575  
Sports information services     1,792       13,229       16,036       2,332  
Financial technology services           353       401       59  
Physical sales of sports lottery tickets                 187       27  
Total revenues     5,259       71,858       126,089       18,339  
Deductibles                        
Net revenues     5,259       71,858       126,089       18,339  

 

Online gaming services in Europe and beyond provided by TMG accounted for nil, 68.7% and 83.7% of net revenues in 2016, 2017 and 2018, respectively. On July 17, 2017, the Company acquired a 93% interest in TMG, one of the top online lottery betting and online casino platforms operating out of Malta with a significant market share in the Nordic countries. This acquisition has contributed significantly to the increase of the Company’s revenue.

 

The table below sets forth our operating expenses from continuing operations for the periods indicated:

 

    Year ended December 31,  
    2016     2017     2018  
    RMB     RMB     RMB     US$  
    (in thousands)  
Operating Expenses:                                
Cost of services     12,749       37,483       80,017       11,638  
Sales and marketing     43,398       63,295       92,465       13,448  
General and administrative     247,408       224,321       251,384       36,562  
Service development expenses     70,741       58,592       61,909       9,004  
Total operating expenses     374,296       383,691       485,775       70,652  

 

Our operating expenses consist primarily of cost of services, sales and marketing expenses, general and administrative expenses and service development expenses.

 

Cost of Services

 

Our cost of services is directly related to the services we provide, and fluctuates in line with our revenues.

 

Our cost of services primarily consists of:

 

· amortization fees, which consist primarily of amortization of intangible assets arising from business combination, were nil, RMB13.7 million and RMB31.5 million (US$4.6 million) in 2016, 2017 and 2018, respectively.

 

· lottery insurance expenses, which consist of insurance premiums charged by insurers for covering the first two categories of winnings in online gaming services for betting on the outcome of lotteries after the acquisition of a 93% equity interest in TMG in July 2017, were RMB7.0 million and RMB20.4 million (US$3.0 million) in 2017 and 2018;

 

· platform fees, which consist of fees payable to online gaming software suppliers for providing various online casino games on TMG’s websites and apps after the acquisition of a 93% equity interest in TMG in July 2017, were RMB4.5 million and 12.1 million (US$1.8 million) in 2017 and 2018;

 

· account handling expenses, which consist primarily of transaction fees charged by banks and third-party payment processors for cash transfers between our users’ accounts on our online platform including websites and mobile applications and their accounts with banks or third-party payment processors, were RMB0.6 million, RMB2.9 million and RMB6.8 million (US$1.0 million) in 2016, 2017 and 2018, respectively;

 

· server leasing and maintenance expenses, which consist primarily of leasing expense of servers and other equipment used in providing online services, were RMB8.3 million, RMB8.2 million and RMB6.1 million (US$0.9 million) in 2016, 2017 and 2018, respectively;

 

· regulatory and compliance fees, which consist of fees payable to regulatory bodies such as Gambling Commission, HM Revenue & Customs, Malta Gaming Authority and Certria EOOD after the acquisition of a 93% equity interest in TMG in July 2017, were RMB0.6 million and RMB2.0 million (US$0.3 million) in 2017 and 2018;

 

· salary and benefit expenses for our lottery ticket processing employees were RMB0.5 million, nil and nil in 2016, 2017 and 2018, respectively; and

 

· share-based compensation expenses, which were RMB3.0 million, nil and nil in 2016, 2017 and 2018, respectively.

 

Sales and marketing expenses

 

Our sales and marketing expenses consist primarily of:

 

· promotional and marketing expenses, which primarily consist of expenses associated with various promotional events, were RMB7.5 million, RMB31.3 million and RMB54.1 million (US$7.9 million) in 2016, 2017 and 2018, respectively;

 

· salary and benefit expenses for sales and marketing employees, which were RMB17.8 million, RMB14.8 million and RMB19.2 million (US$2.8 million) in 2016, 2017 and 2018, respectively;

 

· share-based compensation expenses, which were RMB14.0 million, RMB9.2 million and RMB11.4 million (US$1.7 million) in 2016, 2017 and 2018, respectively;

 

· advertising expenses, which consist primarily of expenses associated with advertisements we placed on TV channels and other media, were RMB0.3 million, RMB1.0 million and RMB2.4 million (US$0.3 million) in 2016, 2017 and 2018, respectively; and

 

· commissions to third-party Internet companies, which are service fees we pay to third-party Internet companies for purchase orders placed on our websites by users redirected from their websites. The amount of such commissions paid to third-party Internet companies for each redirected order depends on an agreed-upon allocation ratio. The commissions to third-party Internet companies were nil, RMB5.2 million and RMB0.3 million (US$0.1 million) in 2016, 2017 and 2018, respectively.

 

General and administrative expenses

 

Our general and administrative expenses consist primarily of:

 

· share-based compensation expenses, which were RMB121.4 million, RMB65.5 million and RMB76.9 million (US$11.2 million) in 2016, 2017 and 2018, respectively;

 

  65  

 

 

· salary and benefit expenses for our management and general administrative employees, which were RMB44.4 million, RMB57.0 million and RMB69.7 million (US$10.1 million) in 2016, 2017 and 2018, respectively;

 

· third-party professional service fees, which consist primarily of professional service fees paid to third-party professionals, were RMB27.1 million, RMB41.2 million and RMB33.3 million (US$4.8 million) in 2016, 2017 and 2018, respectively;

 

· depreciation expenses mainly for improvement of leasehold, which were RMB16.9 million, RMB13.3 million and RMB30.1 million (US$4.4 million) in 2016, 2017 and 2018, respectively;

 

· office expenses, which consist primarily of office rental and other office administrative expenses, were RMB18.8 million, RMB31.6 million and RMB28.0 million (US$4.1 million) in 2016, 2017 and 2018, respectively; and

 

· travel, communication and other business expenses, which consist primarily of expenses associated with business travels, were RMB12.9 million, RMB12.5 million and RMB12.0 million (US$1.7 million) in 2016, 2017 and 2018, respectively.

 

Service development expenses

 

Our service development expenses consist primarily of:

 

· salary and benefit expenses for our research and development employees, which were RMB34.5 million, RMB32.8 million and RMB26.1 million (US$3.8 million) in 2016, 2017 and 2018, respectively;

 

· share-based compensation expenses, which were RMB25.0 million, RMB16.4 million and RMB20.3 million (US$3.0 million) in 2016, 2017 and 2018, respectively; and

 

· rental expenses, which were RMB3.8 million, RMB3.9 million and RMB12.9 million (US$1.9 million) in 2016, 2017 and 2018, respectively.

 

Other Operating Income

 

Our other operating income consists primarily of pool purchase prize amounts to which we are entitled from pool purchase prize distributions with respect to residual payments we make to complete lottery pool purchases, and technical services fees received from third parties. Our other operating income was RMB2.7 million, RMB1.2 million and RMB12.6 million (US$1.8 million) in 2016, 2017 and 2018, respectively.

 

Government Grant

 

In 2016, 2017 and 2018, we recognized grants from Shenzhen local government in an aggregate amount of RMB10.0 million, RMB6.8 million and RMB7.6 million (US$1.1 million), respectively. We might recognize similar grants from time to time in the future, but there is no assurance that we will continue to obtain such grants on a regular basis.

 

Impairment of equity method investments

 

Impairment of equity method investments were nil, RMB28.8 million and RMB149.9 million (US$21.8 million) in 2016, 2017 and 2018, respectively. The impairment loss in 2017 and 2018 were primarily related to our 40.65% equity interest in Loto Interactive, which we acquired in June 2017.

 

  66  

 

 

Gain from disposal of a subsidiary

 

In connection with our disposal of Sumpay.cn, we recognized in 2016 a disposition gain of RMB136.9 million, after deduction of the net loss arising from Sumpay.cn, and amortization expenses relating to the online payment and other licenses during the consolidating period.

 

In connection with our disposal of Shenzhen Caiyu in November 2017, we recognized in 2017 a disposition gain of RMB5.5 million, after deduction of the net loss arising from Shenzhen Caiyu.

 

In connection with our disposal of 500Fu in February 2018, we recognized in 2018 a disposition gain of RMB1.8 million (US$0.3 million), after deduction of the net loss arising from 500Fu.

  

Taxation

 

Our group includes entities incorporated in various jurisdictions throughout the world including the Cayman Islands, the British Virgin Islands, the United States, the United Kingdom, Malta, Curacao, Cyprus, Australia, Hong Kong, Japan and the People’s Republic of China. Most of these entities are either holding companies or non-operating entities. As a result, they are either not subject to any taxes in their respective local jurisdictions or did not generate any income for tax purposes.

 

The applicable taxation for our main operating entities is as follows:

 

Malta

 

Under the current laws, profits tax in Malta is generally assessed at the rate of 35% of taxable income. When a dividend is paid or declared to the holding company, the paying entity is entitled to claim six-sevenths (6/7) of the profits tax paid as a refund, which may effectively reduce the income tax rate to 5%.

 

Curacao

 

Multi Pay N.V. is incorporated in Curacao. Under the current laws, profits tax in Curacao is generally assessed at the rate of 2% of taxable income.

 

Hong Kong

 

500wan HK Limited is incorporated in Hong Kong. Under the current laws, profits tax in Hong Kong is generally assessed at the rate of 16.5% of taxable income. As 500wan HK Limited does not conduct any substantive operations of its own, no provision for Hong Kong income tax has been made in the financial statements as 500wan HK Limited had no assessable income for the year ended December 31, 2016, 2017 and 2018.

 

People’s Republic of China

 

The enterprise income tax law (the “EIT Law”) in the PRC was enacted and became effective on January 1, 2008. The EIT Law applies a uniform 25% enterprise income tax (“EIT”) rate to both foreign-invested enterprises and domestic enterprises. Accordingly, Youlanguang Technology, E-Sun Network, E-Sun Sky Computer, E-Sun Sky Network, Shenzhen Yicai, Baifengrun Technology, Tongfu Technology and Shenzhen Kaisheng were subject to the EIT rate of 25% in 2016, 2017 and 2018. Hainan Menghuanxingchen, Hainan Jingli, Hainan Panfeng and Hangzhou E-Sun Sky Network were subject to the EIT rate of 25% in 2018 since their inception. Guangtiandi Technology obtained a certificate of “Software Enterprise” and was granted a half reduction in tax rate in 2016 and 2017, and was subject to the EIT rate of 12.5% in 2016 and 2017, and 25% in 2018, respectively.

 

  67  

 

 

Lhasa Yicai was established in Tibet in 2014 and qualified as a “Western Area Encouraged Industry.” According to local government policy, qualified entities were granted a preferential tax rate of 15% from January 1, 2011 to December 31, 2020. Therefore, Lhasa Yicai is entitled to a preferential tax rate of 15% in 2016, 2017 and 2018. Additionally, Lhasa Yicai is also exempt from provincial allocated corporate income tax from January 1, 2015 to December 31, 2017 in accordance with local tax regulations.

 

As of December 31, 2018, we had also recognized a total amount of RMB2.1 million (US$0.3 million) as an accrual for uncertain tax positions and associated interest and penalties related to certain unrecognized tax positions.

 

During the years ended December 31, 2016, 2017 and 2018, the Group recognized approximately RMB4,932,000, RMB5,098,000 and nil in interest on these unrecognized tax positions and reversed approximately RMB1,827,000, RMB7,667,000 and RMB7,420,000 (US$1,079,000) in interest. The Group had accrued approximately RMB9,989,000, RMB7,420,000 and nil for the interest on these uncertain tax positions as of December 31, 2016, 2017 and 2018, respectively. In general, the PRC tax authorities have up to three to five years to conduct examinations of the Group’s tax filings. As of December 31, 2018, the PRC subsidiaries 2015 to 2018 tax returns remain open to examination.

 

Critical Accounting Policies

 

We prepare our consolidated financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of our assets and liabilities, disclosure of contingent assets and liabilities on the date of each set of consolidated financial statements and the reported amounts of revenues and expenses during each financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates and assumptions is an integral component of the financial reporting process, actual results could differ from those estimates and assumptions.

 

An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically could materially impact the consolidated financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of our consolidated financial statements. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included elsewhere in this annual report.

