*
Not for trading, but only in connection with the listing on the Nasdaq Global Market of American depositary shares.
PART
I
ITEM 1.
|
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
|
Not
applicable.
ITEM 2.
|
OFFER STATISTICS AND EXPECTED TIMETABLE
|
Not
applicable.
A.
|
SELECTED
FINANCIAL DATA.
|
The
following selected consolidated statement of income and comprehensive income data for the years ended December 31, 2017, 2018
and 2019, selected consolidated balance sheet data as of December 31, 2018 and 2019, and selected consolidated cash flow data
for the years ended December 31, 2017, 2018 and 2019 have been derived from our audited consolidated financial statements included
elsewhere in this annual report. Our selected consolidated balance sheet data as of December 31, 2017 has been derived from our
audited consolidated financial statements not included in this annual report.
The
selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes
and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. The consolidated
financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results are not necessarily indicative
of our results for any future periods.
The
following table presents our selected consolidated statements of income and comprehensive income for the years indicated.
Selected Consolidated Statements of Income and
|
|
For the Years Ended December 31,
|
|
Comprehensive Income:
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
|
192,029,524
|
|
|
|
225,271,564
|
|
|
|
319,181,424
|
|
|
|
45,752,906
|
|
Cost of revenues
|
|
|
(79,180,187
|
)
|
|
|
(85,414,061
|
)
|
|
|
(146,167,843
|
)
|
|
|
(20,952,358
|
)
|
Gross profit
|
|
|
112,849,337
|
|
|
|
139,857,503
|
|
|
|
173,013,581
|
|
|
|
24,800,548
|
|
Operating expenses
|
|
|
(35,550,993
|
)
|
|
|
(39,054,908
|
)
|
|
|
(60,162,041
|
)
|
|
|
(8,623,899
|
)
|
Income from operations
|
|
|
77,298,344
|
|
|
|
100,802,595
|
|
|
|
112,851,540
|
|
|
|
16,176,649
|
|
Other expenses, net
|
|
|
(3,432,362
|
)
|
|
|
(3,509,207
|
)
|
|
|
(7,517,988
|
)
|
|
|
(1,077,663
|
)
|
Provision for income taxes
|
|
|
(528,011
|
)
|
|
|
(8,075,596
|
)
|
|
|
(3,129,080
|
)
|
|
|
(448,536
|
)
|
Net income
|
|
|
73,337,971
|
|
|
|
89,217,792
|
|
|
|
102,204,472
|
|
|
|
14,650,450
|
|
Other comprehensive income (loss)
|
|
|
(250,623
|
)
|
|
|
1,759,288
|
|
|
|
1,589,076
|
|
|
|
227,785
|
|
Comprehensive income
|
|
|
73,087,348
|
|
|
|
90,977,080
|
|
|
|
103,793,548
|
|
|
|
14,878,235
|
|
WEIGHTED AVERAGE NUMBER OF ORDINARY SHARES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
100,000,000
|
|
|
|
100,000,000
|
|
|
|
100,000,000
|
|
|
|
100,000,000
|
|
Diluted
|
|
|
100,000,000
|
|
|
|
100,922,621
|
|
|
|
108,611,133
|
|
|
|
108,611,133
|
|
EARNINGS PER SHARE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
0.73
|
|
|
|
0.89
|
|
|
|
1.02
|
|
|
|
0.15
|
|
Diluted
|
|
|
0.73
|
|
|
|
0.88
|
|
|
|
0.94
|
|
|
|
0.13
|
|
The
following table presents our selected consolidated balance sheet as of December 31, 2017, 2018 and 2019.
|
|
As of December 31,
|
Selected Consolidated Balance Sheet Data:
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Current assets
|
|
|
52,030,035
|
|
|
|
213,295,430
|
|
|
|
177,511,440
|
|
|
|
25,445,291
|
|
Other assets
|
|
|
405,451,567
|
|
|
|
394,187,996
|
|
|
|
385,987,073
|
|
|
|
55,329,130
|
|
Total assets
|
|
|
457,481,602
|
|
|
|
607,483,426
|
|
|
|
563,498,513
|
|
|
|
80,774,421
|
|
Total liabilities
|
|
|
367,275,213
|
|
|
|
288,561,957
|
|
|
|
140,783,496
|
|
|
|
20,180,542
|
|
Total shareholders’ equity
|
|
|
90,206,389
|
|
|
|
318,921,469
|
|
|
|
422,715,017
|
|
|
|
60,593,879
|
|
The
following table presents our selected consolidated cash flow data for the years indicated.
|
|
For the Years Ended December 31
|
|
Selected Consolidated Cash Flow Data:
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Net cash provided by operating activities
|
|
|
108,057,941
|
|
|
|
99,452,205
|
|
|
|
143,955,544
|
|
|
|
20,635,238
|
|
Net cash used in investing activities
|
|
|
(118,364,263
|
)
|
|
|
(98,597,356
|
)
|
|
|
(126,479,892
|
)
|
|
|
(18,130,198
|
)
|
Net cash (used in) provided by financing activities
|
|
|
(3,800,000
|
)
|
|
|
137,493,993
|
|
|
|
(40,974,000
|
)
|
|
|
(5,873,398
|
)
|
Effect of exchange rate change on cash and cash equivalents
|
|
|
(234,124
|
)
|
|
|
937,466
|
|
|
|
599,384
|
|
|
|
85,917
|
|
Net change in cash and cash equivalents
|
|
|
(14,340,446
|
)
|
|
|
139,286,308
|
|
|
|
(22,898,964
|
)
|
|
|
(3,282,441
|
)
|
Cash and cash equivalents, beginning of year
|
|
|
27,002,080
|
|
|
|
12,661,634
|
|
|
|
151,947,942
|
|
|
|
21,780,904
|
|
Cash and cash equivalents, end of year
|
|
|
12,661,634
|
|
|
|
151,947,942
|
|
|
|
129,048,978
|
|
|
|
18,498,463
|
|
B.
|
CAPITALIZATION
AND INDEBTEDNESS
|
Not
applicable.
C.
|
REASONS
FOR THE OFFER AND USE OF PROCEEDS
|
Not
applicable.
Risks
Relating to Our Business and Industry
We
operate in a relatively new and rapidly evolving market.
Our
business and prospects primarily depend on the continuing development and growth of the holographic AR industry in China. Growth
of the holographic AR industry in China is affected by numerous factors, including but not limited to technological innovations,
user experience, development of internet and internet-based services, regulatory environment, and macroeconomic environment. The
markets for our products and services are relatively new and rapidly developing and are subject to significant challenges. In
addition, our continued growth depends, in part, on our ability to respond to changes in the holographic AR industry, including
rapid technological evolution, continued shifts in customer demands, introductions of new products and services and emergence
of new industry standards and practices. Developing and integrating new content, products, services or infrastructure could be
expensive and time-consuming, and these efforts may not yield the benefits we expect to achieve.
In
addition, as the holographic AR industry in China is relatively young, there are few proven methods of projecting customer demand
or available industry standards on which we can rely. Some of our current monetization methods are also in a relatively preliminary
stage. We cannot assure you that our attempts to monetize our current offerings will continue to be successful, profitable or
accepted, and therefore the profit potential of our business is difficult to gauge. Our growth prospects should be considered
in light of the risks and uncertainties that fast-growing early-stage companies with limited operating history in an evolving
industry may encounter, including, among others, risks and uncertainties regarding our ability to:
|
●
|
continue
to develop new software and related solutions that are appealing to end users;
|
|
●
|
enrich
our holographic AR content portfolio;
|
|
●
|
maintain
stable relationships with other key participants in the holographic AR value chain;
|
|
●
|
expand
our products and services into more use cases; and
|
|
●
|
expand
into new geographic markets with high growth potential.
|
Addressing
these risks and uncertainties will require significant capital expenditures and allocation of valuable management and employee
resources. We cannot assure you that we will succeed in any of these aspects or that the holographic AR industry in China will
continue to grow at a rapid pace. If we fail to successfully address any of the above risks and uncertainties, the size of our
user base, our revenue and profits may decline.
Our
competitive position and results of operations could be harmed if we do not compete effectively.
The
markets for our products and services are characterized by intense competition, new industry standards, limited barriers to entry,
disruptive technology developments, short product life cycles, customer price sensitivity and frequent product introductions (including
alternatives with limited functionality available at lower costs or free of charge). Any of these factors could create downward
pressure on pricing and profitability and could adversely affect our ability to attract new customers. Our future success will
depend on our continued ability to enhance our existing products and services, introduce new products and services in a timely
and cost-effective manner, meet changing customer expectations and needs, extend our core technology into new applications, and
anticipate emerging standards, business models, software delivery methods and other technological developments. Furthermore, we
are a small-size company as compared to some of the well-established enterprises that could potentially enter the holographic
AR market. Some of our current and potential competitors enjoy competitive advantages such as greater financial, technical, sales,
marketing and other resources, broader brand awareness, and access to larger customer bases. As a result of these advantages,
potential and current customers might select the products and services of our competitors, causing a loss of our market share.
We
are a relatively young company, and we may not be able to sustain our rapid growth, effectively manage our growth or implement
our business strategies.
Our
business was launched in 2015 and we have a limited operating history. Although we have experienced significant growth since our
business was launched, our historical growth rate may not be indicative of our future performance. We may not be able to achieve
similar results or grow at the same rate as we had in the past. As our business and the holographic AR market in China continue
to develop, we may need to adjust our product and service offerings or modify our business model. These adjustments may not achieve
expected results and may have a material and adverse impact on our financial conditions and results of operations.
In
addition, our rapid growth and expansion have placed, and continue to place, a significant strain on our management and resources.
This level of significant growth may not be sustainable or achievable at all in the future. We believe that our continued growth
will depend on many factors, including our ability to develop new sources of revenues, diversify monetization methods, attract
and retain customers, continue developing innovative hologram-related technologies, increase brand awareness, expand into new
market segments, and adjust to the rapidly changing regulatory environment in China. We cannot assure you that we will achieve
any of the above, and our failure to do so may materially and adversely affect our business and results of operations.
If
we fail to keep up with industry trends or technological developments, our business, results of operations and financial condition
may be materially and adversely affected.
The
holographic AR industry is rapidly evolving and subject to continuous technological changes. Our success depends on our ability
to continue to develop and implement services and solutions that anticipate and respond to rapid and continuing changes in technology
and industry developments and offerings to serve the evolving needs of our customers. Our growth strategy is focused on responding
to these types of developments by driving innovation that will enable us to expand our business into new growth areas. If we do
not sufficiently invest in new technology and industry developments, or evolve and expand our business at sufficient speed and
scale, or if we do not make the right strategic investments to respond to these developments and successfully drive innovation,
our services and solutions, our results of operations, and our ability to develop and maintain a competitive advantage and continue
to grow could be negatively affected. In addition, we operate in a quickly evolving environment, in which there currently are,
and we expect will continue to be, new technology entrants. New services or technologies offered by competitors or new entrants
may make our offerings less differentiated or less competitive, when compared to other alternatives, which may adversely affect
our results of operations. Technological innovations may also require substantial capital expenditures in product development
as well as in modification of products, services or infrastructure. We cannot assure you that we can obtain financing to cover
such expenditure. Failure to adapt our products and services to such changes in an effective and timely manner could materially
and adversely affect our business, financial condition and results of operations.
If
we cannot continue to develop, acquire, market and offer new products and services or enhancements to existing products and services
that meet customer requirements, our operating results could suffer.
The
process of developing and acquiring new technology products and services and enhancing existing offerings is complex, costly and
uncertain. If we fail to anticipate customers’ rapidly changing needs and expectations, our market share and results of
operations could suffer. We must make long-term investments, develop, acquire or obtain appropriate intellectual property and
commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products and
services. If we misjudge customer needs in the future, our new products and services may not succeed and our revenues and earnings
may be harmed. Additionally, any delay in the development, acquisition, marketing or launch of a new offering or enhancement to
an existing offering could result in customer attrition or impede our ability to attract new customers, causing a decline in our
revenue or earnings.
We
make significant investments in new products and services that may not achieve expected returns.
We
have made and will continue to make significant investments in research, development, and marketing for existing products, services,
and technologies, including holographic AR advertising solutions, mobile payment middleware, integrated holographic AR software
and other AR-based holographic offerings, as well as new technology or new applications of existing technology. Investments in
new technology are speculative. Commercial success depends on many factors, including but not limited to innovativeness, developer
support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant
new functionality or other value, they may reduce their purchases of our services or products, unfavorably affecting our revenue
and profits. We may not achieve significant revenue from new product, service or distribution channel investments, or new applications
of existing new product, service or distribution channel investments, for several years, if at all. New products and services
may not be profitable, and even if they are profitable, operating margins for some new products and businesses may not be as high
as the margins we have experienced historically. Furthermore, developing new technologies is complex and can require long development
and testing periods. Significant delays in new releases or significant problems in creating new products or offering new services
could adversely affect our revenue and profits.