 

Revenue Recognition

 

The Group’s revenues were derived principally from online lottery purchase services before the voluntary suspension of this service in April 2015. During the voluntary suspension period, the Group diversified its revenue streams derived from mobile gaming services, online gaming services and sports information services. Revenue is recognized in accordance with ASC 605, “Revenue Recognition” when all of the following four criteria are met: (i) persuasive evidence of an arrangement exists; (ii) the service has been rendered; (iii) the fees are fixed or determinable; and (iv) collectability is reasonably assured, and with ASC 606, “Revenue from Contracts with Customers” when all of the following five steps are met: (i) identify the contract(s) with the customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations; and (v) recognize revenue when (or as) each performance obligation is satisfied.

 

The Company applied the new revenue standard beginning on January 1, 2018, and adopted a modified retrospective approach upon adoption. The Group has set up an implementation schedule and analyzed each of the Group’s revenue streams in accordance with the new revenue standard to determine the impact on the Group’s consolidated financial statements. Specifically, we recognize revenues based on the following revenue recognition principles:

 

  68  

 

 

Online lottery purchase services

 

The Group earns service income for online lottery purchase services and revenues are provided by processing lottery purchase orders from end users (“Service Fee”). The Group receives purchase orders from end users through its online platforms, which include websites and mobile applications, and processes the orders with the lottery administration centers. Service Fee is received from the lottery administration centers based on the pre-determined service fee rate and the total amount of the processed orders. Pursuant to ASC 605-45, “Principal Agent Considerations,” the Group records Service Fee on a net basis because the Group is not the primary obligor in the arrangement, but acts as an agent in providing such purchase services. The Group did not generate any revenue from this service since April 2015 when the Group voluntarily suspended the online lottery purchase services due to the change of related government regulation in the PRC. It is uncertain when the services will be resumed.

 

Contingent service fee

 

The Group was also entitled to receive additional Service Fee from lottery administration centers when the total amounts of purchase orders reach an agreed threshold (“Contingent Service Fee”). As the Group is the agent in providing lottery purchase services, any Contingent Service Fee received is recorded as net revenue when the agreed thresholds are reached. Once the Group reaches the agreed thresholds, the Contingent Service Fee is then fixed and not subject to any adjustments. As a result of the voluntary suspension of the online lottery purchase services mentioned above, the Group did not generate any revenue from this source either since April 2015, and it is uncertain when we will be able to generate this fee again in the future.

 

Sports Information Services

 

The Group offers a comprehensive sports information portal via a designated mobile application, which covers (i) real-time soccer match information; and (ii) data-driven soccer match predictions generated by our proprietary analysis engine. Users can also post free or pay-per-view contents such as proprietary observations and analyses on the sports information portal. The users pay for each information and data subscription at a fixed price, and the Group pays the original information providers a fixed percentage of the total purchase amount. Revenue is recognized when users are accessible to the pay-per-view contents. The Group records the revenue on a net basis because the Group is not the primary obligor to provide the information, but acts as an agent in providing such purchase services.

 

Mobile Gaming Services

 

Before disposing of Qufan and ceasing operations of our designated mobile application Quiz in the first quarter of 2018, the Group formerly provided mobile gaming services through designated mobile applications Night of Texas Hold’em Poker, Paiyou for Texas Hold’em Poker and Quiz, and derived revenues from in-game virtual tokens and other virtual items in its game development operations. Once the users purchased virtual tokens or other virtual items through the Group’s own charging system, the Group had an implied obligation to provide the services which enable the virtual tokens or other virtual items to be displayed or used in the games. Thus, the Group initially recorded the proceeds received from the sales of virtual tokens and other virtual items as deferred revenue, and once they are consumed when the services are rendered to the respective paying players, the Group recognized the attributable portion of the deferred revenue as revenue. For consumable virtual items representing items that are extinguished after consumption in the form of fixed charges levied on each round of games played, the Group recognized revenue when the items are consumed and the related services are rendered since the paying players will not continue to benefit from the virtual items thereafter. For durable virtual items that are accessible and beneficial to paying players over an extended period, the Group recognized revenue ratably over the average life of durable virtual items for the applicable game, which the Group made best estimates to be average playing period of paying players. The Group tracked each paying player’s log-in history to estimate the average playing period of paying players, and believed its estimates to be reasonable based on sufficient available paying player information.

 

  69  

 

 

The Super VIP incentive

 

Certain qualified end users (“Super VIP”) are entitled to receive incentives from the Group based on the actual purchase amount of each transaction. As the Group does not receive an additional service or benefit from the Super VIP other than service fee earned from lottery administration centers by the Group from the transaction, the incentives are recognized as a reduction of revenue at each year end in accordance with ASC 605-50, “Customer Payments and Incentives.”

 

Lottery pool purchase service

 

Lottery pools involve individual end users purchasing a share in a pooled lottery outcome or group of outcomes with other end users. Through the lottery pool purchase service, an end user, as an initiator, starts a lottery pool by specifying a range of parameters, such as the lottery portfolio, total purchase amount and payout ratio.

 

The initiator is required to commit a minimum initial purchase amount when (s)he initiates a pool, usually a certain percentage of the total purchase amount. Other end users then join the pool by agreeing to the parameters set by the initiator and committing to the purchase amount. When the total purchase amount as specified by the initiator is reached, the pooled lottery purchase order will be delivered in the manner specified by the initiator. When the actual purchase amount does not reach the total purchase amount as specified by the initiator, but reaches a certain percentage of the total purchase amount before the lottery pool purchase deadline, the Group contributes the remaining outstanding purchase amount (i.e., residual amount of the lottery pool) to complete the lottery pool transaction. If the tickets win prizes from the lottery, the Group distributes the cash prizes to the end users based on the predetermined payout ratio, and the residual amount after the distribution is retained by the Group.

 

Since the Group contributes the residual amount of the lottery pool to earn Service Fee from the purchase made by the lottery pool and does not provide any service to the lottery administration centers, the residual amount of the lottery pool contributed by the Group paid to the lottery administration centers is recognized as a reduction of revenue. The residual amount of the lottery pool retained by the Group after the distribution of the prizes is presented as “other operating income,” and recognized upon the announcement of lottery results, as the Group’s principal activity is to provide lottery purchase services to end users.

 

Online spot commodity trading services

 

The Group provides online spot commodity trading services through our designated website and mobile application in Shenzhen Kaisheng. The Group provides customers with reliable online spot commodity trading for gold trade and delay products across PC and mobile devices. The Group processes customer orders through a commercial bank, and later formed a joint venture with Shenzhen Gold Exchange on May 11, 2018 to provide online spot commodity trading services. Trading commissions are received from the commercial bank based on the pre-determined commission fee rate and the total amount of the processed orders. The Group began to generate a small amount of revenue from trading commissions on the online spot commodity trading services since 2017.

 

Online gaming services

 

The Group also provides online lottery betting and online casino platforms through our designated website in TMG. We earn the spread by exploiting the price difference between betting and winning for online lottery betting services and online casino platforms as revenues that are generated from our registered users. The registered users agree to be bound by certain terms and conditions when they first open their accounts with us. Lottery and Casino purchase orders are placed by users through our online platforms view website. Then we process these orders. Prior to processing orders, users prepay all purchase amounts. We pay users prizes whenever there are any winnings attributable to users. We record revenues on a net basis by deducting the winning amounts from betting amounts. Revenue comprises the fair value of the consideration received for the provision of internet gaming in the ordinary course of the company’s activities, which is recognized when the outcome of an event is known.

 

Income Taxes

 

We follow the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. We record a valuation allowance to offset deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in the consolidated statements of comprehensive income (loss) in the period that includes the enactment date.

 

Interest and penalties arising from underpayment of income taxes are computed in accordance with the related PRC tax law and are classified in the consolidated statements of comprehensive income (loss) as income tax expense. The amount of interest expense is computed by applying the applicable statutory rate of interest to the difference between the tax position recognized and the amount previously taken or expected to be taken in a tax return.

 

  70  

 

 

In accordance with the provisions of ASC 740 (“ASC 740”), “Income taxes,” we recognize in our financial statements the impact of a tax position if a tax return position or future tax position is “more likely than not” to be sustained upon examination based solely on the technical merits of the position. Tax positions that meet the “more likely than not” recognition threshold are measured at the largest amount of tax benefit that has a greater than a fifty percent likelihood of being realized upon settlement. Our estimated liability for unrecognized tax positions which is included in “long-term payables” is periodically assessed for adequacy and may be affected by changing interpretations of laws, rulings by tax authorities, changes and/or developments with respect to tax audits, and expiration of the statute of limitations. The outcome for a particular audit cannot be determined with certainty prior to the conclusion of the audit and, in some cases, appeal or litigation process. The actual benefits ultimately realized may differ from our estimates. As each audit is concluded, adjustments, if any, are recorded in our consolidated financial statements. Additionally, in future periods, changes in facts, circumstances, and new information may require us to adjust the recognition and measurement estimates with regard to individual tax positions. Changes in recognition and measurement estimates are recognized in the period in which the changes occur.

 

In conjunction with ASC 740, we also applied ASC 740-30 (“ASC 740-30”), “Income Taxes: Other Considerations or Special Areas,” to account for the temporary differences arising from the undistributed earnings of the foreign subsidiaries. According to ASC 740-30, all undistributed earnings of a subsidiary shall be presumed to be transferred to the parent entity. Accordingly, the undistributed earnings of a subsidiary included in consolidated income shall be accounted for as a temporary difference and affect deferred tax expense unless the tax law provides a means by which the investment in a domestic subsidiary can be recovered tax-free.

 

Share-based compensation

 

Share options and restricted shares granted to employees and directors

 

Share options and restricted shares granted to employees and directors are accounted for under ASC 718 (“ASC 718”), “Compensation - Stock compensation.” In accordance with ASC 718, the Group determines whether a share option or restricted shares should be classified and accounted for as a liability award or an equity award. All grants of share options and restricted shares to employees and directors classified as equity awards are recognized in the financial statements based on their grant date fair values. There were no liability awards granted during any of the periods stated herein. The Group recognizes compensation expense using the accelerated method for share options and restricted shares granted with graded vesting based on service conditions, provided that the amount of compensation expense recognized at any date is at least equal to the portion of the grant-date value of the share options and restricted shares that are vested at that date.

 

ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent period if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and is adjusted to reflect future change in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expense was recorded only for those share-based awards that are expected to vest. To the extent the Group revises this estimate in the future, the share-based payments could be materially impacted in the period of revision, as well as in the following periods.

 

The compensation costs associated with a modification of the terms of the award (“Modification Award”) are recognized if either the original vesting condition or the new vesting condition has been achieved. Such compensation costs cannot be less than the grant-date fair value of the original award. The incremental compensation cost is measured as the excess of the fair value of the Modification Award over the fair value of the original award at the modification date. Therefore, in relation to the Modification Award, the Group recognizes share-based compensation over the vesting periods of the new options, which comprises, (1) the amortization of the incremental portion of share-based compensation over the remaining vesting term, and (2) any unrecognized compensation cost of original award, using either the original term or the new term, whichever is higher for each reporting period.

 

  71  

 

 

Share options granted to non-employees

 

The Group records share-based compensation expense for awards granted to non-employees in exchange for services at fair value in accordance with the provisions of ASC 505-50, “Equity-based payment to non-employees.” As the share options granted to non-employees were fully vested on the grant date, the related compensation expense was fully recognized in the consolidated statement of comprehensive income (loss) on the grant date.

 

The Group, with the assistance of an independent valuation firm, determined the fair values of the share options recognized in the consolidated financial statements. The binomial option pricing model is applied in determining the estimated fair value of the share options granted to employees and non-employees.

 

Investments

 

Short-term investments

 

Short-term investments of the Company are comprised of an investment in a targeted asset management plan with a fixed rate. The Company accounts for all highly liquid investments with original maturities of greater than three months, but less than 12 months, in accordance with ASC 320-10, “Investments—Debt and Equity Securities,” which are classified as short-term investments. Dividend and interest income, including amortization of the premium and discount arising at acquisition for all categories of investments in securities, are included in earnings. Any realized gains or losses on the sale of the short-term investments are determined on a specific identification method, and such gains and losses are reflected in earnings during the period in which gains or losses are realized.

 

The Company evaluates whether a decline in fair value below the amortized cost basis is other-than-temporary in accordance with ASC 320. Other-than-temporary impairment loss is recognized in earnings equal to the entire excess of the debt security’s amortized cost basis over its fair value at the balance sheet date of the reporting period for which the assessment is made.

 

Long-term investments

 

The Company’s long-term investments consist of equity investments with and equity investments without readily determinable fair value and equity method investments.

 

Prior to adopting ASC Topic 321, Investments Equity Securities (“ASC 321”) on January 1, 2018, the Company carried at cost its investments in investees that do not have readily determinable fair value and over which the Company does not have significant influence, in accordance with ASC Subtopic 325-20, “Investments-Other: Cost Method Investments.”

 

In accordance with ASC 325, “Investments-Other,” for investments in an investee over which the Group does not have significant influence and which do not have readily determinable fair value, the Group carries the investment at cost and only adjusts for other-than-temporary declines in fair value and distributions of earnings that exceed the Group’s share of earnings since its investment.

 

Management regularly evaluates the impairment of the cost method investments based on performance and financial position of the investee as well as other evidence of market value. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financing, projected and historical financial performance, cash flow forecasts and financing needs. An impairment loss is recognized in earnings equal to the excess of the investment’s cost over its fair value at the balance sheet date of the reporting period for which the assessment is made. The fair value would then become the new cost basis of investment.

 

  72  

 

 

Pursuant to ASC 321, equity investments, except for those accounted for under the equity method, those that result in consolidation of the investee and certain other investments, are measured at fair value, and any changes in fair value, are recognized in earnings. For equity securities without readily determinable fair value and do not qualify for the existing practical expedient in ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”) to estimate fair value using the net asset value per share (or its equivalent) of the investment, the Company elected to use the measurement alternative to measure those investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any. Equity securities with readily determinable fair value are measured at fair values, and any changes in fair value are recognized in earnings. For those equity investments that the Company elects to use the measurement alternative, the Company makes a qualitative assessment of whether the investment is impaired at each reporting date. If a qualitative assessment indicates that the investment is impaired, the entity has to estimate the investment’s fair value in accordance with the principles of ASC 820. If the fair value is less than the investment’s carrying value, the entity has to recognize an impairment loss in net income equal to the difference between the carrying value and fair value.

 

As the Company’s investments in investees do not have readily determinable fair value and over which the Company does not have significant influence, when adopting ASC 321 on January 1, 2018, the Company elected to use the measurement alternative to measure those investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any. There was no effect on the Company’s consolidated financial statements subsequent to the adoption of ASC 321.

 

Investments in entities in which the Group can exercise significant influence but does not own a majority equity interest or control are accounted for using the equity method of accounting in accordance with ASC 323 (“ASC 323”), “Investments-Equity Method and Joint Ventures.” Under the equity method, the Group initially records its investment at cost and the difference between the cost of the equity investee and the fair value of the underlying equity in the net assets of the equity investee is recognized as equity method goodwill, which is included in the equity method investment on the consolidated balance sheets. The equity method goodwill is not subsequently amortized and is not tested for impairment under ASC 350. The Group subsequently adjusts the carrying amount of the investment to recognize the Group’s proportionate share of each equity investee’s net income or loss into earnings after the date of investment. The Group will discontinue applying the equity method if an investment (and additional financial supports to the investee, if any) has been reduced to zero. Under the conditions that the Group is not required to advance additional funds to an investee and the equity-method investment in ordinary shares is reduced to zero, if further investments are made that have a higher liquidation preference than ordinary shares, the Group would recognize the loss based on its percentage of the investment with the same liquidation preference, and the loss would be applied to those investments of a lower liquidation preference first before being further applied to the investments of a higher liquidation preference. The Group evaluates the equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment might not be recoverable. Factors considered by the Company when determining whether an investment has been other-than-temporarily-impaired, include, but are not limited to, the length of the time and the extent to which the market value has been less than cost, the financial performance and near-term prospect of the investee, and the Company’s intent and ability to retain the investment until the recovery of its cost. An impairment loss on the equity method investments is recognized in earnings when the decline in value is determined to be other-than-temporary.

 

According to the above testing, impairment losses of RMB28.8 million and RMB149.9 million (US$ 21.8 million) for the long-term investments were recognized during the years of 2017 and 2018, respectively.

 

Investments in limited partnerships greater than 5% are considered more than minor and accounted for using the equity method, unless it is readily apparent that the Group has virtually no influence over the partnership’s financial and operating policies.

 

Fair value measurements

 

Financial instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, an investment in a targeted asset management plan with a fixed rate (Note 6), other receivables, and accounts payable. As of December 31, 2017 and 2018, the carrying values of these financial instruments, approximate their fair values due to their short-term maturities.

 

  73  

 

 

The Group applies ASC 820 (“ASC 820”), “Fair Value Measurements and Disclosures.” ASC 820 defines fair value, establishes a framework for measuring fair value and requires disclosures to be provided on fair value measurement.

 

ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

Level 1—   Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—   Include other inputs that are directly or indirectly observable in the marketplace.

Level 3—   Unobservable inputs which are supported by little or no market activity.

 

ASC 820 describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach, and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required to replace an asset.

 

Earnings (Loss) per share

 

The Group computes earnings per Class A and Class B ordinary shares in accordance with ASC 260 (“ASC 260”), “Earnings Per Share,” using the two-class method. Under the provisions of ASC 260, basic net income (loss) per share is computed using the weighted average number of ordinary shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted average number of ordinary shares and, if dilutive, potential ordinary shares outstanding during the period. Potentially dilutive securities have been excluded from the computation of diluted net income (loss) per share if their inclusion is anti-dilutive. Potential ordinary shares consist of the incremental ordinary shares issuable upon the exercise of stock options. The dilutive effect of outstanding stock options is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income (loss) per share of Class A ordinary shares assumes the conversion of Class B ordinary shares, while the diluted net income (loss) per share of Class B ordinary shares does not assume the conversion of those shares.

 

The liquidation and dividend rights of the holders of the Group’s Class A and Class B ordinary shares are identical, except with respect to voting. As a result, and in accordance with ASC 260, the undistributed earnings for each year are allocated based on the contractual participation rights of Class A and Class B ordinary shares as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. Further, as the conversion of Class B ordinary shares is assumed in the computation of the diluted net loss per share of Class A ordinary shares, the undistributed earnings are equal to net loss for that computation.

 

For the purposes of calculating the Group’s basic and diluted earnings (loss) per Class A and Class B ordinary shares, the ordinary shares relating to the options that were exercised are assumed to have been outstanding from the date of exercise of such options.

 

Business combinations and noncontrolling interests

 

We account for our business combinations using the purchase method of accounting in accordance with ASC 805 (“ASC 805”), “ Business Combinations.” The purchase method of accounting requires that the consideration transferred to be allocated to the assets, including separately identifiable assets and liabilities we acquired, based on their estimated fair values. The consideration transferred in an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent considerations and all contractual contingencies as of the acquisition date. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any noncontrolling interests. The excess of (i) the total of cost of acquisition, fair value of the noncontrolling interests and acquisition date fair value of any previously held equity interest in the acquiree over, (ii) the fair value of the identifiable net assets of the acquiree, is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in earnings.

 

  74  

 

 

The determination and allocation of fair values to the identifiable assets acquired, liabilities assumed and noncontrolling interests is based on various assumptions and valuation methodologies requiring considerable judgment from management. The most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. We determine discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of assets, forecasted life cycle and forecasted cash flows over that period.

 

For our majority-owned VIEs, a noncontrolling interest is recognized to reflect the portion of their equity which is not attributable, directly or indirectly, to our consolidated net income (loss) on the consolidated income statements includes the net income (loss) attributable to noncontrolling interests. The cumulative results of operations attributable to noncontrolling interests are also recorded as noncontrolling interests in our consolidated balance sheets.

 

Internal Control over Financial Reporting

 

We are a public company in the United States subject to Sarbanes-Oxley. Section 404 of Sarbanes-Oxley and applicable rules and regulations thereunder require that we include a report of management on our internal control over financial reporting in this annual report.

 

Results of Operations

 

The following summary of the consolidated financial data for the periods and as of the dates indicated is qualified by reference to, and should be read in conjunction with, our consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects.”

 

Our historical results do not necessarily indicate our results to be expected for any future period.

 

    For the years ended December 31,  
    2016     2017     2018     2018  
    RMB     RMB     RMB     US$  
    (in thousands, except for per share data)  
                         
Net Revenues     5,259       71,858       126,089       18,339  
Operating costs and expenses:                                
Cost of services     (12,749 )     (37,483 )     (80,017 )     (11,638 )
Sales and marketing     (43,398 )     (63,295 )     (92,465 )     (13,448 )
General and administrative     (247,408 )     (224,321 )     (251,384 )     (36,562 )
Service development expenses     (70,741 )     (58,592 )     (61,909 )     (9,004 )
Total operating expenses     (374,296 )     (383,691 )     (485,775 )     (70,652 )
Other operating income     2,731       1,204       12,638       1,838  
Government grant     10,017       6,789       7,620       1,108  
Indemnity cost     (9,979 )     -       -       -  
Other operating expenses     (1,915 )     (34,691 )     (5,060 )     (736 )
Operating loss from continuing operations     (368,183 )     (338,531 )     (344,488 )     (50,103 )
Other income/(expenses), net     -       821       (43 )     (6 )
Interest income     23,859       20,032       15,308       2,226  
Loss from equity method investments     (406 )     (2,128 )     (15,025 )     (2,185 )
Impairment of equity method investments     -       (28,781 )     (149,896 )     (21,801 )
Gain from disposal of subsidiaries     136,914       5,477       2,805       408  
Changes in fair value of contingent considerations     -       (2,384 )     -       -  
Loss before income taxes from continuing operations     (207,816 )     (345,494 )     (491,339 )     (71,461 )
Income taxes (expenses) benefit     (2,143 )     14,025       19,602       2,851  
Net loss from continuing operations     (209,959 )     (331,469 )     (471,737 )     (68,610 )
income from discontinued operations, net of applicable income taxes     707       15,327       2,183       316  
Gain on disposal of discontinued operations, net of applicable income taxes     -       -       10,160       1,478  

 

  75  

 

 

    For the years ended December 31,  
    2016     2017     2018     2018  
    RMB     RMB     RMB     US$  
    (in thousands, except for per share data)  
                         
Net income from discontinued operations, net of applicable income taxes     707       15,327       12,343       1,794  
Net loss     (209,252 )     (316,142 )     (459,394 )     (66,816 )
Net loss from continuing operations attributable to noncontrolling interest and redeemable noncontrolling interest     (6,633 )     (6,734 )     (8,820 )     (1,283 )
Net income from discontinued operations attributable to noncontrolling interest     346       7,691       1,099       161  
Less: Net (loss) income attributable to the noncontrolling interests     (6,287 )     1,524       (4,486 )     (652 )
Less: Net (loss) attributable to redeemable noncontrolling interest     -       (567 )     (3,235 )     (470 )
Net loss attributable to 500.com Limited     (202,965 )     (317,099 )     (451,673 )     (65,694 )
Other comprehensive income (loss):                                
Foreign currency translation gain (loss)     82,347       (55,805 )     23,023       3,349  
Unrealized gain (loss) on available for sale investments     754       (733 )     -       -  
Other comprehensive income (loss) net of tax     83,101       (56,538 )     23,023       3,349  
Comprehensive loss     (126,151 )     (372,680 )     (436,371 )     (63,467 )
Less: Comprehensive (loss) income attributable to redeemable noncontrolling interest and noncontrolling interests     (6,287 )     1,348       (6,383 )     (928 )
Comprehensive loss attributable to 500.com Limited     (119,864 )     (374,028 )     (429,988 )     (62,539 )
                                 
Losses per share for Class A and Class B ordinary shares outstanding-Basic and Diluted:                                
Net loss from continuing operations     (0.49 )     (0.80 )     (1.13 )     (0.164 )
Net income from discontinued operations     0.001       0.02       0.03       0.004  
Net loss     (0.489 )     (0.78 )     (1.10 )     (0.16 )
Losses per American Depositary Share (“ADS”) (1 ADS represents 10 Class A ordinary shares)-Basic and Diluted                                
Net loss from continuing operations     (4.90 )     (7.95 )     (11.28 )     (1.64 )
Net income from discontinued operations     0.01       0.19       0.27       0.04  
Net loss     (4.89 )     (7.76 )     (11.01 )     (1.60 )
Weighted average number of Class A and Class B ordinary shares outstanding:                                
Basic     414,872,756       408,310,122       418,911,292       418,911,292  
Diluted     414,872,756       408,310,122       418,911,292       418,911,292  
Non-GAAP financial data (1)                                
Net loss attributable to 500.com Limited     (202,965 )     (317,099 )     (451,673 )     (65,694 )
Adjustment for share-based compensation expenses     163,341       91,143       108,628       15,799  
Adjusted net loss attributable to 500.com Limited (non-GAAP)     (39,624 )     (225,956 )     (343,045 )     (49,895 )
Adjusted net income (loss) from continuing operations attributable to 500.com Limited (non-GAAP)     (39,985 )     (233,592 )     (354,289 )     (51,528 )
Adjusted net income from discontinued operations attributable to 500.com Limited (non-GAAP)     316       7,636       11,244       1,633  

 

 

 

(1) As a supplement to net income, we use the non-GAAP financial measure of adjusted net income which is U.S. GAAP net income as adjusted to exclude share-based compensation expenses, and deferred tax expenses relating to valuation allowance. This non-GAAP financial measure is provided as additional information to help our investors compare business trends among different reporting periods on a consistent basis and to enhance investors’ overall understanding of our current financial performance and prospects for the future. This non-GAAP financial measure should not be considered in addition to or as a substitute for or superior to U.S. GAAP net income. In addition, our definition of adjusted net income may be different from the definition of such term used by other companies, and therefore comparability may be limited.