We
cannot guarantee our monetization strategies will be successfully implemented or generate sustainable revenues and profit.
Our
monetization model is evolving. We currently generate a substantial majority of our revenues from holographic AR advertising services
and payment middleware licensing. We plan to increase revenue contribution from our other hologram-related monetization methods
including, for example, holographic AR IP licensing. If our strategic initiatives do not enhance our monetization ability or enable
us to develop new approaches to monetization, we may not be able to maintain or increase our revenues or profits or recover any
associated costs. In addition, we may in the future introduce new services to further diversify our revenue streams, including
services with which we have little or no prior development or operating experience. If these new or enhanced services fail to
engage customers, we may fail to attract or retain users or to generate sufficient revenues or profits to justify our investments,
and our business and operating results may suffer as a result.
Our
results of operations could materially suffer if we are not able to obtain sufficient pricing to enable us to meet our profitability
expectations.
If
we are not able to obtain sufficient pricing for our services and solutions, our revenues and profitability could materially suffer.
The rates we are able to charge for our services and solutions are affected by a number of factors, including:
|
●
|
general
economic and political conditions;
|
|
●
|
the
competitive environment in our industry;
|
|
●
|
our
customers’ desire to reduce their costs; and
|
|
●
|
our
ability to accurately estimate, attain and sustain contract revenues, margins and cash flows over the full contract period.
|
In
addition, our profitability with respect to our services and solutions for new technologies may be different when compared to
the profitability of our current business, due to factors such as the use of alternative pricing, the mix of work and the number
of service providers, among others.
The
competitive environment in our industry affects our ability to obtain favorable pricing in a number of ways, any of which could
have a material negative impact on our results of operations. The less we are able to differentiate our services and solutions
and/or clearly convey the value of our services and solutions, the more risk we have that they will be seen as commodities, with
price being the driving factor in selecting a service provider. In addition, the introduction of new services or products by competitors
could reduce our ability to obtain favorable pricing for the services or products we offer. Competitors may be willing, at times,
to price contracts lower than us in an effort to enter new markets or increase market share. Further, if competitors develop and
implement methodologies that yield greater efficiency and productivity, they may be better positioned to offer services similar
to ours at lower prices.
We
require a significant amount of capital to fund our research and development investments. If we cannot obtain sufficient capital
on favorable terms or at all, our business, financial condition and prospects may be materially and adversely affected.
Operating
our holographic AR business requires significant, continuous investment in acquiring, maintaining and upgrading content and technology.
Historically, we have financed our operations primarily with net cash generated from operating activities, financial support from
our shareholders and equity financings and loans from third parties. As part of our growth strategy, we plan to continue to invest
substantial capital in our research and development activities in the future, which may require us to obtain additional equity
or debt financing. Our ability to obtain additional financing in the future is subject to a number of uncertainties, including
but not limited to those relating to:
|
●
|
our
future business development, financial condition and results of operations;
|
|
●
|
general
market conditions for financing activities; and
|
|
●
|
macro-economic
and other conditions in China and elsewhere.
|
Although
we expect to rely increasingly on net cash provided by operating activities and financing through capital markets for our liquidity
needs as our business continues to grow and after we become a public company, we cannot assure you that we will be successful
in our efforts to diversify our sources of liquidity. If we raise additional funds through future issuances of equity or convertible
debt securities, our existing shareholders could suffer significant dilution, and any new equity securities we issue could have
rights, preferences and privileges superior to those of holders of our ordinary shares. Any debt financing that we secure in the
future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters,
including the ability to pay dividends. This may make it more difficult for us to obtain additional capital to fund our research
and pursue business opportunities, including potential acquisitions. If we cannot obtain sufficient capital to meet our capital
needs, we may not be able to implement our growth strategies, and our business, financial condition and prospects may be materially
and adversely affected.
If
we fail to attract, retain and engage appropriately skilled personnel, including senior management and technology professionals,
our business may be harmed.
Our
future success depends on our retention of highly skilled executives and employees. Competition for well-qualified and skilled
employees is intense, and our future success also depends on our continuing ability to attract, develop, motivate and retain highly
qualified and skilled employees, including, in particular, software engineers, artificial intelligence scientists and AR technology
professionals. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and
motivate existing employees. All of our senior management and key personnel are employees at will and, as a result, any of these
employees could leave with little or no prior notice. If any member of our senior management team or other key employees leave
our company, our ability to successfully operate our business and execute our business strategy could be adversely affected. In
particular, such individuals are free to compete with us in the event that they leave. Furthermore, under PRC law, certain of
our employees may have ownership rights to our intellectual property, which rights would continue in the event they left our company.
We may also have to incur significant costs in identifying, hiring, training and retaining replacements of departing employees.
If
existing or new customers are less willing to cooperate with us, our revenues and profits may be adversely affected.
We
offer holographic AR advertising solutions primarily through contracts entered into with advertisers or third-party advertising
agencies and middleware services primarily through contracts entered into with app developers and content providers. We promote
our products and services directly through our experienced and creative sales and marketing team by making direct office visits,
attending conferences and industry exhibitions, and through word-of-mouth referral. Our ability to retain existing customers or
attract new customers depends on many factors, some of which are out of our control, including:
|
●
|
Our
ability to innovate and rapidly respond to customer needs;
|
|
●
|
The
competitiveness of our pricing and payment terms for our clients, which may, in turn, be constrained by our capital and financial
resources;
|
|
●
|
Sufficient
capital support;
|
|
●
|
Our
ability to acquire complementary technologies, products and businesses to enhance the features and functionality of our applications;
and
|
|
●
|
Brand
awareness and reputation.
|
We
cannot assure you that we will be able to continue retain these customers or attract new customers. If we fail to retain and enhance
our business relationships with new and existing customers, our business and results of operations may be materially and adversely
affected.
If
we fail to successfully compete with other advertising platforms, media companies, AR or traditional advertisement producers,
our revenues and profits may be adversely affected.
Revenue
generated from our advertising business is affected by the online advertising industry in China and advertisers’ allocation
of budgets to Internet advertising and promotion in general, and specifically with respect to online holographic AR advertising.
Companies that decide to advertise or promote online may utilize more established methods or channels for online advertising and
promotion, such as key words advertising on established Chinese search engines, over in-video holographic AR advertising. In addition,
we compete with media companies, AR or traditional advertisement producers. If the holographic AR advertising market size does
not increase from current levels, if we are unable to capture and retain a sufficient share of that market, or if we are unable
to compete effectively with our competitors, our ability to maintain or increase our current level of advertisement revenue and
our profitability and prospects could be adversely affected.
Our
products and software are highly technical and may contain undetected software bugs or vulnerabilities, which could manifest in
ways that could seriously harm our reputation and our business.
Our
products and software are highly technical and complex. Our software or any of our products may contain undetected software bugs,
hardware errors, and other vulnerabilities. These bugs and errors can manifest in any number of ways in our products, including
through diminished performance, security vulnerabilities, malfunctions, or even permanently disabled products. We have a practice
of regularly updating our products and some errors in our products may be discovered only after a product has been used by users,
and may in some cases be detected only under certain circumstances or after extended use. Any errors, bugs or other vulnerabilities
discovered in our code or backend after release could damage our reputation, drive away users, allow third parties to manipulate
or exploit our software, lower revenue and expose us to claims for damages, any of which could seriously harm our business.
Our
business could be materially harmed by the ongoing coronavirus (COVID-19) pandemic.
The
outbreak of the novel coronavirus (COVID-19) starting from late January 2020 in the PRC has spread rapidly to many parts of the
world. The epidemic has resulted in quarantines, travel restrictions, and the temporary closure of stores and business facilities
in China for the past few months. In March 2020, the World Health Organization declared the COVID-19 as a pandemic. Given the
rapidly expanding nature of the COVID-19 pandemic, and because substantially all of our business operations and our workforce
are concentrated in China, we believe there is a substantial risk that our business, results of operations, and financial condition
may be materially and adversely affected. Potential impact to our results of operations will also depend on future developments
and new information that may emerge regarding the duration and severity of the COVID-19 and the actions taken by government authorities
and other entities to contain the COVID-19 or mitigate its impact, almost all of which are beyond our control.
The
impacts of COVID-19 on our business, financial condition, and results of operations include, but are not limited to, the following:
|
●
|
We
temporarily closed our offices and implemented work from-home policy beginning from February until mid-March 2020, as required
by relevant PRC regulatory authorities.
|
|
●
|
Our
customers could potentially be negatively impacted by the outbreak, which may reduce their budgets for online advertising and
marketing in 2020. As a result, our revenue, gross profit and net income may be negatively impacted in 2020.
|
|
●
|
The
situation may worsen if the COVID-19 outbreak continues. Certain of our customers have requested, and additional customers may
request, additional time to pay us or fail to pay us on time, or at all, which may require us to record additional allowances.
|
|
●
|
The
global stock markets have experienced, and may continue to experience, significant decline from the COVID-19 outbreak. It is possible
that the price of our ADSs will decline significantly, in which case you may lose your investment.
|
Because
of the uncertainty surrounding the COVID-19 outbreak, the business disruption and the related financial impacts related to the
outbreak of and response to the coronavirus cannot be reasonably estimated at this time.
Our
failure to protect our intellectual property rights may undermine our competitive position.
We
believe that our patents, copyrights, trademarks and other intellectual property are essential to our success. Please see Item
4.B. “Business Overview—Intellectual Property” for more details. We depend to a large extent on our ability
to develop and maintain the intellectual property rights relating to AR technology and our hologram content. We have devoted considerable
time and energy to the development and improvement of our software, middleware, websites, and our hologram IPs.
We
rely primarily on a combination of patents, copyrights, trademarks and trade secrets laws, and contractual restrictions for the
protection of the intellectual property used in our business. Nevertheless, these provide only limited protection and the actions
we take to protect our intellectual property rights may not be adequate. Our trade secrets may become known or be independently
discovered by our competitors. We may have no or limited rights to stop others’ use of our information. Moreover, to the
extent that our employees or third parties with whom we do business use intellectual property owned by others in their work for
us, disputes may arise as to the rights to such intellectual property. Furthermore, it is often difficult to maintain and enforce
intellectual property rights in China. Statutory laws and regulations are subject to judicial interpretation and enforcement,
and may not be applied consistently due to the lack of clear guidance on statutory interpretation. Contractual restrictions may
be breached by counterparties, and there may not be adequate remedies available to us for any such breach. Accordingly, we may
not be able to effectively protect our intellectual property rights or to enforce our contractual rights in China. Preventing
any unauthorized use of our intellectual property is difficult and costly and the steps we take may be inadequate to prevent the
misappropriation of our intellectual property. In the event that we resort to litigation to enforce our intellectual property
rights, such litigation could result in substantial costs and a diversion of our managerial and financial resources. We can provide
no assurance that we will prevail in such litigation. Any failure in protecting or enforcing our intellectual property rights
could have a material adverse effect on our business, financial condition and results of operations.
We
may not be able to protect our source code from copying if there is an unauthorized disclosure.
Source
code, the detailed program commands for our middleware and software programs, is critical to our business. Although we license
portions of our application and operating system source code to several licensees, we take significant measures to protect the
secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that
code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely
affect our revenue and operating margins.
As
our patents may expire and may not be extended, our patent rights may be contested, circumvented, invalidated or limited in scope,
our patent rights may not protect us effectively. In particular, we may not be able to prevent others from developing or exploiting
competing technologies, which could have a material and adverse effect on our business operations, financial condition and results
of operations.
In
China, the validity period of utility model patent rights or design patent rights is ten years and not extendable. As of December
31, 2019, we had 145 registered patents, 68 patent applications pending in China and no additional patent applications under the
patent cooperation treaty. For our pending application, we cannot assure you that we will be granted patents pursuant to our pending
applications. Even if our patent applications succeed, it is still uncertain whether these patents will be contested, circumvented
or invalidated in the future. In addition, the rights granted under any issued patents may not provide us with sufficient protection
or competitive advantages. The claims under any pending patents that issue from our patent applications may not be broad enough
to prevent others from developing technologies that are similar to or that achieve results similar to ours. It is also possible
that the intellectual property rights of others will bar us from licensing and from exploiting any patents that issue from our
pending applications. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the fields
in which we have developed and are developing our technology. These patents and patent applications might have priority over our
patent applications and could subject our patent applications to invalidation. Finally, in addition to those who may claim priority,
any of our existing or pending patents may also be challenged by others on the basis that they are otherwise invalid or unenforceable.