 

  76  

 

 

The year ended December 31, 2018 compared with the year ended December 31, 2017

 

Net revenues

 

Our net revenues increased by 75.4% from RMB71.9 million in 2017 to RMB126.1 million (US$18.3 million) in 2018, primarily attributable to revenues generated from online gaming services and sports information services. The Company acquired the TMG in July 2017, which contributed significantly to the net revenues.

 

Revenues generated from mobile gaming services decreased by 55.1% from RMB8.9 million in 2017 to RMB4.0 million (US$0.6 million) in 2018. We started generating revenues from mobile gaming services at the end of 2016 with the development of our app “Quiz.” In February 2018, we ceased Quiz, and stopped generating mobile gaming revenues since then.

 

Revenues generated from online gaming services increased by 113.6% from RMB49.4 million after the acquisition of 93% equity interest in TMG in July 2017 to RMB105.5 million (US$15.3 million) in 2018. On a pro forma basis, had the acquisition of this equity interest in TMG been completed on January 1,2017, it would have contributed a full-year total net revenue of RMB93.3 million to the Company, which would have brought the total net revenue of the Company to RMB115.8 million for the year 2017. The increase in net revenue on pro forma basis would have been only 13.1%.

 

Revenues generated from sports information services increased by 21.2% from RMB13.2 million in 2017 to RMB16.0 million (US$2.3 million) in 2018, primarily due to the 2018 FIFA World Cup, which led to an increase in the number of users and user payment for these services. We started generating revenues from sports information services in the fourth quarter of 2016 upon the acquisition of Shenzhen Caiyu. In November 2017, we disposed of our equity interest in Shenzhen Caiyu, we continued to generate revenues from sports information services through our own service offerings “Cai Xun Hao,” which was ceased in March 2019.

 

Operating expenses

 

Our operating expenses increased by 26.6% from RMB383.7 million in 2017 to RMB485.8 million (US$70.7 million) in 2018. Our operating expenses consisted of the following:

 

Cost of Services . Our cost of services increased by 113.3% from RMB37.5 million in 2017 to RMB80.0 million (US$11.6 million) in 2018. The increase was primarily due to (i) an increase in amortization expenses relating to the licenses through the acquisition of a 93% equity interest in TMG in July 2017, from RMB13.7 million in 2017 to RMB31.5 million (US$4.6 million) in 2018; (ii) an increase in business insurance costs of TMG associated with online lottery betting, from RMB7.0 million to RMB20.4 million (US$3.0 million) in 2018; (iii) an increase in platform service fees of TMG associated with online casino platforms, from RMB4.5 million to RMB12.1 million (US$1.8 million) in 2018; and (iv) an increase in account handling expenses relating to our mobile distribution channels from RMB2.9 million in 2017 to RMB6.8 million (US$1.0 million) in 2018, slightly offset by a decrease in server leasing and maintenance expenses from RMB8.2 million in 2017 to RMB6.1 million (US$0.9 million) in 2018.

 

Sales and marketing expenses . Sales and marketing expenses increased by 46.1% from RMB63.3 million in 2017 to RMB92.5 million (US$13.5 million) in 2018: The increase was mainly due to: (i) an increase in promotional and marketing expenses from RMB31.3 million in 2017 to RMB54.1 million (US$7.9 million) in 2018, which was primarily due to the operation of mobile gaming services, online gaming services and sports information services in 2018 and (ii) an increase in salary and benefit expenses for employees from RMB14.8 million in 2017 to RMB19.2 million (US$2.8 million) in 2018.

 

General and administrative expenses . General and administrative expenses increased by 12.1% from RMB224.3 million in 2017 to RMB251.4 million (US$36.6 million) in 2018. The increase primarily consisted of:

 

  77  

 

 

· an increase in share-based compensation expenses associated with share options granted to our directors and employees from RMB65.5 million in 2017 to RMB76.9 million (US$11.2 million) in 2018, which was primarily related to the share options granted in 2018;

 

· an increase in salary and benefit expenses for employees from RMB57.0 million in 2017 to RMB69.7 million (US$10.1 million) in 2018, which was primarily related to the increased number of employees of the newly acquired subsidiary, TMG; and

 

· an increase in depreciation expenses from RMB13.3 million in 2017 to RMB30.1 million (US$4.4 million) in 2018, which was primarily related to the leasehold improvements for the Company’s new offices which were put into use at the end of 2017.

 

The increase in general and administrative expenses was slightly offset by a decrease in third-party professional service fees from RMB41.2 million in 2017 to RMB33.3 million (US$4.8 million) in 2018, which was primarily due to the acquisition activities conducted in 2017.

 

Service development expenses . Service development expenses increased by 5.6% from RMB58.6 million in 2017 to RMB61.9 million (US$9.0 million) in 2018. The increase was primarily due to (i) an increase in share-based compensation expenses associated with the share options granted to our service development employees from RMB16.4 million in 2017 to RMB20.3 million (US$3.0 million) in 2018; and (ii) an increase in rental expense in from RMB3.9 million in 2017 to RMB12.9 million (US$1.9 million) in 2018. The increase in service development expenses was slightly offset by a decrease in salary and benefit expenses for employees from RMB32.8 million in 2017 to RMB26.1 million (US$3.8 million) in 2018, due to the decrease in the number of employees.

 

Other operating income

 

Other operating income increased by 950.0% from RMB1.2 million in 2017 to RMB12.6 million (US$1.8 million) in 2018. The increase was mainly due to: (i) gain from exchange rate of U.S. dollars to Renminbi of RMB6.4 million in 2018 and (ii) an increase in technical and management services fees received from third parties from RMB0.7 million in 2017 to RMB3.6 million (US$0.5 million) in 2018.

 

Operating loss

 

As a result of the foregoing factors, we recorded operating loss from continuing operations of RMB344.5 million (US$50.1 million) in 2018, an increase of RMB6.0 million compared with operating loss from continuing operations of RMB338.5 million in 2017.

 

Impairment of equity method investments.

 

Impairment of equity method investments increased by 420.5% from RMB28.8 million in 2017 to RMB149.9 million (US$21.8 million) in 2018, the impairment loss in 2017 and 2018 being primarily related to our 40.65% equity interest in Loto Interactive, which we acquired in June 2017;

 

Gain from disposal of subsidiaries

 

Gain from disposal of subsidiaries was RMB2.8 million (US$0.4 million) in 2018, a decrease of RMB2.7 million compared with gain from disposal of “Caiyu” of RMB5.5 million in 2017.

 

Loss before income taxes

 

Loss before income taxes was RMB491.3 million (US$71.5 million) in 2018, an increase of RMB145.8 million compared with loss before income taxes of RMB345.5 million in 2017.

 

  78  

 

 

Income tax benefit

 

We recorded income tax benefit of RMB19.6 million (US$2.9 million) in 2018, an increase of RMB5.6 million compared with income tax benefit of RMB14.0 million in 2017. Income tax benefit was primarily due to a reversal of uncertain tax liabilities of RMB20.7 million in 2018.

 

Net loss

 

As a result of the forgoing factors, we recorded net loss from continuing operations of RMB471.7 million (US$68.6 million) in 2018, as compared to net loss from continuing operations of RMB331.5 million in 2017.

 

Net loss attributable to 500.com Limited

 

We recorded net loss from continuing operations attributable to 500.com Limited of RMB462.9 million (US$67.3 million) in 2018, as compared to net loss from continuing operations attributable to 500.com Limited of RMB324.7 million in 2017. We also recorded non-GAAP net loss from continuing operations attributable to 500.com Limited of RMB354.3 million (US$51.5 million) in 2018, as compared to non-GAAP net loss from continuing operations attributable to 500.com Limited of RMB233.6 million in 2017.

 

The year ended December 31, 2017 compared with the year ended December 31, 2016

 

Net revenues

 

Our net revenues increased by 1,256.6% from RMB5.3 million in 2016 to RMB71.9 million in 2017, primarily attributable to revenues generated from mobile gaming services, online gaming services and sports information services. The increase in our net revenues was slightly offset by the discontinuance of our payment processing and complementary services in May 2016.

 

Revenues generated from mobile gaming services from nil in 2016 to RMB8.9 million in 2017, primarily due to an increase in the number of users and user payment for these services. We started generating revenues from mobile gaming services in the fourth quarter of 2016 upon the development of our app “Quiz.” In February 2018, we ceased Quiz, and stopped generating mobile gaming revenues since then.

 

We began to generate revenues from online gaming services after the acquisition of 93% equity interest in TMG in July 2017, and generated revenues of RMB49.4 million in 2017.

 

Revenues generated from sports information services increased by 633.3% from RMB1.8 million in 2016 to RMB13.2 million in 2017, primarily due to an increase in the number of users and user payment for these services. We started generating revenues from sports information services in the fourth quarter of 2016 upon the acquisition of Shenzhen Caiyu. In November 2017, we disposed of our equity interest in Shenzhen Caiyu, and “Cai Xun Hao” was ceased in March 2019.

 

We also generated revenues from payment processing and complementary services in the amount of RMB3.5 million in 2016 through our investment in Sumpay.cn, which we disposed of in May 2016.

 

Operating expenses

 

Our operating expenses increased by 2.5% from RMB374.3 million in 2016 to RMB383.7 million in 2017. Our operating expenses consisted of the following:

 

Cost of Services . Our cost of services increased by 195.3% from RMB12.7 million in 2016 to RMB37.5 million in 2017. The increase was primarily due to (i) amortization expenses relating to the licenses through the acquisition of a 93% equity interest in TMG in July 2017 of RMB13.7 million in 2017; (ii) an increase in business insurance costs of TMG associated with online lottery betting of RMB7.0 million in 2017; (iii) an increase in platform service fees of TMG associated with online casino platforms of RMB4.5 million in 2017; and (iv) an increase in account handling expenses relating to our mobile distribution channels from RMB0.6 million in 2016 to RMB2.9 million in 2017, slightly offset by a decrease in share-based compensation expenses associated with share options granted to our employees from RMB3.0 million in 2016 to nil in 2017.

 

  79  

 

 

Sales and marketing expenses . Sales and marketing expenses increased by 45.9% from RMB43.4 million in 2016 to RMB63.3 million in 2017: The increase mainly due to:

 

· an increase in promotional and marketing expenses from RMB7.5 million in 2016 to RMB31.3 million in 2017, which was primarily due to the operation of mobile gaming services, online gaming services and sports information services in 2017.

 

The increase in sales and marketing expenses was slightly offset by a decrease in share-based compensation expenses associated with share options granted to our employees from RMB14.0 million in 2016 to RMB9.2 million in 2017, which was primarily due to the expiration of share options granted in 2014.