Our
services or solutions could infringe upon the intellectual property rights of others or we might lose our ability to utilize the
intellectual property of others.
We
cannot be sure that our services and solutions do not infringe on the intellectual property rights of third parties, and these
third parties could claim that we or our clients are infringing upon their intellectual property rights. These claims could harm
our reputation, cause us to incur substantial costs or prevent us from offering some services or solutions in the future. Any
related proceedings could require us to expend significant resources over an extended period of time. Any claims or litigation
in this area could be time-consuming and costly, damage our reputation and/or require us to incur additional costs to obtain the
right to continue to offer a service or solution to our clients. If we cannot secure this right at all or on reasonable terms,
or we cannot substitute alternative technology, our results of operations could be materially adversely affected. The risk of
infringement claims against us may increase as we expand our industry software solutions.
In
the operation of our AR holographic ads business, we do not enter into any agreements directly with the copyright owners of the
videos in which ads are placed using our software. Consequently, there is no assurance that we will not be affected by disputes
between platform operators, on the one hand, and copyright owners of such videos, on the other hand.
Additionally,
in recent years, individuals and firms have purchased intellectual property assets in order to assert claims of infringement against
technology providers and customers that use such technology. Any such action naming us or our clients could be costly to defend
or lead to an expensive settlement or judgment against us. Moreover, such an action could result in an injunction being ordered
against our client or our own services or operations, causing further damages.
In
addition, we rely on third-party software in providing some of our services and solutions. If we lose our ability to continue
using such software for any reason, including in the event that the software is found to infringe the rights of others, we will
need to obtain substitute software or seek alternative means of obtaining the technology necessary to continue to provide such
services and solutions. Our inability to replace such software, or to replace such software in a timely or cost-effective manner,
could materially adversely affect our results of operations.
Third
parties may register trademarks or domain names or purchase internet search engine keywords that are similar to our trademarks,
brands or websites, or misappropriate our data and copy our platform, all of which could cause confusion to our users, divert
online customers away from our products and services or harm our reputation.
Competitors
and other third parties may purchase (i) trademarks that are similar to our trademarks and (ii) keywords that are confusingly
similar to our brands or websites in internet search engine advertising programs and in the header and text of the resulting sponsored
links or advertisements in order to divert potential customers from us to their websites. Preventing such unauthorized use is
inherently difficult. If we are unable to prevent such unauthorized use, competitors and other third parties may continue to drive
potential online customers away from our platform to competing, irrelevant or potentially offensive platform, which could harm
our reputation and cause us to lose revenue.
Our
business is highly dependent on the proper functioning and improvement of our information technology systems and infrastructure.
Our business and operating results may be harmed by service disruptions, or by our failure to timely and effectively scale up
and adjust our existing technology and infrastructure.
Our
business depends on the continuous and reliable operation of our information technology (“IT”) systems. Our IT systems
are vulnerable to damage or interruption as a result of fires, floods, earthquakes, power losses, telecommunications failures,
undetected errors in software, computer viruses, hacking and other attempts to harm our IT systems. Disruptions, failures, unscheduled
service interruptions or a decrease in connection speeds could damage our reputation and cause our customers and end-users to
migrate to our competitors’ platforms. If we experience frequent or constant service disruptions, whether caused by failures
of our own IT systems or those of third-party service providers, our user experience may be negatively affected, which in turn
may have a material and adverse effect on our reputation and business. We may not be successful in minimizing the frequency or
duration of service interruptions. As the number of our end-users increases and more user data are generated on our platform,
we may be required to expand and adjust our technology and infrastructure to continue to reliably store and process content.
Our
operations depend on the performance of the Internet infrastructure and fixed telecommunications networks in China, which may
experience unexpected system failure, interruption, inadequacy or security breaches.
Almost
all access to the Internet in China is maintained through state-owned telecommunication operators under the administrative control
and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. Moreover, we primarily rely on
a limited number of telecommunication service providers to provide us with data communications capacity through local telecommunications
lines and Internet data centers to host our servers. We have limited access to alternative networks or services in the event of
disruptions, failures or other problems with China’s Internet infrastructure or the fixed telecommunications networks provided
by telecommunication service providers. Web traffic in China has experienced significant growth during the past few years. Effective
bandwidth and server storage at Internet data centers in large cities such as Beijing are scarce. With the expansion of our business,
we may be required to upgrade our technology and infrastructure to keep up with the increasing traffic on our platform. We cannot
assure you that the Internet infrastructure and the fixed telecommunications networks in China will be able to support the demands
associated with the continued growth in Internet usage. If we cannot increase our capacity to deliver our online services, we
may not be able to expand customer base, and the adoption of our services may be hindered, which could adversely impact our business
and profitability.
In
addition, we have no control over the costs of the services provided by telecommunication service providers. If the prices we
pay for telecommunications and Internet services rise significantly, our results of operations may be materially and adversely
affected. Furthermore, if Internet access fees or other charges to Internet users increase, some users may be prevented from accessing
the mobile Internet and thus cause the growth of mobile Internet users to decelerate. Such deceleration may adversely affect our
ability to continue to expand our user base.
We
use third-party services and technologies in connection with our business, and any disruption to the provision of these services
and technologies to us could result in adverse publicity and a slowdown in the growth of our users, which could materially and
adversely affect our business, financial condition and results of operations.
Our
business partially depends on services provided by, and relationships with, various third parties. Some third-party software we
use in our operations is currently publicly available and free of charge. If the owner of any such software decides to charge
users or no longer makes the software publicly available, we may need to incur significant costs to obtain licensing, find replacement
software or develop it on our own. If we are unable to obtain licensing, find or develop replacement software at a reasonable
cost, or at all, our business and operations may be adversely affected.
We
exercise no control over the third parties with whom we have business arrangements. If such third parties increase their prices,
fail to provide their services effectively, terminate their service or agreements or discontinue their relationships with us,
we could suffer service interruptions, reduced revenues or increased costs, any of which may have a material adverse effect on
our business, financial condition and results of operations.
If
we are unable to collect our receivables or unbilled services, our results of operations, financial condition and cash flows could
be adversely affected.
Our
business depends on our ability to successfully and timely obtain payment from our customers of the amounts they owe us for work
performed. We evaluate the financial condition of our clients and usually bill and collect on 30 to 60 day cycles. We have established
allowances for losses of receivables and unbilled services. Actual losses on client balances could differ from those that we currently
anticipate, and, as a result, we might need to adjust our allowances. We might not accurately assess the creditworthiness of our
clients. Macroeconomic conditions could also result in financial difficulties for our customers, including bankruptcy and insolvency.
This could cause customers to delay payments to us, request modifications to their payment arrangements that could increase our
receivables balance, or default on their payment obligations to us. Recovery of customer financing and timely collection of client
balances also depend on our ability to complete our contractual commitments and bill and collect our contracted revenues. If we
are unable to meet our contractual requirements, we might experience delays in collection of and/or be unable to collect our customer
balances, and if this occurs, our results of operations and cash flows could be adversely affected. In addition, if we experience
an increase in the time to bill and collect for our services, our cash flows could be adversely affected.
If
we fail to obtain or maintain the required licenses and approvals or if we fail to comply with laws and regulations applicable
to our industry, our business, financial condition and results of operations may be materially and adversely affected.
The
Internet industry in China is highly regulated, which requires certain licenses, permits, filings and approvals to conduct and
develop business. Currently, we have obtained business performance permit, telecom value-added service license and network culture
operation license business performance permit.
Due
to the uncertainties of interpretation and implementation of existing and future laws and regulations, the licenses we held may
not be sufficient to meet regulatory requirements, which may restrain our ability to expand our business scope and may subject
us to fines or other regulatory actions by relevant regulators if our practice is deemed as violating relevant laws and regulations.
As we further develop and expand our business scope, we may need to obtain additional qualifications, permits, approvals or licenses.
Moreover, we may be required to obtain additional licenses or approvals if the PRC government adopts more stringent policies or
regulations for our industry.
As
the Internet industry in China is still at a relatively early stage of development, new laws and regulations may be adopted from
time to time to address new issues that come to the authorities’ attention. Considerable uncertainties still exist with
respect to the interpretation and implementation of existing and future laws and regulations governing our business activities.
We cannot assure you that we will not be found in violation of any future laws and regulations or any of the laws or regulations
currently in effect due to changes in the relevant authorities’ interpretation of these laws and regulations.
In
accordance with the Notice on Adjusting the Scope and Standardizing the Examination and Approval Process of Network Culture Operation
License (“Notice”) of the Ministry of Culture and Tourism, dated May 14, 2019, any network culture operation licenses
whose business scope contains online-games related activities remains valid, although such licenses may not be renewed by the
Ministry of Culture and Tourism upon expiration thereof. It is not clear yet whether new licenses could be issued by an alternative
governmental authority. As a result, there is risk that we may not have a valid license to conduct online-gaming activities after
the expiration of such license.
As
of the date of this annual report, we have not received any material penalties from the relevant government authorities for our
past business operations. We cannot assure you, however, that the government authorities will not do so in the future. In addition,
we may be required to obtain additional license or permits, and we cannot assure you that we will be able to timely obtain or
maintain all the required licenses or permits or make all the necessary filings in the future. If we fail to obtain, hold or maintain
any of the required licenses or permits or make the necessary filings on time or at all, we may be subject to various penalties,
such as confiscation of the net revenues that were generated through the unlicensed activities, the imposition of fines and the
discontinuation or restriction of our operations. Any such penalties may disrupt our business operations and materially and adversely
affect our business, financial condition and results of operations.
We
may be materially and adversely affected by the complexity, uncertainties and changes in PRC regulation of the Internet industry
and companies.
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 regulations 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 and the
requirement for real-name registrations. Permits, licenses or operations at some of our subsidiaries and PRC variable interest
entity levels may be subject to challenge, we may not be able to timely obtain or maintain all the required licenses or approvals,
permits, or to complete filing, registration or other formalities necessary for our present or future operations, and we may not
be able to renew certain permits or licenses or renew certain filing or registration or other formalities. See “Item 3.D.
Risk Factors—If we fail to obtain or maintain the required licenses and approvals or if we fail to comply with laws and
regulations applicable to our industry, our business, financial condition and results of operations may be materially and adversely
affected” and ” Item 4.B. Business Overview- Regulation.”
|
|
●
|
The
evolving PRC regulatory system for the Internet industry may lead to the establishment of new regulatory agencies. For example,
in May 2011, the State Council announced the establishment of a new department, the State Internet Information Office. The primary
role of this new agency is to facilitate the policy-making and legislative development in this field to direct and coordinate
with the relevant departments in connection with online content administration and to deal with cross-ministry regulatory matters
in relation to the Internet industry. We are unable to determine what policies this new agency or any new agencies to be established
in the future may have or how they may interpret existing laws, regulations and policies and how they may affect us. Further,
new laws, regulations or policies may be promulgated or announced that will regulate Internet activities, including online video
and online advertising businesses. If these new laws, regulations or policies 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.
|
The
interpretation and application of existing PRC laws, regulations and policies and possible 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, Internet businesses in China, including our business. There are also risks that we may
be found to violate the existing or future laws and regulations given the uncertainty and complexity of China’s regulation
of Internet business.
Our
business generates and processes a large amount of data, and we are required to comply with PRC laws and regulations relating
to cyber security. These laws and regulations could create unexpected costs, subject us to enforcement actions for compliance
failures, or restrict portions of our business or cause us to change our data practices or business model.
Our
business generates and processes a large quantity of data. We face risks inherent in handling and protecting large volume of data.
In particular, we face a number of challenges relating to data we collect through our game distribution platform and integrated
holographic AR software offering, including:
|
●
|
protecting
the data in and hosted on our system, including against attacks on our system by outside parties or fraudulent behavior or improper
use by our employees;
|
|
●
|
addressing
concerns related to privacy and sharing, safety, security and other factors; and
|
|
●
|
complying
with applicable laws, rules and regulations relating to the collection, use, storage, transfer, disclosure and security of personal
information, including any requests from regulatory and government authorities relating to this data.
|
Governments
around the world, including the PRC government, have enacted or are considering legislation related to online businesses. There
may be an increase in legislation and regulation related to the collection and use of anonymous internet user data and unique
device identifiers, such as IP address or mobile unique device identifiers, and other data protection and privacy regulation.
The PRC regulatory and enforcement regime with regard to data security and data protection is evolving. We may be required by
Chinese governmental authorities to share personal information and data that we collect to comply with PRC laws relating to cybersecurity.
All these laws and regulations may result in additional expenses to us and any non-compliance may subject us to negative publicity
which could harm our reputation and negatively affect the trading price of our ADSs. There are also uncertainties with respect
to how these laws will be implemented in practice. PRC regulators have been increasingly focused on regulation in the areas of
data security and data protection. We expect that these areas will receive greater attention and focus from regulators, as well
as attract continued or greater public scrutiny and attention going forward, which could increase our compliance costs and subject
us to heightened risks and challenges associated with data security and protection. If we are unable to manage these risks, we
could become subject to penalties, fines, suspension of business and revocation of required licenses, and our reputation and results
of operations could be materially and adversely affected. In addition, regulatory authorities around the world have recently adopted
or are considering a number of legislative and regulatory proposals concerning data protection. These legislative and regulatory
proposals, if adopted, and the uncertain interpretations and application thereof could, in addition to the possibility of fines,
result in an order requiring that we change our data practices, which could have an adverse effect on our business and results
of operations.
Our
business depends on the market recognition of our brand, and if we are unable to maintain and enhance brand recognition, or promote
or maintain our brand in a cost-effective manner, our business, financial conditions and results of operations may be materially
and adversely affected.
We
believe that maintaining and enhancing our brand is of significant importance to the success of our business. A well-recognized
brand is important to attract customers, especially in this novel and evolving market. We promote our brand though marketing team
and word-of-mouth referrals. Successful promotion of our brand will depend on the effectiveness of our marketing efforts and amount
of word-of-mouth referrals we received from satisfied customers. We may incur extra expenses in promoting our brand. However,
our brand promotion activities and marketing efforts may not yield increased revenues, and even if they do, any increased revenues
may not offset the expenses we incurred in promoting our brand. Since we operate in a highly competitive industry, our brand recognition
directly affects our ability to maintain our market position. If we fail to successfully promote and maintain our brand, or if
we incur extra expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract enough new customers
or retain our existing customers, and our business and results of operations may be materially and adversely affected.
Our
success depends on the interoperability of our products and services with next-generation AR hardware.
The
success of our products depends upon the cooperation of AR hardware manufactures to ensure interoperability with our products
and offer compatible products and services to end users. To the extent that hardware manufactures perceive that their products
and services compete with ours, they may have an incentive to withhold their cooperation, decline to share access or sell to us
their proprietary application programming interfaces (“APIs”), protocols or formats, or engage in practices to actively
limit the functionality, compatibility and certification of our products. If any of the foregoing occurs, our product development
efforts may be delayed or foreclosed and it may be difficult and more costly for us to achieve functionality and service levels
that would make our services attractive to end users, any of which could negatively impact our business and operating results.
Potential
and threatened litigation could have a material and adverse impact on our business, financial condition and results of operations.
From
time to time, we have been, and may in the future be, subject to potential or threatened lawsuits brought by our competitors,
individuals, or other entities against us, in matters relating to intellectual property rights, contractual disputes and competition
claims. We may also institute potential legal actions against our competitors, individuals, or other entities. The outcomes of
actions we institute may not be successful or favorable to us. Lawsuits against us may also generate negative publicity that significantly
harms our reputation, which may adversely affect our user base. In addition to the related costs, managing and defending litigation
and related indemnity obligations can significantly divert our management’s attention from operating our business. We may
also need to pay damages or settle lawsuits with a substantial amount of cash. While we do not believe that any currently pending
proceedings are likely to have a material adverse effect on us, if there were adverse determinations in legal proceedings against
us, we could be required to pay substantial monetary damages or adjust our business practices, which could have an adverse effect
on our business, financial condition and results of operations.
Negative
media coverage could adversely affect our business.
Negative
publicity about us and our business, shareholders, affiliates, directors, officers, and other employees, as well as the industry
in which we operate, can harm our operations. Negative publicity concerning these parties could be related to a wide variety of
matters, including:
|
●
|
alleged
misconduct or other improper activities committed by our shareholders, affiliates, directors, officers and other employees;
|
|
●
|
false
or malicious allegations or rumors about us or our shareholders, affiliates, directors, officers, and other employees;
|
|
●
|
user
complaints about the quality of our products and services;
|
|
●
|
copyright
or patent infringements involving us and contents offered on our platforms; and
|
|
●
|
governmental
and regulatory investigations or penalties resulting from our failure to comply with applicable laws and regulations.
|
In
addition to traditional media, there has been an increasing use of social media platforms and similar devices in China, including
instant messaging applications, social media websites and other forms of internet-based communications that provide individuals
with access to a broad audience of users and other interested persons. The availability of information on instant messaging applications
and social media platforms is virtually immediate as is its impact without affording us an opportunity for redress or correction.
The opportunity for dissemination of information, including inaccurate information, is seemingly limitless and readily available.
Information concerning our company, shareholders, directors, officers and employees may be posted on such platforms at any time.
The risks associated with any such negative publicity or incorrect information cannot be completely eliminated or mitigated and
may materially harm our reputation, business, financial condition and results of operations.
If
we fail to implement and maintain an effective system of internal controls, we may be unable to accurately report our results
of operations, meet our reporting obligations or prevent fraud, and investor confidence and the market price of our ADSs may be
materially and adversely affected.
We are subject to the reporting
requirements of the Exchange Act of 1934, or Exchange Act, the Sarbanes-Oxley Act of and the rules and regulations of the
Nasdaq Stock Market. We are not required to provide a report of management’s assessment on our internal control over
financial reporting in this annual report due to a transition period established by the rules of the SEC for newly public
companies. In addition, we are not required to include an attestation report on internal control over financial reporting
issued by our independent registered public accounting firm in this annual report, since we are an emerging growth company as
defined under the JOBS Act. However, in the course of auditing our consolidated
financial statements included in this annual report, we and our independent registered public accounting firm
identified one material weakness in our internal control over financial reporting. As defined in standards established
by the Public Company Accounting Oversight Board (“PCAOB”), a “material weakness” is a deficiency, or
a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that
a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
The material weakness identified relates to our lack of sufficient skilled staff with U.S. GAAP knowledge and the SEC
reporting knowledge for the purpose of financial reporting as well as the lack in formal accounting policies and procedures
manual to ensure proper financial reporting in accordance with U.S. GAAP and SEC reporting requirements.
We have already taken some steps and have continued to implement
measures to remediate the material weakness identified, including but not limited to (i) streamline our accounting department
structure and enhance our staff’s U.S. GAAP expertise on a continuous basis; (2) hire a new reporting manager who has sufficient
expertise in U.S. GAAP to improve the quality of U.S. GAAP reports; (3) make an overall assessment on the current finance and
accounting resources and have plans to hire new finance team members with U.S. GAAP qualification in order to strengthen our U.S.
GAAP reporting framework; (4) participate in trainings and seminars provided by professional services firms on a regular basis
to gain knowledge on regular accounting/SEC reporting updates; and (5) provide internal training to our current accounting team
on US GAAP knowledge. We are also in the process of completing a systematic accounting manual for US GAAP and financial closing
process. However, we cannot assure you that we will not identify additional material weaknesses or significant deficiencies in
the future. In addition, if we are unable to meet the requirements of Section 404 of the Sarbanes-Oxley Act, our ADSs may not
be able to remain listed on the NASDAQ Global Market.
Section 404 of the Sarbanes-Oxley Act of 2002
requires that we include a report of management on our internal control over financial reporting in our annual report on Form 20-F
beginning with our annual report for the fiscal year ending December 31, 2020. In addition, once we cease to be an “emerging
growth company” as such term is defined under the JOBS Act, our independent registered public accounting firm must attest
to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal
control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial
reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue
a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented,
designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, as we are a public
company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems
for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.
During the course of documenting and testing
our internal control procedures, in order to satisfy the requirements of Section 404 of the Sarbanes- Oxley Act of 2002, we may
identify other weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain
the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time
to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting. If
we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial
statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial
information. This could in turn limit our access to capital markets, harm our results of operations and lead to a decline in the
trading price of our shares. Additionally, ineffective internal control over financial reporting could expose us to increased risk
of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory
investigations and civil or criminal sanctions. We may also be required to restate our financial statements from prior periods.
Future
strategic alliances or acquisitions may have a material and adverse effect on our business, financial condition and results of
operations.
We
may enter into strategic alliances, including joint ventures or minority equity investments, with various third parties to further
our business purpose from time to time. These alliances could subject us to a number of risks, including risks associated with
sharing proprietary information, non-performance by the third party and increased expenses in establishing new strategic alliances,
any of which may materially and adversely affect our business. We may have limited ability to monitor or control the actions of
these third parties and, to the extent any of these strategic third parties suffers negative publicity or harm to their reputation
from events relating to their business, we may also suffer negative publicity or harm to our reputation by virtue of our association
with any such third party.
In
addition, when appropriate opportunities arise, we may acquire additional assets, products, technologies or businesses that are
complementary to our existing business. In addition to possible shareholders’ approval, we may also have to obtain approvals
and licenses from relevant government authorities for the acquisitions and to comply with any applicable PRC laws and regulations,
which could result in increased delay and costs, and may derail our business strategy if we fail to do so. Furthermore, past and
future acquisitions and the subsequent integration of new assets and businesses 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. 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 costs of identifying and consummating acquisitions may be significant. Furthermore, our equity investees may generate
significant losses, a portion of which will be shared by us in accordance with U.S. GAAP. Any such negative developments could
have a material adverse effect on our business, reputation, results of operations and financial condition.
We
have limited business insurance coverage.
Insurance
companies in China offer limited business insurance products. We do not have any business liability or disruption insurance coverage
for our operations in China. Any business disruption may result in our incurring substantial costs and the diversion of our resources,
which could have an adverse effect on our results of operations and financial condition.
Risks
Related to Our Corporate Structure
We
are subject to changing law and regulations regarding regulatory matters, corporate governance and public disclosure that have
increased both our costs and the risk of non-compliance.
We
are subject to rules and regulations by various governing bodies, including, for example, the SEC, which are charged with the
protection of investors and the oversight of companies whose securities are publicly traded, and to new and evolving regulatory
measures under applicable law. Our efforts to comply with new and changing laws and regulations have resulted in, and are likely
to continue to result in, increased general and administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities.
Moreover,
because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve
over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters
and additional costs necessitated by ongoing revisions to our disclosure and governance practices. If we fail to address and comply
with these regulations and any subsequent changes, we may be subject to penalty and our business may be harmed.
If
the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply
with PRC regulations relating to the relevant industries, or if these regulations or their interpretation change in the future,
we could be subject to severe penalties or be forced to relinquish our interests in those operations.
Foreign
ownership of the telecommunication business and certain other businesses in China is extensively regulated and subject to numerous
restrictions. Pursuant to the Special Administrative Measures for Access of Foreign Investment (Negative List) (2018 Edition),
or the Negative List, and Administrative Provisions on Foreign-Invested Telecommunications Enterprises (Revised in 2016) , foreign
investors are generally not allowed to own more than 50% of the equity interests in a commercial internet content provider or
other value-added telecommunication service provider other than operating e-commerce, and the major foreign investor in a value-added
telecommunication service provider in China must have experience in providing value-added telecommunications services overseas
and maintain a good track record in accordance with the Negative List, Administrative Provisions on Foreign-Invested Telecommunications
Enterprises (Revised in 2016) and other applicable laws and regulations. In addition, foreign investors are prohibited from investing
in companies engaged in online operating business, internet audio-visual programs business, internet culture business and radio
and television program production business.
We
are a Cayman Islands company and our PRC subsidiary is currently considered foreign-invested enterprise. Our PRC subsidiary is
not eligible to operate internet content service, online culture activities or other businesses which foreign-owned companies
are prohibited or restricted from conducting in China. To ensure strict compliance with the PRC laws and regulations, we conduct
such business activities through our VIE and its subsidiaries in the PRC. Through a series of contractual arrangements entered
into by our wholly owned subsidiary in China, our VIE and its shareholders, we exercise effective control over the VIE, receive
substantially all of the economic benefits of our VIE, and have an exclusive option to purchase all or part of the equity interests
and assets in our VIE when and to the extent permitted by PRC laws and regulations. As a result of these contractual arrangements,
we have control over and are the primary beneficiary of our VIE and hence consolidate its financial results in our consolidated
financial statements under U.S. GAAP. See “Item 4. Information on the Company- 4.C. Organization Structure” for details.