 

General and administrative expenses . General and administrative expenses decreased by 9.3% from RMB247.4 million in 2016 to RMB224.3 million in 2017. The decrease primarily due to:

 

· a decrease in share-based compensation expenses associated with share options granted to our directors and employees from RMB121.4 million in 2016 to RMB65.5 million in 2017, which was primarily due to the expiration of share options granted in 2014.

 

The decrease in general and administrative expenses was slightly offset by: (i) an increase in third-party professional service fees from RMB27.1 million in 2016 to RMB41.2 million in 2017, which was primarily related to the acquisition activities conducted in 2017; (ii) an increase in salary and benefit expense for employees from RMB44.4 million in 2016 to RMB57.0 million in 2017, which was primarily related to the increased number of employees of the newly acquired subsidiary, TMG; (iii) and an increase in rental expenses from RMB11.7 million in 2016 to RMB24.8 million in 2017, which was primarily related to our newly rented offices located in Hong Kong and Shenzhen starting late 2016.

 

Service development expenses . Service development expenses decreased by 17.1% from RMB70.7 million in 2016 to RMB58.6 million in 2017. The decreased was primarily due to (i) a decrease in share-based compensation expenses associated with the share options granted to our service development employees from RMB25.0 million in 2016 to RMB16.4 million in 2017; and (ii) a decrease in technical services fee from RMB2.0 million in 2016 to RMB1.0 million in 2017. (iii) a decrease in salary and benefit expenses for employees from RMB34.5 million in 2016 to RMB32.8 million in 2017.

 

Other operating income

 

Other operating income decreased slightly from RMB2.7 million in 2016 to RMB1.2 million in 2017.

 

Operating loss

 

As a result of the foregoing factors, we recorded operating loss from continuing operations of RMB338.5 million in 2017, a decrease of RMB29.7 million compared with operating loss from continuing operations of RMB368.2 million in 2016.

 

Impairment of equity method investments.

 

Impairment loss on equity investment increased from nil in 2016 to RMB28.8 million in 2017, the impairment loss in 2017 being primarily related to our 40.65% equity interest in Loto Interactive, which we acquired in June 2017;

 

  80  

 

 

Gain from disposal of subsidiaries

 

Gain from disposal of subsidiaries was RMB5.5 million in 2017, a decrease of RMB131.4 million compared with gain from disposal of Sumpay.cn of RMB136.9 million in 2016.

 

Loss before income taxes

 

Loss before income taxes was RMB345.5 million in 2017, an increase of RMB137.7 million compared with loss before income taxes of RMB207.8 million in 2016.

 

Income tax expense

 

We recorded income tax benefit of RMB14.0 million in 2017, as compared to income tax expense of RMB2.1 million in 2016. Income tax benefit was primarily due to a reversal of uncertain tax liabilities of RMB14.7 million in 2017.

 

Net loss

 

As a result of the forgoing factors, we recorded net loss from continuing operations of RMB331.5 million in 2017, as compared to net loss from continuing operations of RMB210.0 million in 2016.

 

Net loss attributable to 500.com Limited

 

We recorded net loss from continuing operations attributable to 500.com Limited of RMB324.7 million in 2017, as compared to net loss from continuing operations attributable to 500.com Limited of RMB203.3 million in 2016. We also recorded non-GAAP net loss from continuing operations attributable to 500.com Limited of RMB233.6 million in 2017, as compared to non-GAAP net loss from continuing operations attributable to 500.com Limited of RMB40.0 million in 2016.

 

B. Liquidity and Capital Resources

 

Our principal sources of liquidity has been cash provided by our operating activities and proceeds from the issuances of preferred shares and ordinary shares. As of December 31, 2018, we had RMB435.1 million (US$63.3 million) in cash and cash equivalents and RMB100.0 million (US$14.5 million) in short-term investments.

 

As a holding company with no material operations of our own, we conduct our operations primarily through our wholly-owned subsidiaries and our consolidated affiliated entities in China and Europe. Our PRC subsidiaries’ ability to make dividends or other cash payments to us are subject to various restrictions under PRC laws and regulations. See “Item 3D. Risk Factors—Risks Related to Our Corporate Structure—We may rely principally on dividends and other distributions on equity paid by our PRC and Hong Kong subsidiaries to fund any cash and financing requirements we may have. Any limitation on the ability of our PRC and Hong Kong subsidiaries to pay dividends to us could have a material adverse effect on our ability to conduct our business.” and “Item 3D. Risk Factors—Risks Related to Doing Business in China—Governmental control of currency conversion may affect the value of your investment.” Although we consolidate the results of our PRC consolidated affiliated entities, we do not have direct access to their cash and cash equivalents or future earnings. However, we can direct the use of their cash through agreements that provide us with effective control of these entities. Moreover, we are entitled to receive service fees from them in exchange for certain technology consulting and other services provided by us and the use of certain intellectual properties owned by us.

 

  81  

 

 

We believe that our current cash and the net proceeds we received from equity financing will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures, for at least the next 12 months from the date of this report, after taking into consideration that we have suspended all of our online sports lottery sales since April 4, 2015 and are currently not generating any revenue from sports lottery sales. Our subsidiary, TMG, can be self-sufficient without requiring additional capital from us. We disposed of Qufan and received a significant amount of cash from that disposal. All these factors combined will have a positive impact on our cash flows for at least the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities or debt securities or borrow from lending institutions. Financing may be unavailable in the amounts we need or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would dilute our earnings per share. The incurrence of debt would divert cash for working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business operations and prospects may suffer.

 

The following table sets forth a summary of our cash flows for the years indicated.

 

    Year ended December 31,  
    2016     2017     2018  
    RMB     RMB     RMB     US$  
    (in thousands)  
Net cash used in operating activities     (114,341 )     (199,875 )     (160,506 )     (23,346 )
Net cash provided by (used in) investing activities     496,938       108,355       (9,486 )     (1,379 )
Net cash (used in) provided by financing activities     (117,094 )     (11,700 )     54,791       7,969  
Effect of exchange rate changes on cash and cash equivalents     47       (43,224 )     21,226       3,087  
Cash, cash equivalents and restricted cash at the beginning of the year     411,256       676,806       530,362       77,138  
Cash, cash equivalents and restricted cash at the end of the year     676,806       530,362       436,387       63,469  

 

Net cash provided by (used in) operating activities

 

Net cash used in operating activities in 2018 was RMB160.5 million (US$23.3 million), which was primarily attributable to (i) net loss of RMB459.4 million (US$66.8 million) adjusted by subtracting RMB108.6 million (US$15.8 million) of share-based compensation; (ii) depreciation and amortization expenses of RMB64.0 million (US$9.3 million); (iii) impairment loss on equity investment of RMB149.9 million (US$21.8 million); (iv) loss from equity method investments of RMB15.0 million (US$2.2 million); and (v) a decrease in prepayments and other receivables of RMB7.9 million (US$1.2 million). Net cash provided by operating activities in 2018 was partially offset by (i) a decrease in accrued expenses and other current liabilities of RMB1.4 million (US$0.2 million); (ii) a decrease in long-term payables of RMB24.7 million (US$3.6 million); (iii) a gain on disposal of subsidiary of RMB13.0 million (US$1.9 million); (iv) investment income from short-term investments of RMB6.1 million (US$0.9 million), and (v) a decrease in accrued salary and benefit expenses for employees of RMB1.8 million (US$0.3 million).

 

Net cash used in operating activities in 2017 was RMB199.9 million, which was primarily attributable to (i) net loss of RMB316.1 million adjusted by subtracting RMB91.1 million of share-based compensation; (ii) depreciation and amortization expenses of RMB39.5 million; (iii) impairment loss on equity investment of RMB28.8 million; (iv) loss from equity method investments of RMB2.1 million; (v) provision for bad debt of RMB1.5 million, and (vi) an increase in accrued expenses and other current liabilities of RMB11.6 million. Net cash provided by operating activities in 2017 was partially offset by (i) an increase in prepayments and other receivables of RMB32.2 million; (ii) a decrease in long-term payables of RMB19.6 million; (iii) a gain from disposal of subsidiary of RMB5.5 million; and (iv) a decrease in income tax payable of RMB2.1 million.

 

Net cash used in operating activities in 2016 was RMB114.3 million, which was primarily attributable to (i) net loss of RMB209.3 million adjusted by subtracting RMB163.3 million of share-based compensation; (ii) depreciation and amortization expenses of RMB19.7 million; (iii) impairment loss on equity investment of RMB3.4 million; (iv) an increase in accrued expenses and other current liabilities of RMB55.4 million; (v) an increase in income tax payable of RMB5.3 million, and (vi) an increase in accrued payroll and welfare payables of RMB1.8 million. Net cash provided by operating activities in 2016 was partially offset by (i) gain from disposal of a subsidiary of RMB136.9 million; (ii) an increase in deposits of RMB4.8 million; (iii) an increase in prepayments and other receivables of RMB4.3 million; (iv) an increase in accounts receivables of RMB4.4 million; and (v) a decrease in long-term payables of RMB2.5 million.

 

  82  

 

 

Net cash provided by (used in) investing activities

 

Net cash used in investing activities in 2018 was RMB9.5 million (US$1.4 million), which was primarily attributable to (i) cash distribution from short-term investments of RMB6.1 million (US$0.9 million); (ii) cash received from return of other long-term investments of RMB7.6 million (US$1.1 million), (iii) cash proceeds from disposal of other long-term assets of RMB5.8 million (US$0.9 million); (iv) repayment of loans provided to third-parties of RMB5.0 million (US$0.7 million); and (v) cash received from disposal of subsidiaries and VIEs, net of cash disposed of RMB23.7 million (US$3.4 million); which was partially offset by (i) cash paid for acquisition of other non-current assets of RMB11.1 million (US$1.6 million); (ii) cash paid for acquisition of property and equipment of RMB35.6 million (US$5.2 million); (iii) cash paid for loans provided to third-parties of RMB10.0 million (US$1.5 million), and (iv) cash paid for acquisition of intangible asset of RMB1.1 million (US$0.2 million).

 

Net cash provided by investing activities in 2017 was RMB108.4 million, which was primarily attributable to (i) cash received from return of time deposits of RMB804.7 million; (ii) cash received from disposal of subsidiaries and VIEs, net of cash of RMB71.8 million, and (iii) cash received from disposal of property and equipment of RMB3.5 million; which was partially offset by (i) net cash paid for business combination, net of cash of RMB374.3 million; (ii) cash paid for acquisition of other non-current assets (primarily attributable to investment in Loto Interactive) of RMB302.3 million; (iii) cash paid for acquisition of property and equipment of RMB72.9 million; (iv) cash paid for short-term investments of RMB20.0 million, and (v) cash paid for acquisition of intangible asset of RMB2.1 million.

 

Net cash provided by investing activities in 2016 was RMB496.9 million, which was primarily attributable to (i) cash received from return of time deposits of RMB1,386.9 million; (ii) cash received from the maturity of short-term investments of RMB100.0 million; and (iii) cash received from disposal of subsidiaries and VIEs, net of cash proceeds of RMB224.4 million; which was partially offset by (i) cash paid for time deposits of RMB938.9 million; (ii) cash paid for short-term investments of RMB213.5 million; (iii) cash paid for acquisition of other non-current assets of RMB28.4 million; (iv) cash paid for business combination with Sumpay.cn of RMB6.7 million; and (v) cash paid for acquisition of property and equipment of RMB26.9 million.

 

Net cash provided by (used in) financing activities

 

Net cash provided by financing activities in 2018 was RMB54.8 million (US$8.0 million) which was primarily attributable to (i) withdrawal of prepayment for share repurchase of RMB13.3 million (US$1.9 million); and (ii) proceeds from the exercise of share options of RMB41.5 million (US$6.0 million).

 

Net cash used in financing activities in 2017 was RMB11.7 million which was primarily attributable to payment for repurchase of shares of RMB17.3 million; which was partially offset by proceeds from the exercise of share options of RMB5.6 million.

 

Net cash used in financing activities in 2016 was RMB117.1 million which was primarily attributable to payment for repurchase of shares of RMB131.0 million; which was partially offset by proceeds from the exercise of share options of RMB12.6 million and reimbursement of ADR program-related expenses of RMB1.4 million.