If
the PRC government finds that our contractual arrangements do not comply with its restrictions on foreign investment in the telecommunication
business and certain other businesses, or if the PRC government otherwise finds that we, our VIE, or any of its subsidiaries is
in violation of PRC laws or regulations or lacks the necessary permits or licenses to operate our business, the relevant PRC regulatory
authorities, including the MIIT and the Ministry of Commerce of the People’s Republic of China (“MOFCOM”), would
have broad discretion in dealing with such violations or failures, including:
|
●
|
revoking
the business licenses and/or operating licenses of such entities;
|
|
●
|
discontinuing
or placing restrictions or onerous conditions on our operation through any transactions between our PRC subsidiary and our VIE;
|
|
●
|
imposing
fines, confiscating the income from our PRC subsidiary or our VIE, or imposing other requirements with which we or our VIE may
not be able to comply;
|
|
●
|
requiring
us to restructure our ownership structure or operations, including terminating the contractual arrangements with our VIE and deregistering
the equity pledges of our VIE, which in turn would affect our ability to consolidate, derive economic interests from, or exert
effective control over our VIE; or
|
|
●
|
restricting
or prohibiting our use of the proceeds we receive from our offshore financing activities to finance our business and operations
in China.
|
Any
of these events could cause significant disruption to our business operations and severely damage our reputation, which would
in turn materially and adversely affect our business, financial condition and results of operations. If occurrence of any of these
events results in our inability to direct the activities of our VIE that most significantly impacts its economic performance and/or
our failure to receive the economic benefits from our VIE, we may not be able to consolidate the entities in our consolidated
financial statements in accordance with U.S. GAAP.
Substantial
uncertainties exist with respect to the enactment timetable, interpretation and implementation of PRC Foreign Investment Law and
how it may impact the viability of our current corporate structure, corporate governance and business operations.
In
March 2019, the Standing Committee of the National People’s Congress of the PRC passed the Foreign Investment Law of the
People’s Republic of China (“Foreign Investment Law”). Among other things, the Foreign Investment Law defines
the “foreign investment” as the investment activities in China conducted by foreign individuals, enterprises and other
organizations (collectively, the “Foreign Investors”) in a direct or indirectly manner, including any of the following
circumstances: (1) the foreign investor establishes a foreign-invested enterprise within the territory of China, independently
or jointly with any other investor; (2) the foreign investor acquires shares, equities, property shares or any other similar rights
and interests of an enterprise within the territory of China; (3) the foreign investor makes investment to initiate a new project
within the territory of China, independently or jointly with any other investor; and (4) the foreign investor makes investment
in any other way stipulated by laws, administrative regulations or provisions of the State Council. The Foreign Investment Law
leaves uncertainty with respect to whether Foreign Investors control PRC onshore variable interest entities via contractual arrangements
will be recognized as “foreign investment”. PRC governmental authorities will administrate foreign investment by applying
the principal of pre-entry national treatment together with a “negative list” (the “Negative List”, which
shall be promulgated by or promulgated with approval by the State Counsel), to be specific, Foreign Investors are prohibited from
making any investments in the fields which are catalogued into prohibited industries for foreign investment based on the Negative
List, while Foreign Investors are allowed to make investments in the restricted industries provided that all the requirements
and conditions as set forth in the Negative List have been satisfied; when Foreign Investors make investments in the fields other
than those included in the Negative List, the national treatment principle shall apply. Besides, certain approval and/or filing
requirements shall be fulfilled in accordance with applicable foreign investment laws and regulations.
The
internet content service and online culture activities that we conduct through our VIE are subject to Special Management Measures
for the Market Entry of Foreign Investment (Negative List) (2018 Version) (the “2018 Negative List”) issued by MOFCOM
and the National Development and Reform Commission. It is unclear whether any new “negative list” to be issued under
the Foreign Investment Law will be different from the 2018 Negative List. If our control over our VIE through contractual arrangements
are deemed as foreign investment in the future, and any business of our VIE is restricted or prohibited from foreign investment
under the “negative list” effective at the time, we may be deemed to be in violation of the Foreign Investment Law,
the contractual arrangements that allow us to have control over our VIE may be deemed as invalid and illegal, and we may be required
to unwind such contractual arrangements and/or restructure our business operations, any of which may have a material adverse effect
on our business operation.
We
rely on contractual arrangements with our VIE and its shareholders for our operations in China, which may not be as effective
in providing operational control as direct ownership.
We
have relied and expect to continue to rely on contractual arrangements with Beijing WiMi, or our VIE, and its shareholders, and
certain of its subsidiaries to operate our business in China. These contractual arrangements may not be as effective as direct
ownership in providing us with control over our VIE. For example, our VIE and its shareholders could breach their contractual
arrangements with us by, among other things, failing to conduct their operations in an acceptable manner or taking other actions
that are detrimental to our interests. The revenues contributed by our VIE and its subsidiaries constituted substantially all
of our revenues in 2017, 2018 and 2019.
If
we had direct ownership of our VIE, we would be able to exercise our rights as a shareholder to effect changes in the board of
directors of our VIE, which in turn could implement changes, subject to any applicable fiduciary obligations, at the management
and operational level. However, under the current contractual arrangements, we rely on the performance by our VIE and its shareholders
of their respective obligations under the contracts to exercise control over our VIE. The shareholders of our VIE may not act
in the best interests of our company or may not perform their obligations under these contracts. Such risks exist throughout the
period in which we intend to operate certain portion of our business through the contractual arrangements with our VIE. If any
dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through arbitration,
litigation or other legal proceedings and therefore will be subject to uncertainties in the PRC legal system. Therefore, our contractual
arrangements with our VIE may not be as effective in controlling our business operations as direct ownership.
Any
failure by our VIE or its shareholders to perform their obligations under our contractual arrangements with them would have a
material and adverse effect on our business.
If
our VIE or its shareholders fail to perform their respective obligations under the contractual arrangements, we may have to incur
substantial costs and expend additional resources to enforce such arrangements. We may also have to rely on legal remedies under
PRC law, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure will be effective
under PRC law. For example, if the shareholders of our VIE refuse to transfer its equity interest in our VIE to our PRC subsidiary
or its designee after we exercise the purchase option pursuant to these contractual arrangements, or if they otherwise act in
bad faith or otherwise fail to fulfill their contractual obligations, we may have to take legal actions to compel them to perform
their contractual obligations. In addition, if any third parties claim any interest in such shareholders’ equity interests
in our VIE, our ability to exercise shareholders’ rights or foreclose the share pledge according to the contractual arrangements
may be impaired. If these or other disputes between the shareholders of our VIE and third parties were to impair our control over
our VIE, our ability to consolidate the financial results of our VIE would be affected, which would in turn result in a material
adverse effect on our business, operations and financial condition.
Our
shareholders or the shareholders of our VIE may have potential conflicts of interest with us, which may materially and adversely
affect our business.
The
shareholders of our VIE may have actual or potential conflicts of interest with us. These shareholders may breach, or cause our
VIE to breach, or refuse to renew, the existing contractual arrangements we have with them and our VIE, which would have a material
and adverse effect on our ability to effectively control our VIE and receive economic benefits from them. For example, the shareholders
may be able to cause our agreements with our VIE to be performed in a manner adverse to us by, among other things, failing to
remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest
arise any or all of these shareholders will act in the best interests of our company or such conflicts will be resolved in our
favor. Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our
company. If we cannot resolve any conflict of interest or dispute between us and these shareholders, we would have to rely on
legal proceedings, which could result in disruption of our business and subject us to substantial uncertainty as to the outcome
of any such legal proceedings.
All
the agreements under our contractual arrangements with our VIE and its equity owners are governed by PRC law and provide for the
resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC
law, and any disputes would be resolved in accordance with PRC legal procedures.
All
the agreements under our contractual arrangements with our VIE and its equity owners are governed by PRC law and provide for the
resolution of disputes through arbitration in China. 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 system in the PRC is not as developed
as in some 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. Meanwhile, there are very few precedents and little formal guidance as to how
contractual arrangements in the context of a VIE should be interpreted or enforced under PRC law. There remain significant uncertainties
regarding the ultimate outcome of such arbitration should legal action become necessary. In addition, under PRC law, rulings by
arbitrators are final, parties cannot appeal the arbitration results in courts, and if the losing parties fail to carry out the
arbitration awards within a prescribed time limit, the prevailing parties may only enforce the arbitration awards in PRC courts
through arbitration award recognition proceedings, which would require additional expenses and delay. In the event we are unable
to enforce these contractual arrangements, or if we suffer significant delay or other obstacles in the process of enforcing these
contractual arrangements, we may not be able to exert effective control over our VIE, and our ability to conduct our business
may be negatively affected.
We
may lose the ability to use and enjoy assets held by our VIE and its subsidiaries that are important to our business if our VIE
and its subsidiaries declare bankruptcy or become subject to a dissolution or liquidation proceeding.
As
part of our contractual arrangements with our VIE, the entity holds certain assets that are material to the operation of certain
portion of our business. If our VIE goes bankrupt and all or part of its assets become subject to liens or rights of third-party
creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our
business, financial condition and results of operations. Under the contractual arrangements, our VIE may not, in any manner, sell,
transfer, mortgage or dispose of its assets or legal or beneficial interests in the business without our prior consent. If our
VIE undergoes a voluntary or involuntary liquidation proceeding, the independent third-party creditors may claim rights to some
or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our
business, financial condition and results of operations.
Contractual
arrangements we have entered into with our VIE may be subject to scrutiny by the PRC tax authorities. A finding that we owe additional
taxes could negatively affect our financial condition and the value of your investment.
Under
applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge
by the PRC tax authorities within ten years after the taxable year when the transactions are conducted. We could face material
and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between us and our VIE were
not entered into on an arm’s-length basis in such a way as to result in an impermissible reduction in taxes under applicable
PRC laws, rules and regulations, and adjust the income of our VIE in the form of a transfer pricing adjustment. A transfer pricing
adjustment could, among other things, result in a reduction of expense deductions recorded by our VIE for PRC tax purposes, which
could in turn increase its tax liabilities without reducing our PRC subsidiary’s tax expenses. In addition, the PRC tax
authorities may impose late payment fees and other penalties on our VIE for the adjusted but unpaid taxes according to the applicable
regulations. Our financial position could be materially and adversely affected if our VIE’s tax liabilities increase or
if it is required to pay late payment fees and other penalties.
If
the chops of our PRC subsidiary, our VIE and its subsidiaries, are not kept safely, are stolen or are used by unauthorized persons
or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised.
In
China, a company chop or seal serves as the legal representation of the company towards third parties even when unaccompanied
by a signature. Each legally registered company in China is required to maintain a company chop, which must be registered with
the local Public Security Bureau. In addition to this mandatory company chop, companies may have several other chops which can
be used for specific purposes. The chops of our PRC subsidiary and VIE are generally held securely by personnel designated or
approved by us in accordance with our internal control procedures. To the extent those chops are not kept safely, are stolen or
are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and
adversely compromised and those corporate entities may be bound to abide by the terms of any documents so chopped, even if they
were chopped by an individual who lacked the requisite power and authority to do so. In addition, if the chops are misused by
unauthorized persons, we could experience disruption to our normal business operations. We may have to take corporate or legal
action, which could involve significant time and resources to resolve while distracting management from our operations.
Risks
Related to Doing Business in China
Adverse
changes in China’s economic, political or social conditions or government policies could have a material adverse effect
on our business, financial condition and results of operations.
The
majority of our revenues are sourced from China. Accordingly, our results of operations, financial condition and prospects are
influenced by economic, political and legal developments in China. Economic reforms begun in the late 1970s have resulted in significant
economic growth. However, any economic reform policies or measures in China may from time to time be modified or revised. China’s
economy differs from the economies of most developed countries in many respects, including with respect to the amount 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 industry 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 PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and among
different economic sectors. The Chinese government has implemented measures to encourage economic growth and guide the allocation
of the 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.
Although
the PRC economy has grown significantly in the past decade, that growth may not continue, as evidenced by the slowing of the growth
of the PRC economy since 2012. Any adverse changes in economic conditions in China, in the policies of the PRC government or in
the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments
could adversely affect our business and operating results, lead to reduction in demand for our services and adversely affect our
competitive position.
A
severe or prolonged downturn in the PRC or global economy could materially and adversely affect our business and our financial
condition.
The
global macroeconomic environment is facing challenges. There is considerable uncertainty over the long-term effects of the expansionary
monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies,
including the United States and China. There have been concerns over unrest and terrorist threats in the Middle East, Europe and
Africa and over the conflicts involving Ukraine, Syria and North Korea. There have also been concerns on the relationship among
China and other Asian countries, which may result in or intensify potential conflicts in relation to territorial disputes, and
the trade disputes between the United States and China. It is unclear whether these challenges and uncertainties will be contained
or resolved, and what effects they may have on the global political and economic conditions in the long term. The uncertainty
caused by the exit of the United Kingdom from the European Union could negatively impact all of the economies and market conditions
of European Union and/or worldwide and could continue to contribute to instability in the global financial market.
Economic
conditions in China are sensitive to global economic conditions, changes in domestic economic and political policies and the expected
or perceived overall economic growth rate in China. While the economy in China has grown significantly over the past decades,
growth has been uneven, both geographically and among various sectors of the economy, and the rate of growth has been slowing
in recent years. Although growth of China’s economy remained relatively stable, there is a possibility that China’s
economic growth may materially decline in the near future. Any severe or prolonged slowdown in the global or PRC economy may materially
and adversely affect our business, results of operations and financial condition.
Uncertainties
in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.
The
PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions under the
civil law system may be cited for reference but have limited precedential value. Since these laws and regulations are relatively
new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always
uniform and enforcement of these laws, regulations and rules involves uncertainties. From time to time, we may have to resort
to administrative and court proceedings to enforce our legal rights. However, since PRC administrative and court authorities have
significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate
the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems.
Furthermore, the PRC legal system is based in part on government policies and internal rules (some of which are not published
in a timely manner or at all) that may have retroactive effect. As a result, we may not be aware of our violation of these policies
and rules until sometime after the violation. Such uncertainties, including uncertainty over the scope and effect of our contractual,
property (including intellectual property) and procedural rights, could materially and adversely affect our business and impede
our ability to continue our operations.
Under
the PRC enterprise income tax law, we may be classified as a “PRC resident enterprise”, which could result in unfavorable
tax consequences to us and our shareholders and have a material adverse effect on our results of operations and the value of your
investment.
Under
the PRC enterprise income tax law that became effective on January 1, 2008, an enterprise established outside the PRC with “de
facto management bodies” within the PRC is considered a “resident enterprise” for PRC enterprise income tax
purposes and is generally subject to a uniform 25% enterprise income tax rate on its worldwide income. On April 22, 2009, the
State Administration of Taxation, or the SAT, issued the Notice Regarding the Determination of Chinese-Controlled Overseas Incorporated
Enterprises as PRC Tax Resident Enterprise on the Basis of De Facto Management Bodies, or SAT Circular 82, which provides certain
specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated
offshore is located in China. Further to SAT Circular 82, on August 3, 2011, the SAT issued the Administrative Measures of Enterprise
Income Tax of Chinese-Controlled Offshore Incorporated Resident Enterprises (Trial), or SAT Bulletin 45, which became effective
on September 1, 2011, to provide more guidance on the implementation of SAT Circular 82.
According
to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be considered
a PRC tax resident enterprise by virtue of having its “de facto management body” in China and will be subject to PRC
enterprise income tax on its worldwide income only if all of the following conditions are met: (a) the senior management and core
management departments in charge of its daily operations function have their presence mainly in the PRC; (b) its financial and
human resources decisions are subject to determination or approval by persons or bodies in the PRC; (c) 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
(d) not less than half of the enterprise’s directors or senior management with voting rights habitually reside in the PRC.
SAT Bulletin 45 further clarifies the resident status determination, post-determination administration as well as competent tax
authorities.
Although
SAT Circular 82 and SAT Bulletin 45 only apply to offshore incorporated enterprises controlled by PRC enterprises or PRC enterprise
group instead of those controlled by PRC individuals or foreigners, the determination criteria set forth therein may reflect SAT’s
general position on how the term “de facto management body” could be applied in determining the tax resident status
of offshore enterprises, regardless of whether they are controlled by PRC enterprises, individuals or foreigners.
We
believe none of our entities outside of China is a PRC resident enterprise for PRC tax purposes even if the standards for “de
facto management body” prescribed in the SAT Circular 82 are applicable to us. However, the tax resident status of an enterprise
is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term
“de facto management body.” If the PRC tax authorities determine that our company or any of our subsidiaries outside
of China is a PRC resident enterprise for enterprise income tax purposes, we may be subject to PRC enterprise income on our worldwide
income at the rate of 25%, which could materially reduce our net income. In addition, we will also be subject to PRC enterprise
income tax reporting obligations.
Although
dividends paid by one PRC tax resident to another PRC tax resident should qualify as “tax-exempt income” under the
enterprise income tax law, we cannot assure you that dividends by our PRC subsidiary to our Cayman Islands holding company will
not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax on
dividends, and the PRC tax authorities have not yet issued guidance with respect to the processing of outbound remittances to
entities that are treated as resident enterprises for PRC enterprise income tax purposes.
Non-PRC
resident ADS holders may also be subject to PRC withholding tax on dividends paid by us and PRC tax on gains realized on the sale
or other disposition of ADSs or Class B ordinary shares, if such income is sourced from within the PRC. The tax would be imposed
at the rate of 10% in the case of non-PRC resident enterprise holders and 20% in the case of non-PRC resident individual holders.
In the case of dividends, we would be required to withhold the tax at source. Any PRC tax liability may be reduced under applicable
tax treaties or similar arrangements. Although our holding company is incorporated in the Cayman Islands, it remains unclear whether
dividends received and gains realized by our non-PRC resident ADS holders will be regarded as income from sources within the PRC
if we are classified as a PRC resident enterprise. Any such tax will reduce the returns on your investment in our ADSs.
We
cannot assure you that the PRC tax authorities will not, at their discretion, adjust any capital gains and impose tax return filing
and withholding or tax payment obligations with respect to any internal restructuring, and our PRC subsidiary may be requested
to assist in the filing. Any PRC tax imposed on a transfer of our shares not through a public stock exchange, or any adjustment
of such gains would cause us to incur additional costs and may have a negative impact on the value of your investment in our company.
We
may not be able to obtain certain benefits under relevant tax treaty on dividends paid by our PRC subsidiary to us through our
Hong Kong subsidiary.
We
are an exempted limited liability company, used as holding company, incorporated under the laws of the Cayman Islands and as such
rely on dividends and other distributions on equity from our PRC subsidiary, as paid to us through our Hong Kong subsidiary, to
satisfy part of our liquidity requirements. Pursuant to the PRC Enterprise Income Tax Law, a withholding tax rate of 10% currently
applies to dividends paid by a PRC “resident enterprise” to a foreign enterprise investor, unless any such foreign
investor’s jurisdiction of incorporation has a tax treaty with China that provides for preferential tax treatment. Pursuant
to the Arrangement between the Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation
and Tax Evasion on Income, or the Double Tax Avoidance Arrangement, and Circular 81 issued by the State Administration of Taxation,
such withholding tax rate may be lowered to 5% if the PRC enterprise is at least 25% held by a Hong Kong enterprise throughout
the 12 months prior to distribution of the dividends and is determined by the relevant PRC tax authority to have satisfied other
requirements. Furthermore, under the Administrative Measures for Non-Resident Enterprises to Enjoy Treatments under Tax Treaties,
which became effective in August 2015, the non-resident enterprises shall determine whether they are qualified for preferential
tax treatment under the tax treaties and file relevant reports and materials with the tax authorities. There are also other conditions
for benefiting from the reduced withholding tax rate according to other relevant tax rules and regulations. We cannot assure you
that our determination regarding our Hong Kong subsidiary’ qualification to benefit from the preferential tax treatment
will not be challenged by the relevant PRC tax authority or that we will be able to complete the necessary filings with the relevant
PRC tax authority and benefit from the preferential withholding tax rate of 5% under the Double Taxation Avoidance Arrangement
with respect to dividends to be paid by our PRC subsidiary to our Hong Kong subsidiary.
We
face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.
We
face uncertainties regarding the reporting on and consequences of previous private equity financing transactions involving the
transfer and exchange of shares in our company by non-resident investors.
In
February 2015, the SAT issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident
Enterprises, or SAT Bulletin 7, as amended in 2017. Pursuant to this bulletin, an “indirect transfer” of assets, including
equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct
transfer of PRC taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the
purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject
to PRC enterprise income tax. According to SAT Bulletin 7, “PRC taxable assets” include assets attributed to an establishment
in China, immovable properties located in China, and equity investments in PRC resident enterprises, in respect of which gains
from their transfer by a direct holder, being a non-PRC resident enterprise, would be subject to PRC enterprise income taxes.
When determining whether there is a “reasonable commercial purpose” of the transaction arrangement, features to be
taken into consideration include: whether the main value of the equity interest of the relevant offshore enterprise derives from
PRC taxable assets; whether the assets of the relevant offshore enterprise mainly consist of direct or indirect investment in
China or if its income mainly derives from China; whether the offshore enterprise and its subsidiaries directly or indirectly
holding PRC taxable assets have real commercial nature which is evidenced by their actual function and risk exposure; the duration
of existence of the business model and organizational structure; the replicability of the transaction by direct transfer of PRC
taxable assets; and the tax situation of such indirect transfer and applicable tax treaties or similar arrangements. In respect
of an indirect offshore transfer of assets of a PRC establishment, the resulting gain is to be included with the enterprise income
tax filing of the PRC establishment or place of business being transferred, and would consequently be subject to PRC enterprise
income tax at a rate of 25%. Where the underlying transfer relates to the immovable properties located in China or to equity investments
in a PRC resident enterprise, which is not related to a PRC establishment or place of business of a non-resident enterprise, a
PRC enterprise income tax of 10% would apply, subject to available preferential tax treatment under applicable tax treaties or
similar arrangements, and the party who is obligated to make the transfer payments has the withholding obligation. SAT Bulletin
7 does not apply to transactions of sale of shares by investors through a public stock exchange where such shares were acquired
from a transaction through a public stock exchange.
There
is uncertainty as to the application of SAT Bulletin 7. We face uncertainties as to the reporting and other implications of certain
past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our
offshore subsidiaries or investments. Our company may be subject to filing obligations or taxed if our company is transferor in
such transactions, and may be subject to withholding obligations if our company is transferee in such transactions under SAT Bulletin
7. For transfer of shares in our company by investors that are non-PRC resident enterprises, our PRC subsidiary may be requested
to assist in the filing under SAT Bulletin 7. As a result, we may be required to expend valuable resources to comply with SAT
Bulletin 7 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish
that our company should not be taxed under these circulars, which may have a material adverse effect on our financial condition
and results of operations.
Certain
judgments obtained against us by our shareholders may not be enforceable.
We
are a Cayman Islands exempted company and substantially all of our current operations are conducted in China. In addition, most
of our current directors and officers are nationals and residents of countries other than the United States. As a result, it may
be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event
that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful
in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against
our assets or the assets of our directors and officers.
Implementation
of labor laws and regulations in China may adversely affect our business and results of operations.
Pursuant
to the labor contract law that took effect in January 2008, its implementation rules that took effect in September 2008 and its
amendment that took effect in July 2013, employers are subject to stricter requirements in terms of signing labor contracts, minimum
wages, paying remuneration, determining the term of employees’ probation and unilaterally terminating labor contracts. Due
to lack of detailed interpretative rules and uniform implementation practices and broad discretion of the local competent authorities,
it is uncertain as to how the labor contract law and its implementation rules will affect our current employment policies and
practices. Our employment policies and practices may violate the labor contract law or its implementation rules, and we may thus
be subject to related penalties, fines or legal fees. Compliance with the labor contract law and its implementation rules may
increase our operating expenses, in particular our personnel expenses. In the event that we decide to terminate some of our employees
or otherwise change our employment or labor practices, the labor contract law and its implementation rules may also limit our
ability to effect those changes in a desirable or cost-effective manner, which could adversely affect our business and results
of operations. According to the Social Insurance Law and the Regulations on the Management of Housing Fund, employees must participate
in pension insurance, work-related injury insurance, medical insurance, unemployment insurance and maternity insurance and housing
funds, and the employers must, together with their employees or separately, pay the social insurance premiums and housing funds
for such employees.
As
the interpretation and implementation of these laws and regulations are still evolving, we cannot assure you that our employment
practice will at all times be deemed in full compliance with labor-related laws and regulations in China, which may subject us
to labor disputes or government investigations. If we are deemed to have violated relevant labor laws and regulations, we could
be required to provide additional compensation to our employees and our business, financial condition and results of operations
could be materially and adversely affected.
Further,
labor disputes, work stoppages or slowdowns at our company or any of our third-party service providers could significantly disrupt
our daily operation or our expansion plans and have a material adverse effect on our business.
China’s
M&A Rules and certain other PRC regulations establish complex procedures for certain acquisitions of Chinese companies by
foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.