 

Capital Expenditures

 

We made capital expenditures, including for property and equipment and intangible assets, of RMB26.7 million, RMB75.0 million and RMB36.7 million (US$5.3 million) in 2016, 2017 and 2018, respectively. In addition, our capital expenditures in 2016, 2017 and 2018 primarily consisted of purchases of additional information technology-related equipment and leasehold improvement of our new office. We expect that our capital expenditures will increase in the future as we make technological improvements to our transaction and service platform.

 

Recent Accounting Pronouncements

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases” (“ASU 2016-02”). ASU 2016-02 specifies the accounting for leases. For operating leases, ASU 2016-02 requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. ASU 2016-02 is effective for public companies for annual reporting periods, and interim periods within those years beginning after December 15, 2018.

 

  83  

 

 

The Company has adopted ASU 2016-02 on January 1, 2019 using a modified retrospective method and will not restate comparable periods. The Company elected the package of practical expedients permitted under the transition guidance, which allow the Company to carry forward the historical lease classification, the assessment whether a contract is or contains a lease and initial direct costs for any leases that exist prior to the adoption of the new standard. The Company also elected the practical expedient not to separate lease and non-lease components for certain classes of underlying assets and the short-term lease exemption for contracts with lease terms of 12 months or less. Certain operating leases related to offices which are subject to ASU 2016-02 and right-of-use assets and lease liabilities are recognized on the Company’s consolidated balance sheet. The Company currently believes the most significant change is related to the recognition of right-of-use assets and lease liabilities on the Company’s balance sheet for certain in-scope operating leases. There is no material impact on net assets and the consolidated statement of comprehensive income as a result of adopting the new standard.

 

In June 2016, the FASB issued ASU No. 2016-13 (“ASU 2016-13”), “Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 changes the impairment model for most financial assets and certain other instruments. The standard will replace “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For available-for-sale debt securities, entities will be required to record allowances rather than reduce the carrying amount, as they do today under the other-than-temporary impairment model. The standard is effective for public business entities for annual periods beginning after December 15, 2019, and interim periods therein. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adopting ASU 2016-13 on its consolidated financial statements.

 

In January 2017, the FASB issued Accounting Standards Update No. 2017-04(“ASU 2017-04”), “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. This standard is effective for public business entities in fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adopting ASU 2017-04 on its consolidated financial statements.

 

In July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), and Derivatives and Hedging (Topic 815). The guidance of Part I is to clarify accounting for certain financial instruments with down round feature in a financial instrument that reduces the strike price of an issued financial instrument if the issuer sells shares of its stock for an amount less than the currently stated strike price of the issued financial instrument or issues an equity-linked financial instrument with a strike price below the currently stated strike price of the issued financial instrument. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (“EPS”) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion features. The amendments also recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. The amendments in Part I of ASU No. 2017-11 are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. The amendments in Part II of this Update do not require any transition guidance because those amendments do not have an accounting effect. The Group has not early adopted this update. The Group is currently in the process of evaluating the impact of the adoption of ASU 2017-11 on its consolidated financial statements.

 

  84  

 

 

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” The amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. ASU No. 2018-02 is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Group has not early adopted this update. The Group does not expect that the adoption of this guidance will have a material impact on its consolidated financial statements.

 

In March 2018, the FASB issued ASU 2018-05 - Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 that was signed into law on December 22, 2017 and Staff Accounting Bulletin No. 118 (“SAB 118”) that was released by the Securities and Exchange Commission. The Tax Cuts and Jobs Act changes numerous provisions that impact U.S. corporate tax rates, business-related exclusions, and deductions and credits and may additionally have international tax consequences for many companies that operate internationally. The Group has evaluated the impact of the Tax Cuts and Jobs Act as well as the guidance of SAB 118 and incorporated the changes into the determination of a reasonable estimate of the deferred tax and appropriate disclosures in the notes to our consolidated financial statements (see Note 13).

 

In June 2018, the FASB issued ASU No. 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting to simplify the accounting for share-based payments to nonemployees (“ASU 2018-07”) by aligning it with the accounting for share-based payments to employees, with certain exceptions. Under the guidance, the measurement of equity-classified nonemployee awards will be fixed at the grant date, which may lower their cost and reduce volatility in the income statement. The guidance is effective for public business entities in annual periods beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted, including in an interim period. The ASU 2018-07 will impact the accounting of the share-based awards granted to non-employees and the Company does not expect a significant impact on its consolidated financial statements.

 

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”) which eliminates, adds and modifies certain disclosure requirements for fair value measurements. Under the guidance, public companies will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The guidance is effective for all entities for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years, but entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. The Company does not expect a significant impact on its consolidated financial statements.

 

C. Research and Development

 

We do not make, and do not expect to make, significant expenditures on research and development activities in the future as a result of the suspension of our online sports lottery sales services.

 

Intellectual Property

 

We rely on a combination of trademark, copyright and trade secret protection laws in the PRC and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property rights and our brands. “500wan”, “500.com“, “fengkuangcaiqiu”, “youqiu”, “youqiubiying” and “500gold” are trademarks registered in the PRC, USA, UK, Hong Kong and Macau, respectively, which are owned by E-Sun Network, E-Sun Sky Network and 500wan HK Limited. We have registered 45 trademarks relating to “500wan”, 46 trademarks relating to “500.com“ and 5 trademarks relating to “youqiu”, 4 trademarks relating to “youqiubiying”, 13 trademarks relating to “fengkuangcaiqiu”, and 1 trademark relating to “500gold” with the Trademark Office of the State Administration for Industry and Commerce of the PRC, registered 5 trademarks relating to “500.com” with United States Patent and Trademark Office, 5 trademarks relating to “500.com” with United Kingdom Intellectual Property Office, 5 trademarks relating to “500.com” with Japan Patent Office, 5 trademarks relating to “500.com” with Hong Kong Trade Marks Registry Intellectual Property Department, and 5 trademarks relating to “500wan” and 5 trademarks relating to “500.com“ with Macau Economic Services. We have also registered domain names including “500wan.com,” “500wan.com.cn,” “500wan.cn,” “500wan.net.cn,” and “500.com.” We own 87 software copyright registrations in PRC through Guangtiandi Technology, E-Sun Sky Computer and E-Sun Sky Network as of the date of this annual report mostly for our client software.

 

  85  

 

 

D. Trend Information

 

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the year 2018 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

 

E. Off-Balance Sheet Arrangements

 

We do not engage in trading activities involving non-exchange traded contracts or interest rate swap transactions or foreign currency forward contracts. In the ordinary course of our business, we do not enter into transactions involving, or otherwise form relationships with, unconsolidated entities or financial partnerships that are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

F. Tabular Disclosure of Contractual Obligations

 

The following table sets forth our future minimum payments under non-cancelable operating leases of office rent with initial terms in excess of one year as of the indicated dates.

 

    As of December 31, 2018  
    (RMB)     (US$)  
    (in thousands)  
2019     25,661       3,780  
2020     26,892       3,961  
2021     21,952       3,234  
2022     16,499       2,430  
Total     91,004       13,405  

 

As of December 31, 2018, we did not have any long-term debt obligations or purchase obligations.

 

G. Safe Harbor

 

This annual report contains forward-looking statements that relate to future events, including our future operating results and conditions, our prospects and our future financial performance and condition, all of which are largely based on our current expectations and projections. The forward-looking statements are contained principally in the sections entitled “Item 3. Key Information—D. Risk Factors”, “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects.” These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as “may,” “will,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to” or other and similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things, statements relating to:

 

· our goals and strategies;

 

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

 

· the expected growth of the online lottery market in China;

 

· our expectations regarding demand for and market acceptance of our services;

 

· our expectations regarding the retention and strengthening of our relationships with provincial lottery administration centers;

 

  86  

 

 

· our plans to enhance user experience, infrastructure and service offerings;

 

· competition in our industry in China; and

 

· relevant government policies and regulations relating to our industry.

 

The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report completely and with the understanding that our actual future results may be materially different from what we expect.

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. Directors and Senior Management

 

Directors and Executive Officers

 

The following table sets forth information regarding our directors and executive officers as of the date of this annual report.

 

Directors and Executive Officers   Age   Position/Title
         
Huixuan Wang   [52]   Chairman
Bo Yu   [51]   Director
Qian Sun   [44]   Independent Director
Honghui Deng   [48]   Independent Director
Yu Wei   [48]   Independent Director
Angel Yan Ki Wong   [48]   Independent Director
Zhengming Pan   [40]   Director and Chief Executive Officer
Qiang Yuan   [46]   Chief Financial Officer
Zhaofu Tian   [43]   Chief Technology Officer

 

Mr. Huixuan Wang has served as a director and Chairman of the Board since August 2018. Mr. Wang has been the director and Co-President of Tsinghua Unigroup since July 2016. Prior to joining Tsinghua Unigroup, Mr.Wang was the director of the management committee of Midong New Zone in Xinjiang, the Vice President of Xinjiang Branch of China Life Insurance Company Ltd., Person Chiefly in Charge of Guangdong Branch, General Manager of Shandong Branch and Executive Director and Vice President of head office of Chinese People’s Life Insurance Company Ltd., and Chairman of Board of Directors, Director and Principal Member of the Investment Decision-Making Committee of Life Insurance Capital Investment Management Company Ltd. Mr. Wang received a bachelor of Laws degree from Central China Normal University in 1987, and EMBA and a Ph.D. degree in Technological Economics and Management from Tianjin University in 2005.

 

Mr. Qian Sun has served as our director from October 21, 2013, and became our independent director from August 2016. Mr. Sun is a managing director of Sequoia Capital China, where he focuses on consumer and technology-related investment. Prior to joining Sequoia Capital China in 2006, Mr. Sun worked at General Atlantic from 2003 to 2005, focusing on technology-related growth investment in China. He also worked as a management consultant at Monitor Group in Hong Kong from 1997 to 1999. Mr. Sun received a BA degree in applied mathematics from Harvard College in 1997, an MBA from Harvard Business School and a J.D. from Harvard Law School in 2003.

 

Mr. Bo Yu has served as our director from January 20, 2017. Mr. Yu was the Company’s general counsel. Mr. Yu received a master’s degree in law from the University of Iowa, and a master’s degree in law and a bachelor’s degree in science from the University of Wuhan. Mr. Yu is admitted to the Bar of the State of Michigan.

 

  87  

 

 

Mr. Honghui Deng has served as our independent director since May 2011. Mr. Deng is also an independent director at Pacific Special Acquisition Corp., a company listed on NASDAQ. Mr. Deng has served as a fellow at the Innovation Creativity Capital Institute (IC2) of the University of Texas at Austin since 2010. He has taught as an EMBA/MBA professor at Peking University Guanghua School of Management since 2005. He has also taught as an assistant professor and associate professor at the School of Business of University of Nevada, Las Vegas since 2003. Mr. Deng was the founder and served as the chief executive officer of HHD Consulting Service LLC from 2003 to 2008. Mr. Deng has extensive consulting experiences for business firms on long-term strategy, finance and management. Mr. Deng received a bachelor’s degree in electronic engineering and business administration from the School of Electronic Engineering of Chongqing University in 1990 and 1994, and a Ph.D. degree in business administration from University of Texas at Austin in 2003.

 

Mr. Yu Wei has served as our independent director from November 21, 2013. Mr. Wei is the founder and director of Artix International Group Co., Ltd. Mr. Wei has served as vice president of China Railway Modern Logistics Technology Co., Ltd. since 2007 and vice president of Guiyang Longyuan Real Estate Co., Ltd. since 2011. Mr. Wei has served as a director in Guangxi Dirun Mining Industry Investment Co., Ltd. and Beijing Happy Forever Investment Management Co., Ltd. in 2011 and 2012, and has served as vice president of Guangzhou China Railway Taibo Real Estate Co., Ltd. since 2013. Mr. Wei graduated from Beijing Jiaotong University, Institute of Economics and Logistics in 1990, and received an EMBA degree from Cheung Kong Graduate School of Business in 2009.

 

Ms. Angel Yan Ki Wong has served as our independent director from November 22, 2015. Ms. Wong has been the President and Executive Director of Advanced Capital Limited since January 2008, a financial and management consulting group providing advice and services to companies seeking IPOs and merger and acquisitions. Prior to that, Ms. Wong was the Vice President and Executive Director at Benefit Capital Limited, and was also previously the Chief Financial Officer of Shengda Holdings. Ms. Wong is currently a Non-Executive Independent Director at China Public Procurement Limited (HK: 1094), and was previously a Non-Executive Independent Director at China Shengda Packaging Group, (NASDAQ: CPGI) and also a Non-Executive Independent Director at Hengxing Gold Holding Company Limited (HK: 2303). Ms. Wong was a founding member of the Hong Kong Independent Non-Executive Director Association, and received her Bachelor of Art in Economics from Xiamen University.

 

Mr. Zhengming Pan has served as our President since September 1, 2014, and our chief financial officer from April 2011 to August 2014. On May 15, 2015, Mr. Pan was appointed as our chief executive officer and a director. Prior to joining us, Mr. Pan served as a vice president at Deutsche Bank AG, Hong Kong Branch from 2007 to April 2011 and an attorney at Simpson Thacher & Bartlett LLP from 2003 to 2007. Mr. Pan received a Master of Law degree and a Juris Doctor degree from Columbia University Law School in 2001 and 2003, respectively, a Master of Law degree from the University of Edinburgh in 2000 and a bachelor’s degree in law from Fudan University in 1999.

 

Mr. Qiang Yuan has served as our chief financial officer since December 18, 2017. Prior to his appointment as a chief financial officer, Mr. Yuan has served in various positions within the Company since 2001. Mr. Yuan was a vice president in charge of financial matters for the Company from June 2014 to July 2016 and has served as a senior vice president since July 2016. Mr. Yuan received a bachelor’s degree in Financial Management from Zhongnan University of Finance and Economics.

 

Mr. Zhaofu Tian has served as our chief technology officer since October 2012. Mr. Tian has over 11 years of experience in the information technology industry. From 2007 to 2009, Mr. Tian served as a director in Tencent Engineering. From 2001 to 2007, Mr. Tian worked in UTStarcom Shenzhen R&D Center. From 1997 to 1999, Mr. Tian worked in SONY Precise Devices (Huizhou) Co. Ltd. Mr. Tian received a bachelor’s degree from Harbin Institute of Technology in 1997, a master degree from Harbin Institute of Technology in 2001, and a Master of Business Administration degree from Hong Kong University of Science and Technology in 2011.

 

  88  

 

 

B. Compensation

 

Compensation of Directors and Executive Officers

 

In 2018, the aggregate cash compensation to all our directors and our executive officers was RMB5.5 million (US$0.8 million). For share-based compensation, see “Item 6B. Compensation—Share Incentive Plans.” We did not have any amount accrued in 2018 for pension, retirement or other similar benefits to our directors and our executive officers.

 

Share Incentive Plans

 

We have adopted our 2011 share incentive plan to attract and retain the best available personnel, provide additional incentives to our employees, directors and consultants, and promote the success of our business. The 2011 share incentive plan provides for the grant of options, restricted shares and other share-based awards, collectively referred to as “awards.” The board has authorized under the plan the issuance of up to 12% of our issued and outstanding ordinary shares from time to time, on an as-exercised and fully diluted basis, upon exercise of awards granted under our 2011 share incentive plan.

 

The following table summarizes the share options and restricted shares granted to our employees under the 2011 share incentive plan that was outstanding as of the date of this annual report, respectively.

 

Name   Number of
Ordinary Shares
Underlying
Options
   

Exercise Price (1)
(US$/Share)

    Vesting
Commencement Date
  Date of Grant   Date of Expiration
Man San Law     660,000       0.2     April 8, 2012   April 8, 2011   April 8, 2021
      1,400,000       0.4     October 22, 2014   October 22, 2013   October 22, 2023
      2,980,000       1     June 19, 2015   June 19, 2014   June 19, 2019
      100,000       1.851     November 21, 2016   January 6, 2016   November 22, 2019
Zhengming Pan     2,483,330       1     June 19, 2015   June 19, 2014   June 19, 2019
      100,000       1.851     November 21, 2016   January 6, 2016   November 22, 2019
      100,000       1.35     November 21, 2017   December 16, 2016   November 22, 2019
Zhaofu Tian     *       1     June 19, 2015   June 19, 2014   June 19, 2019
Qiang Yuan     *       1     June 19, 2015   June 19, 2014   June 19, 2019
Honghui Deng     *       1     November 22, 2014   June 19, 2014   November 22, 2019
              1.851     November 21, 2016   January 6, 2016   November 22, 2019
              1.35     November 21, 2017   December 16, 2016   November 22, 2019
Yu Wei     *       1     November 22, 2014   June 19, 2014   November 22, 2019
              1.851     November 21, 2016   January 6, 2016   November 22, 2019
              1.35     November 21, 2017   December 16, 2016   November 22, 2019
Qian Sun     *       1     November 22, 2014   June 19, 2014   November 22, 2019
              1.851     November 21, 2016   January 6, 2016   November 22, 2019
              1.35     November 21, 2017   December 16, 2016   November 22, 2019
Angel Yan Ki Wong     *       1.851     November 21, 2016   January 6, 2016   November 22, 2019
              1.35     November 21, 2017   December 16, 2016   November 22, 2019
Bo Yu     *       1     June 19, 2016   June 19, 2014   June 19, 2020
              1.35     November 21, 2017   December 16, 2016   November 22, 2019
Directors and officers as a group     660,000       0.2              
      1,400,000       0.4              
      7,946,680       1              
      600,000       1.851              
      500,000       1.35              
Other Individuals as a group     1,073,500       0.2              
      41,350       0.4              
      14,302,410       1              
      200,000       2.545              

 

 

 

* Options to purchase less than 1% of our issued and outstanding share capital from time to time on an as-exercised and fully diluted basis as of the date of this annual report.

 

(1) The exercise price of the options granted on April 8, 2011 was set by our board of directors at US$0.40 per share on the date of grant, and was adjusted to US$0.20 per share by our board of directors on June 8, 2012 as it believed the voluntary suspension would materially and adversely affect our revenues for 2012 and the fair value of our ordinary shares. The exercise price of options granted on June 19, 2014 was set by our board of directors at US$3.23 per share, which was equivalent to the market price of our publicly traded shares on the previous day, and was adjusted to US$1.00 per share by our board of directors on March 19, 2015 as it believed the suspension by provincial sports lottery administration centers to accept online lottery purchase orders would materially and adversely affect our revenues for 2015 and the fair value of our ordinary shares. The last vest date of the remaining unexercised shares of options granted on June 19, 2014 was extended by our board of directors from June 19, 2017 to June 19, 2018. All the other terms of the options remain unchanged.

 

  89  

 

 

Name   Number of Ordinary
Shares
    Vesting
Commencement Date
  Date of Grant   Date of Expiration
Zhengming Pan     300,000     June 1, 2019   August 15, 2017   August 15, 2027
Zhaofu Tian     *     June 1, 2019   August 15, 2017   August 15, 2027
Qiang Yuan     *     June 1, 2019   August 15, 2017   August 15, 2027
Bo Yu     *     June 1, 2019   August 15, 2017   August 15, 2027
Directors and officers as a group     500,000              
Other Individuals as a group     14,130,740              

 

The following paragraphs describe the principal terms of our Share Incentive Plan.

 

Plan Administration . Our compensation committee administers the 2011 share incentive plan. The committee or the full board of directors, as appropriate, will determine the participants to receive awards, the type and number of awards to be granted, and the terms and conditions of each award grant.

 

Option Agreements . Awards granted under our 2011 share incentive plan are evidenced by an option agreement that sets forth the terms, conditions and limitations for each grant, which may include the term of the award, the provisions applicable in the event that the grantee’s employment or service terminates, and our authority to unilaterally or bilaterally amend, modify, suspend, cancel or rescind the award.

 

Transfer Restrictions . The right of a grantee in an award granted under our 2011 share incentive plan may not be transferred in any manner by the grantee other than by will or the laws of succession and, with limited exceptions, may be exercised during the lifetime of the grantee only by the grantee.

 

Option Exercise . The term of options granted under the 2011 share incentive plan may not exceed 10 years from the date of grant. The consideration to be paid for our ordinary shares upon exercise of an option or purchase of ordinary shares underlying the option may include cash, check or other cash-equivalent, ordinary shares, consideration received by us in a cashless exercise, or any combination of the foregoing methods of payment.

 

Acceleration upon a Change of Control . If a change of control of our company occurs, (i) the compensation committee may determine that any outstanding unexercisable, unvested or lapsable awards shall automatically be deemed exercisable, vested and not subject to lapse immediately prior to the event triggering the change of control and (ii) the compensation committee may cancel such awards for fair value, provide for the issuance of substitute awards or provide that for a period of at least 15 days prior to the event triggering the change of control, such options shall be exercisable and that upon the occurrence of the change of control, such options shall terminate and be of no further force and effect.

 

  90  

 

 

Termination and Amendment . Unless terminated earlier, our share incentive plan will expire after 10 years. Our board of directors has the authority to amend or terminate our share incentive plan, subject to shareholder approval, to the extent necessary to comply with applicable laws. Shareholders’ approval is required for any amendment to the 2011 share incentive plan that (i) increases the number of ordinary shares available under the 2011 share incentive plan, or (ii) changes the maximum number of shares for which awards may be granted to any participant, or (iii) diminishes any of the rights of the participant under any award previously granted to such participant under the plan without such participant’s consent.

 

C. Board Practices

 

Committees of the Board of Directors

 

Board of Directors

 

We currently have seven directors, including four independent directors, on our board of directors. Our board of directors consists of an audit committee, a compensation committee, a nominating and corporate governance committee and a strategy committee. Each committee’s members and functions are described below.

 

Audit Committee

 

Our audit committee consists of Angel Yan Ki Wong, Honghui Deng and Yu Wei. Angel Yan Ki Wong is the chairman of our audit committee. Angel Yan Ki Wong satisfies the criteria of an audit committee financial expert as set forth under the applicable rules of the SEC. All three committee members satisfy the requirements for an “independent director” within the meaning of NYSE rules and will meet the criteria for independence set forth in Rule 10A-3 of the United States Securities Exchange Act of 1934, as amended, or the Exchange Act.

 

The audit committee oversees our accounting and financial reporting processes and the audits of our financial statements. Our audit committee is responsible for, among other things:

 

· selecting the independent auditor;

 

· pre-approving auditing and non-auditing services permitted to be performed by the independent auditor;

 

· annually reviewing the independent auditor’s report describing the auditing firm’s internal quality control procedures, any material issues raised by the most recent internal quality control review, or peer review, of the independent auditors and all relationships between the independent auditor and our company;

 

· setting clear hiring policies for employees and former employees of the independent auditors;

 

· reviewing with the independent auditor any audit problems or difficulties and management’s response;

 

· reviewing and approving all related party transactions on an ongoing basis;

 

· reviewing and discussing the annual audited financial statements with management and the independent auditor;

 

· reviewing and discussing with management and the independent auditors major issues regarding accounting principles and financial statement presentations;

 

· reviewing reports prepared by management or the independent auditors relating to significant financial reporting issues and judgments;

 

  91  

 

 

· discussing earnings press releases with management, as well as financial information and earnings guidance provided to analysts and rating agencies;

 

· reviewing with management and the independent auditors the effect of regulatory and accounting initiatives, as well as off-balance sheet structures, on our financial statements;

 

· discussing policies with respect to risk assessment and risk management with management, internal auditors and the independent auditor;

 

· timely reviewing reports from the independent auditor regarding all critical accounting policies and practices to be used by our company, all alternative treatments of financial information within U.S. GAAP that have been discussed with management and all other material written communications between the independent auditor and management;

 

· establishing procedures for the receipt, retention and treatment of complaints received from our employees regarding accounting, internal accounting controls or auditing matters and the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters;

 

· annually reviewing and reassessing the adequacy of our audit committee charter;

 

· such other matters that are specifically delegated to our audit committee by our board of directors from time to time;

 

· meeting separately, periodically, with management, internal auditors and the independent auditor; and

 

· reporting regularly to the full board of directors.

 

Compensation Committee

 

Our compensation committee consists of Bo Yu, Huixuan Wang, and Honghui Deng. Bo Yu is the chairman of our compensation committee. Honghui Deng satisfies the requirements for an “independent director” within the meaning of NYSE rules.