The
Regulations on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory
agencies in 2006 and amended in 2009, and some other regulations and rules concerning mergers and acquisitions established additional
procedures and requirements that could make merger and acquisition activities by foreign investors more time consuming and complex,
including requirements in some instances that the anti-monopoly law enforcement agency be notified in advance of any change-of-control
transaction in which a foreign investor takes control of a PRC domestic enterprise. Moreover, the Anti-Monopoly Law requires that
the anti-monopoly law enforcement agency shall be notified in advance of any concentration of undertaking if certain thresholds
are triggered. In addition, the security review rules issued by the MOFCOM, that became effective in September 2011 specify that
mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and
acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national
security” concerns are subject to strict review by the MOFCOM, and the rules prohibit any activities attempting to bypass
a security review, including by structuring the transaction through a proxy or contractual control arrangement. In the future,
we may grow our business by acquiring complementary businesses. Complying with the requirements of the above-mentioned regulations
and other relevant rules to complete such transactions could be time consuming, and any required approval processes, including
obtaining approval from the MOFCOM or its local counterpart or anti-monopoly law enforcement agency may delay or inhibit our ability
to complete such transactions, which could affect our ability to expand our business or maintain our market share.
PRC
regulations relating to offshore investment activities by PRC residents may limit our PRC subsidiary’s ability to increase
their registered capital or distribute profits to us or otherwise expose us to liability and penalties under PRC law.
The
State Administration of Foreign Exchange (“SAFE”) promulgated the Circular on Relevant Issues Relating to PRC Resident’s
Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, in July 2014 that requires
PRC residents or entities to register with SAFE or its local branch in connection with their establishment or control of an offshore
entity established for the purpose of overseas investment or financing. In addition, such PRC residents or entities must update
their SAFE registrations when the offshore special purpose vehicle undergoes material events relating to any change of basic information
(including change of such PRC residents or entities, name and operation term), increases or decreases in investment amount, transfers
or exchanges of shares, or mergers or divisions.
SAFE
Circular 37 is issued to replace the Circular on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents
Engaging in Financing and Roundtrip Investments through Overseas Special Purpose Vehicles.
If
our shareholders who are PRC residents or entities do not complete their registration with the local SAFE branches, our PRC subsidiary
may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to
us, and we may be restricted in our ability to contribute additional capital to our PRC subsidiary. Moreover, failure to comply
with SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.
However,
we may not be informed of the identities of all the PRC residents or entities holding direct or indirect interest in our company,
nor can we compel our shareholders to comply with the requirements of SAFE Circular 37. As a result, we cannot assure you that
all of our shareholders who are PRC residents or entities have complied with, and will in the future make or obtain any applicable
registrations or approvals required by, SAFE Circular 37. Failure by such shareholders 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 PRC subsidiary’s ability to make distributions or pay dividends
to us or affect our ownership structure, which could adversely affect our business and prospects.
PRC
regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency
conversion may delay or prevent us from using the proceeds we receive from our offshore financing activities to make loans to
or make additional capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and
our ability to fund and expand our business.
Any
transfer of funds by us to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, are subject
to approval by or registration or filing with relevant governmental authorities in China. According to the relevant PRC regulations
on foreign-invested enterprises in China, capital contributions to our PRC subsidiary are subject to the approval of or filing
with the Ministry of Commerce in its local branches and registration with a local bank authorized by SAFE. In addition, (i) any
foreign loan procured by our PRC subsidiary is required to be registered with SAFE or its local branches or filed with SAFE in
its information system; and (ii) our PRC subsidiary may not procure loans which exceed the difference between its total investment
amount and registered capital or, as an alternative, only procure loans subject to the calculation approach and limitation as
provided in the People’s Bank of China Notice No. 9 (“PBOC Notice No. 9”). Any medium- or long-term loan to
be provided by us to our VIE must be registered with the National Development and Reform Commission and SAFE or its local branches.
We may not be able to obtain these government approvals or complete such registrations on a timely basis, if at all, with respect
to future capital contributions or foreign loans by us to our PRC subsidiary. If we fail to receive such approvals or complete
such registration or filing, our ability to use the proceeds we receive from our offshore financing activities and to capitalize
our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our
business. There is, in effect, no statutory limit on the amount of capital contribution that we can make to our PRC subsidiary.
This is because there is no statutory limit on the amount of registered capital for our PRC subsidiary, and we are allowed to
make capital contributions to our PRC subsidiary by subscribing for their initial registered capital and increased registered
capital, provided that the PRC subsidiary completes the relevant filing and registration procedures. With respect to loans to
the PRC subsidiary by us, (i) if the PRC subsidiary adopt the traditional foreign exchange administration mechanism, or the Current
Foreign Debt Mechanism, the outstanding amount of the loans shall not exceed the difference between the total investment and the
registered capital of the PRC subsidiary; and (ii) if the PRC subsidiary adopt the foreign exchange administration mechanism as
provided in Notice of the People’s Bank of China on Matters concerning the Macro-Prudential Management of Full-Covered Cross-Border
Financing, or the PBOC Notice No. 9, the risk-weighted outstanding amount of the loans, which shall be calculated based on the
formula provided in PBOC Notice No. 9, shall not exceed 200% of the net asset of the PRC subsidiary. According to the PBOC Notice
No. 9, after a transition period of one year since the promulgation of PBOC Notice No. 9, the PBOC and SAFE will determine the
cross-border financing administration mechanism for the foreign-invested enterprises after evaluating the overall implementation
of PBOC Notice No. 9. As of the date hereof, neither the PBOC nor SAFE has promulgated and made public any further rules, regulations,
notices or circulars in this regard. It is uncertain which mechanism will be adopted by the PBOC and SAFE in the future and what
statutory limits will be imposed on us when providing loans to our PRC subsidiaries. Currently, our PRC subsidiary has the flexibility
to choose between the Current Foreign Debt Mechanism and the Notice No. 9 Foreign Debt Mechanism. However, if a more stringent
foreign debt mechanism becomes mandatory, our ability to provide loans to our PRC subsidiary or our consolidated affiliated entities
may be significantly limited, which may adversely affect our business, financial condition and results of operations.
The
Circular on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-Invested Enterprises, or SAFE Circular
19, effective as of June 1, 2015, as amended by Circular of the State Administration of Foreign Exchange on Reforming and Regulating
Policies on the Control over Foreign Exchange Settlement under the Capital Account, or SAFE Circular 16, effective on June 9,
2016, allows FIEs to settle their foreign exchange capital at their discretion, but continues to prohibit FIEs from using the
Renminbi fund converted from their foreign exchange capitals for expenditure beyond their business scopes, and also prohibit FIEs
from using such Renminbi fund to provide loans to persons other than affiliates unless otherwise permitted under its business
scope. As a result, we are required to apply Renminbi funds converted from the net proceeds we received from our offshore financing
activities within the business scopes of our PRC subsidiaries. SAFE Circular 19 and SAFE Circular 16 may significantly limit our
ability to use Renminbi converted from the net proceeds we receive from our offshore financing activities to fund the establishment
of new entities in China by our VIE or its subsidiaries, to invest in or acquire any other PRC companies through our PRC subsidiary,
or to establish new consolidated VIEs in China, which may adversely affect our business, financial condition and results of operations.
Our
PRC subsidiary and VIE are subject to restrictions on paying dividends or making other payments to us, which may restrict our
ability to satisfy our liquidity requirements, conduct our business and to pay dividends to holders of our ADSs and our ordinary
shares.
We
are a holding company incorporated in the Cayman Islands. We rely on dividends from our PRC subsidiary which in turn relies on
consulting and other fees paid by our VIE for our cash and financing requirements, such as the funds necessary to pay dividends
and other cash distributions to our shareholders, including holders of our ADSs, and service any debt we may incur. Current PRC
regulations permit our PRC subsidiary to pay dividends to us only out of their accumulated after-tax profits upon satisfaction
of relevant statutory condition and procedures, if any, determined in accordance with Chinese accounting standards and regulations.
In addition, our PRC subsidiary is required to set aside at least 10% of its accumulated profits each year, if any, to fund certain
reserve funds until the total amount set aside reaches 50% of its registered capital. Furthermore, if our PRC subsidiary, our
VIE and its subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability
to pay dividends or make other payments to us, which may restrict our ability to satisfy our liquidity requirements.
In
addition, the Enterprise Income Tax Law of the PRC, or the PRC EIT Law, and its implementation rules provide that withholding
tax rate of 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises unless otherwise
exempted or reduced according to treaties or arrangements between the PRC central government and governments of other countries
or regions where the non-PRC-resident enterprises are incorporated.
Fluctuations
in exchange rates could have a material adverse effect on our results of operations and the value of your investment.
The
value of the Renminbi against the U.S. dollar and other currencies is affected by changes in China’s political and economic
conditions and China’s foreign exchange policies, among other things. In 2005, the PRC government changed its decades-old
policy of pegging the value of the Renminbi to the U.S. dollar, and the Renminbi appreciated more than 20% against the U.S. dollar
over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between Renminbi
and the U.S. dollar remained within a narrow band. Since June 2010, Renminbi has fluctuated against the U.S. dollar, at times
significantly and unpredictably. With the development of the foreign exchange market and progress towards interest rate liberalization
and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system and
we cannot assure you that Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future.
It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between Renminbi and
the U.S. dollar in the future.
Governmental
control of currency conversion may limit our ability to utilize our revenues effectively and 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 currency out of China. We receive substantially all of our revenues in Renminbi. Under our current corporate structure, our
Cayman Islands holding company may rely on dividend payments from our PRC subsidiary to fund any cash and financing requirements
we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions,
interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior
approval of SAFE by complying with certain procedural requirements. Specifically, under the existing exchange restrictions, without
prior approval of SAFE, cash generated from the operations of our PRC subsidiary in China may be used to pay dividends to our
company. However, approval from or registration with appropriate government authorities 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. As a result, we need to obtain SAFE approval to use cash generated from the operations of our PRC subsidiary and consolidated
affiliated entities to pay off their respective debt in a currency other than Renminbi owed to entities outside China, or to make
other capital expenditure payments outside China in a currency other than Renminbi.
In
light of the flood of capital outflows of China in 2016 due to the weakening Renminbi, the PRC government has imposed more restrictive
foreign exchange policies and stepped up scrutiny of major outbound capital movement including overseas direct investment. More
restrictions and substantial vetting process are put in place by SAFE to regulate cross-border transactions falling under the
capital account. If any of our shareholders regulated by such policies fails to satisfy the applicable overseas direct investment
filing or approval requirement timely or at all, it may be subject to penalties from the relevant PRC authorities. The PRC government
may at its discretion further restrict access in the future to foreign currencies for current account transactions. If the foreign
exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may
not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.
Failure
to comply with PRC regulations regarding the registration requirements for employee stock ownership plans or share option plans
may subject the PRC plan participants or us to fines and other legal or administrative sanctions.
Pursuant
to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit
applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies.
In the meantime, our directors, executive officers and other employees who are PRC citizens or who are non-PRC residents residing
in the PRC for a continuous period of not less than one year, subject to limited exceptions, and who have been granted incentive
share awards by us, may follow the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating
in Stock Incentive Plan of Overseas Publicly-Listed Company, or 2012 SAFE notices, promulgated by the SAFE in 2012. Pursuant to
the 2012 SAFE notices, PRC citizens and non-PRC citizens who reside in China for a continuous period of not less than one year
who participate in any stock incentive plan of an overseas publicly listed company, subject to a few exceptions, are required
to register with SAFE through a domestic qualified agent, which could be the PRC subsidiaries of such overseas listed company,
and complete certain other procedures. In addition, an overseas entrusted institution must be retained to handle matters in connection
with the exercise or sale of stock options and the purchase or sale of shares and interests. Our executive officers and other
employees who are PRC citizens or who reside in the PRC for a continuous period of not less than one year and who have been granted
options are subject to these regulations. Failure to complete the SAFE registrations may subject them to fines, and legal sanctions
and may also limit our ability to contribute additional capital into our PRC subsidiary and limit our PRC subsidiary’s ability
to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive
plans for our directors, executive officers and employees under PRC law.
The
SAT has issued certain circulars concerning employee share options and restricted shares. Under these circulars, our employees
working in China who exercise share options or are granted restricted shares will be subject to PRC individual income tax. Our
PRC subsidiary has obligations to file documents related to employee share options or restricted shares with relevant tax authorities
and to withhold individual income taxes of those employees who exercise their share options. If our employees fail to pay or we
fail to withhold their income taxes according to relevant laws and regulations, we may face sanctions imposed by the tax authorities
or other PRC governmental authorities.