 

Our compensation committee is responsible for, among other things:

 

· reviewing and evaluating and, if necessary, revising our compensation policy;

 

· reviewing and evaluating the performance of our executive officers and determining the compensation of our executive officers;

 

· reviewing and approving our executive officers’ employment agreements and severance arrangements, if any;

 

· reviewing and evaluating the performance of our directors and recommending to our board the compensation for our directors;

 

· reviewing all annual bonus, long-term incentive compensation, share option, employee pension and welfare benefit plans, setting performance targets of the executive officers under all annual bonus and long-term incentive compensation plans as appropriate, certifying that any and all performance targets of the executive officers have been met, and granting any awards under any performance-based annual bonus, long-term incentive compensation and equity compensation plans to the executive officers;

 

  92  

 

 

· periodically reviewing our policies concerning perquisite benefits, change of control or “parachute” payments, if any;

 

· reviewing and approving our executive officer and director indemnification and insurance matters; and

 

· such other matters that are specifically delegated to the compensation committee by our board of directors from time to time.

 

Nominating and Corporate Governance Committee

 

Our nominating and corporate governance committee consists of Bo Yu, Yu Wei and Zhengming Pan. Bo Yu is the chairman of our nominating and corporate governance committee. Our nominating and corporate governance committee assists the board of directors in selecting individuals qualified to become our directors and executive officers and in determining the composition of the board and its committees. The nominating and corporate governance committee will be responsible for, among other things:

 

· identifying qualified candidates as consistent with the criteria approved by our board of directors for director nominees and recommending such candidates to the board for selection for all directorships to be filled by the board or by the shareholders;

 

· identifying qualified candidates as consistent with the criteria approved by our board of directors for executive officer nominees and recommending such candidates to our board of directors for selection;

 

· conducting annual reviews of our board of directors’ independence, qualifications and experiences in light of the availability of potential board members; and

 

· monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our internal rules and procedures to ensure compliance with applicable laws and regulations.

 

Strategy Committee

 

Our strategic planning committee consists of Huixuan Wang, Qian Sun and Zhengming Pan. Huixuan Wang is the chairman of our strategic planning committee. Our strategic planning committee assists the board of directors in designing the strategic plan of our business. Our strategic planning committee is responsible for, among other things:

 

· reviewing and providing guidance to our management and the board of directors with respect to our strategy for strategic transactions;

 

· reporting to our board of directors any strategic transactions being considered, or authorized and approved, by our management;

 

· notifying our nominating and corporate governance committee of any conflict of interest or related party transaction that comes to its attention; and

 

· exercising such additional powers and duties as may be reasonable, necessary or desirable, in the committee’s discretion, to fulfill its duties.

 

Terms of Directors and Executive Officers

 

We have 7 directors, 4 of whom are independent directors, on our board of directors. Any director on our board may be appointed or removed by way of an ordinary resolution of shareholders. Any vacancies on our board of directors or additions to the existing board of directors can be filled by the affirmative vote of a majority of the remaining directors, provided that any candidate for the vacancy or addition must be nominated by our nominating and corporate governance committee. Each of our directors holds office until he or she is removed by an ordinary resolution of shareholders or by a resolution of the board.

 

  93  

 

 

All of our executive officers are appointed by and serve at the discretion of our board of directors. Our executive officers are elected by and may be removed by a majority vote of our board of directors, provided that any candidate for an executive officer position must be nominated by our nominating and corporate governance committee.

 

Employment Agreements

 

We have entered into employment agreements with each of our executive officers. We may terminate an executive officer’s employment for cause, at any time, without notice or remuneration, for certain acts of the officer, including, but not limited to, a conviction or plea of guilty to a felony, willful misconduct to our detriment or a failure to perform agreed duties. We may also terminate an executive officer’s employment under certain conditions, including, but not limited to, incapacity or disability of the officer, by a one-month prior written notice or upon paying compensation of one-month salary to the officer. An executive officer may terminate his or her employment with us with or without cause, or by a one-month prior written notice. The benefits provided upon termination of employment is T+1 months’ salary of the employee (T represents years of working experience in the Company).

 

D. Employees

 

Employees

 

Our ability to maintain a trained management team and other employees is critical to the success of our business. We had a total of 366, 408 and 282 employees as of December 31, 2016, 2017 and 2018, respectively. The table below sets forth the number of employees categorized by function as of December 31, 2018.

 

Function   Number of employees  
Management and Administration     9  
Sales, Marketing and Website Operation     87  
Service and User Support     17  
Technology and Product Development     108  
Administrative Support     61  
Total     282  

 

The remuneration package of our employees includes salary, bonus, stock options and other cash benefits. In accordance with applicable regulations in China, we participate in a pension contribution plan, a medical insurance plan, an unemployment insurance plan, a personal injury insurance plan, a maternity insurance plan and a housing reserve fund for the benefit of all of our employees.

 

We have not experienced any material labor disputes or disputes with the labor department of the PRC government since our inception.

 

E. Share Ownership

 

The following table sets forth information as of the date of this annual report with respect to the beneficial ownership of our ordinary shares, by:

 

· each person known to us to own beneficially more than 5.0% of our ordinary shares; and

 

· each of our directors and executive officers.

 

  94  

 

 

Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Except as indicated below, and subject to applicable laws, the persons named in the table have sole voting and investment power with respect to all ordinary shares shown as beneficially owned by them. Percentage of beneficial ownership for each of the persons listed below is determined by dividing (i) the number of ordinary shares beneficially owned by such person, including ordinary shares such person has the right to acquire within 60 days after the date of this annual report by (ii) the total number of ordinary shares outstanding plus the number of ordinary shares such person has the right to acquire within 60 days after the date of this annual report. The total number of ordinary shares outstanding as of the date of this annual report is 373,088,212 Class A ordinary shares and 54,400,299 Class B ordinary shares.

 

    Shares Beneficially
Owned
          Percentage of
Votes
Held
 
    Number     Percent     Percent  
Directors and Executive Officers:                        
Zhengming Pan (1)     6,033,330       1.40 %     0.66 %
Zhaofu Tian     *       *       *  
Qiang Yuan     *       *       *  
Honghui Deng     *       *       *  
Yu Wei     *       *       *  
Qian Sun     *       *       *  
Angel Yan Ki Wong     *       *       *  
Bo Yu     *       *       *  
Huixuan Wang     *       *       *  
                         
Principal Shareholders:                        
Tsinghua Unigroup International Co., Ltd. (2)     136,343,110       31.89 %     14.87 %
Man San Law (3)     44,413,854       10.27 %     30.19 %
Sequoia Capital 2010 CGF Holdco, Ltd. (4)     35,042,735       8.20 %     3.82 %

 

 

 

The business address of our directors and executive officers is 12F, West Side, Block B, Building No.7, Shenzhen Bay Eco-Technology Park, Nanshan District, Shenzhen, 518115, People’s Republic of China.

 

* Less than 1% of our outstanding ordinary shares.

(1) represents (i) 240,000 ADSs which represent 2,400,000 Class A ordinary shares owned by Ace Chance Global Limited, a BVI company wholly and beneficially owned by Mr. Pan, with the address of P.O. Box 957, Offshore Incorporations Center, Road Town, Tortola, British Virgin Islands. Mr. Pan, by virtue of his sole ownership of Ace Chance Global Limited, may be deemed to beneficially own such 2,400,000 Class B ordinary shares, and (ii) 2,983,330 Class A ordinary shares issuable upon the exercise of options and RSUs within 60 days of the date of this annual report granted to Mr. Pan under our 2011 Share Incentive Plan and 2014 Share Incentive Plan, and (iii) 65,000 ADSs which represent 650,000 Class A ordinary shares.

(2) represents (i) 63,500,500 Class A ordinary shares, and (ii) 6,456,905 ADSs which represent 64,569,050 Class A ordinary shares, owned by Tsinghua Unigroup International Co., Ltd. (iii) 827,356 ADSs which represent 8,273,560 Class A ordinary shares, owned by Unis Technology Strategy Investment Limited. The address of Tsinghua Unigroup International Co., Ltd. is Floor 6, Unis Plaza, Tsinghua Science Park, Haidian District, Beijing, China.

(3) represents (i) 21,000,006 Class B ordinary shares and (ii) 800,883 ADSs which represent 8,008,830 Class A ordinary shares owned by Delite Limited, (iii) 5,000,008 Class B ordinary shares and (iv) 526,501 ADSs which represent 5,265,010 Class A ordinary shares owned by Smart Mega Holdings Limited, as well as (v) 5,140,000 Class A ordinary shares issuable upon the exercise of options and RSUs within 60 days of the date of this annual report granted to Mr. Law under our 2011 Share Incentive Plan. Delite Limited is a BVI company with the address of P.O. Box 3321, Road Town, Tortola, British Virgin Islands. Delite Limited is wholly owned by Jackpot International Ltd, a Guernsey company which is wholly owned by The Jackpot Trust, a revocable discretionary trust established by Mr. Law with Mr. Law as settlor and Mr. Law and his family members as beneficiaries, which include Ms. Ping Yuan, wife of Mr. Law, Ms. Yuhan Law, daughter of Mr. Law, Mr. Lin Law, father of Mr. Law, and Ms. Ruihua Hu, mother of Mr. Law. The 21,000,006 Class B ordinary shares and 800,883 ADSs owned by Delite Limited are held by Credit Suisse Trust Limited as trustee of The Jackpot Trust. Smart Mega Holdings Limited is a BVI company with the address of P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands. Smart Mega Holdings Limited is wholly owned by Vibrant Jade Ltd., a Guernsey company which is wholly owned by The Vibrant Jade Trust, a revocable discretionary trust established by Ms. Ping Yuan, wife of Mr. Law, with Ms. Yuan as settlor and Mr. Law and Ms. Yuhan Law, daughter of Ms. Ping Yuan, as beneficiaries. The 5,000,008 Class B ordinary shares and 526,501 ADSs owned by Smart Mega Holdings Limited are held by Credit Suisse Trust Limited as trustee of The Vibrant Jade Trust.

 

  95  

 

 

(4) represents (i) 5 Class B ordinary shares, and (ii) 3,504,273 Restricted ADSs which represent 35,042,730 Class A ordinary shares, owned by Sequoia Capital 2010 CGF Holdco, Ltd. Sequoia Capital 2010 CGF Holdco, Ltd. is wholly owned by Sequoia Capital China Growth 2010 Fund, L.P., Sequoia Capital China Growth 2010 Partners Fund, L.P. and Sequoia Capital China Growth 2010 Principals Fund, L.P. (collectively “SCC 2010 Growth Funds”). The SCC 2010 Growth Funds’ general partner is SC China Growth 2010 Management, L.P. The general partner of SC China Growth 2010 Management, L.P. is SC China Holding Limited, a company incorporated in the Cayman Islands. SC China Holding Limited is wholly owned by SNP China Enterprises Limited, a company wholly owned by Mr. Neil Nanpeng Shen. Mr. Neil Nanpeng Shen has the power to direct Sequoia Capital 2010 CGF Holdco, Ltd. as to the voting and disposition of shares directly or indirectly held by Sequoia Capital 2010 CGF Holdco, Ltd., Mr. Shen disclaims beneficial ownership of the shares held by Sequoia Capital 2010 CGF Holdco, Ltd., except to the extent of his pecuniary interest therein. The registered address of Sequoia Capital 2010 CGF Holdco, Ltd. is Cricket Square, Hutchins Drive, PO box 2681, Grand Cayman, KY1-1111, Cayman Islands.

 

As of the date of this annual report, we are not aware of any of our shareholders being affiliated with a registered broker-dealer or being in the business of underwriting securities.

 

Please refer to “Item 6.B. Directors, Senior Management and Employees — Compensation of Directors and Executive Officers — Share Incentive Plans” for information regarding options, restricted shares and other share-based awards granted to our employees, directors and consultants.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A. Major Shareholders

 

Please refer to “Item 6E. Share Ownership.”

 

B. Related Party Transactions

 

Non-Interest Bearing Borrowings from Related Parties

 

Historically, we extended loans to certain directors and entities controlled by certain directors, executive officers and a principal shareholder of our company. As of December 31, 2016, 2017 and 2018, there were no outstanding balance due from these related parties.

 

Reorganization and Private Placement

 

See “Item 4. Information on the Company—History and Development of the Company” and “Item 4. Information on the Company—Organizational Structure.”

 

Share Incentives