Our
leased property interests may be defective and our right to lease the properties affected by such defects may be challenged, which
could adversely affect our business.
According
to the PRC Land Administration Law, land in urban districts is owned by the state. The owner of a property built on state-owned
land must possess the proper land and property title certificate to demonstrate that it is the owner of the premises and that
it has the right to enter into lease contracts with the tenants or to authorize a third party to sublease the premises. Some of
the landlords of our learning center locations have failed to provide the title certificates to us. Our right to lease the premises
may be interrupted or adversely affected if our landlords are not the property owners and the actual property owners should appear.
In
addition, the title certificate usually records the approved use of the state-owned land by the government and the property owner
is obligated to follow the approved use requirement when making use of the property. In the case of failure to utilize the property
in accordance with the approved use, the land administration authorities may order the tenant to cease utilizing the premises
or even invalidate the contract between the landlord and the tenant. If our use of the leased premises is not in full compliance
with the approved use of the land, we may be unable to continue to use the property, which may cause disruption to our business.
Risks
Related to the ADSs
The
market price for our ADSs may be volatile.
The
trading price of our ADSs is likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen
because of broad market and industry factors, including 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. In addition to market
and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations,
including the following:
|
●
|
variations
in our revenues, earnings, cash flow and data related to our user base or user engagement;
|
|
●
|
announcements
of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;
|
|
●
|
announcements
of new product and service offerings, solutions and expansions by us or our competitors;
|
|
●
|
changes
in financial estimates by securities analysts;
|
|
●
|
detrimental
adverse publicity about us, our products and services or our industry;
|
|
●
|
additions
or departures of key personnel;
|
|
●
|
release
of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and
|
|
●
|
potential
litigation or regulatory investigations.
|
Any
of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.
In
the past, shareholders of public companies have often brought securities class action suits against those companies following
periods of instability in the market price of their securities. If we were 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 and require us to
incur significant expenses to defend the suit, which could harm our results of operations. 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.
If
securities or industry analysts do not publish research or reports about our business, or if they adversely change their recommendations
regarding our ADSs, the market price for our ADSs and trading volume could decline.
The
trading market for our ADSs will be influenced by research or reports that industry or securities analysts publish about our business.
If one or more analysts who cover us downgrade our ADSs, the market price for our ADSs would likely decline. If one or more of
these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets,
which in turn could cause the market price or trading volume for our ADSs to decline.
The
sale or availability for sale of substantial amounts of our ADSs could adversely affect their market price.
Sales
of substantial amounts of our ADSs in the public market, or the perception that these sales could occur, could adversely affect
the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future.
As of the date of this report, we had 20,115,570 Class A ordinary shares and 97,995,563 Class B ordinary shares outstanding. The
ADSs representing our Class B ordinary shares sold in our initial public offering are freely tradable without restriction or further
registration under the Securities Act. The remaining ordinary shares will be available for sale, upon the expiration of the 180-day
lock-up period, subject to the restrictions in Rule 144 and Rule 701 under the Securities Act. Any or all of these ordinary shares
may be released prior to the expiration of the lock-up period at the discretion of the designated representatives. To the extent
that these ordinary shares are sold into the market, the market price of our ADSs could decline.
Certain
holders of our ordinary shares have the right to cause us to register under the Securities Act the sale of their shares. Registration
of these shares under the Securities Act would result in ADSs representing these shares becoming freely tradable without restriction
under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the form
of ADSs in the public market could cause the price of our ADSs to decline.
You
may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited,
because we are incorporated under Cayman Islands law.
We
are an exempted company limited by shares incorporated under the laws of the Cayman Islands. Our corporate affairs are governed
by our memorandum and articles of association, the Companies Law of the Cayman Islands, as amended from time to time, and the
common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders
and the fiduciary duties 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 the common law of England and Wales, the decisions of whose courts are of persuasive authority, but are
not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties 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. Some
U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands.
In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of
the United States.
Shareholders
of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records (other
than the memorandum and articles of association) or to obtain copies of lists of shareholders of these companies. Our directors
have discretion under our memorandum and 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 resolution or to solicit
proxies from other shareholders in connection with a proxy contest.
As
a result of all of the above, our 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
company incorporated in the United States.
Techniques
employed by short sellers may drive down the market price of our ADSs.
Short
selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the
intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a
decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares,
as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s interest
for the price of the security to decline, many short sellers publish, or arrange for the publication of, negative opinions and
allegations regarding the relevant issuer and its business prospects in order to create negative market momentum and generate
profits for themselves after selling a security short. These short attacks have, in the past, led to selling of shares in the
market. If we were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue,
we could have to expend a significant amount of resources to investigate such allegations and/or defend ourselves. While we would
strongly defend against any such short seller attacks, we may be constrained in the manner in which we can proceed against the
relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality.
Because
we do not expect to pay dividends in the foreseeable future, you must rely on a price appreciation of our ADSs for a return on
your investment.
We
currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth
of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not
rely on an investment in our ADSs as a source for any future dividend income.
Our
board of directors has complete discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands
law. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended
by our board of directors. Under Cayman Islands law, a Cayman Islands company may pay a dividend out of either profit or share
premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to
pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends,
the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations
and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries,
our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the
return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no
guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased our ADSs. You may not realize
a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.
You
may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them, if it is illegal
or impractical to make them available to you.
The
depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary
shares or other deposited securities underlying our ADSs, 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 is not responsible if it decides that
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 under an applicable exemption from registration. The depositary may also determine that
it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less
than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation
to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions.
We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else
to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if
it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value
of our ADSs.
ADSs
holders may not be entitled to a jury trial with respect to claims arising under the deposit agreement, which could result in
less favorable outcomes to the plaintiff(s) in any such action.
The
deposit agreement governing the ADSs representing our Class B ordinary shares provides that, to the fullest extent permitted by
law, ADS holders waive the right to a jury trial for any claim they may have against us or the depositary arising out of or relating
to our shares, our ADSs or the deposit agreement, including any claim under the U.S. federal securities laws.
If
we or the depositary were to oppose a jury trial based on this waiver, the court would have to determine whether the waiver was
enforceable based on the facts and circumstances of the case in accordance with applicable state and federal law. To our knowledge,
the enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the federal securities
laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury
trial waiver provision is generally enforceable, including under the laws of the State of New York, which govern the deposit agreement,
or by a federal or state court in the City of New York, which has non-exclusive jurisdiction over matters arising under the deposit
agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver, courts will generally consider whether
a party knowingly, intelligently and voluntarily waived the right to a jury trial. We believe that this would be the case with
respect to the deposit agreement and our ADSs. It is advisable that you consult legal counsel regarding the jury waiver provision
before investing in our ADSs.
If
you or any other holders or beneficial owners of ADSs bring a claim against us or the depositary in connection with matters arising
under the deposit agreement or our ADSs, including claims under federal securities laws, you or such other holder or beneficial
owner may not be entitled to a jury trial with respect to such claims, which may have the effect of limiting and discouraging
lawsuits against us or the depositary. If a lawsuit is brought against us or the depositary under the deposit agreement, it may
be heard only by a judge or justice of the applicable trial court, which would be conducted according to different civil procedures
and may result in different outcomes than a trial by jury would have, including outcomes that could be less favorable to the plaintiff(s)
in any such action.
Nevertheless,
if this jury trial waiver is not permitted by applicable law, an action could proceed under the terms of the deposit agreement
with a jury trial. No condition, stipulation or provision of the deposit agreement or the ADSs serves as a waiver by any holder
or beneficial owner of ADSs or by us or the depositary of compliance with any substantive provision of the U.S. federal securities
laws and the rules and regulations promulgated thereunder.
The
voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right
to direct the voting of your ordinary shares underlying our ADSs.
Holders
of ADSs do not have the same rights as our registered shareholders. As a holder of our ADSs, you will not have any direct right
to attend general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting
rights which attach to the underlying Class B ordinary shares represented by your ADSs indirectly by giving voting instructions
to the depositary in accordance with the provisions of the deposit agreement. Under the deposit agreement, you may vote only by
giving voting instructions to the depositary, as holder of the underlying Class B ordinary shares represented by your ADSs. Upon
receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the ordinary shares represented
by your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions,
the depositary will try to vote the underlying Class B ordinary shares represented by your ADSs in accordance with these instructions.
If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions
you give, but it is not required to do so. You will not be able to directly exercise any right to vote with respect to the underlying
Class B ordinary shares unless you withdraw such shares and become the registered holder of such shares prior to the record date
for the general meeting. When a general meeting is convened, you may not receive sufficient advance notice of the meeting to enable
you to withdraw the underlying Class B ordinary shares represented by your ADSs and become the registered holder of such shares
prior to the record date for the general meeting to allow you to attend the general meeting and to vote directly with respect
to any specific matter or resolution to be considered and voted upon at the general meeting. In addition, under our articles of
association, for the purposes of determining those shareholders who are entitled receive notice of, to attend or vote at any general
meeting, our directors may close our register of members for a stated period not exceeding thirty calendar days and/or fix in
advance a record date for determining those shareholder that are entitled to receive notice of, attend or vote at such meeting,
and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the underlying
Class B ordinary shares represented by your ADSs and becoming the registered holder of such shares prior to the record date, so
that you would not be able to attend the general meeting or to vote directly. Where any matter is to be put to a vote at a general
meeting, the depositary will use its best endeavors to notify you of the upcoming vote and to deliver our voting materials to
you. We cannot assure you that you will receive the voting material in time to ensure you can direct the depositary to vote your
shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their
manner of carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the
underlying Class B ordinary shares represented by your ADSs are voted and you may have no legal remedy if the underlying Class
B ordinary shares represented by your ADSs are not voted as you requested.
You
may experience dilution of your holdings due to the inability to participate in rights 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.
You
may be subject to limitations on the transfer of our ADSs.
Your
ADSs 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 share register or the books of the depositary are closed, or at any time if we or the depositary thinks
that it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision
of the deposit agreement, or for any other reason in accordance with the terms of the deposit agreement. As a result, you may
be unable to transfer your ADSs when you wish to.
Our
memorandum and articles of association contain anti-takeover provisions that could have a material adverse effect on the rights
of holders of our ordinary shares and ADSs.
Our
memorandum and articles of association contains certain provisions to limit the ability of others to acquire control of our company
or cause us to engage in change-of-control transactions, including a provision that grants authority to our board of directors
to establish and issue from time to time one or more series of preferred shares without action by our shareholders and to determine,
with respect to any series of preferred shares without action by our shareholders and to determine, with respect to any series
of preferred shares, the terms and rights of that series. These provisions could have the effect of depriving our shareholders
and ADSs holders of the opportunity to sell their shares or ADSs at a premium over the prevailing market price by discouraging
third parties from seeking to obtain control of our company in a tender offer or similar transactions.
We
are an emerging growth company and may take advantage of certain reduced reporting requirements.
We
are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from
various requirements applicable to other public companies that are not emerging growth companies including, most significantly,
not being required to comply with the auditor attestation requirements of Section 404 of Sarbanes-Oxley Act of 2002 for so long
as we are an emerging growth company. As a result, if we elect not to comply with such auditor attestation requirements, our investors
may not have access to certain information they may deem important.
The
JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards
until such date that a private company is otherwise required to comply with such new or revised accounting standards. We plan
to take advantage of such exemptions afforded to an emerging growth company. As a result, our operating results and financial
statements may not be comparable to the operating results and financial statements of other companies who have adopted the new
or revised accounting standards.
As
a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate
governance matters that differ significantly from Nasdaq corporate governance listing standards. These practices may afford less
protection to shareholders than they would enjoy if we complied fully with Nasdaq corporate governance listing standards.
As
an exempted company incorporated in the Cayman Islands that is expected to be listed on Nasdaq, we are subject to Nasdaq corporate
governance listing standards. However, Nasdaq rules permit a foreign private issuer like us to follow the corporate governance
practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ
significantly from Nasdaq corporate governance listing standards. Currently, we do not follow our home country practices or rely
on certain exemptions provided by Nasdaq corporate governance listing standards to a foreign private issuer. However, if we choose
to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would enjoy
under Nasdaq corporate governance listing standards applicable to U.S. domestic issuers.
We
are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions
applicable to U.S. domestic public companies.
Because
we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and
regulations in the United States that are applicable to U.S. domestic issuers, including:
|
●
|
the
rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K;
|
|
●
|
the
sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered
under the Exchange Act;
|
|
●
|
the
sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability
for insiders who profit from trades made in a short period of time; and
|
|
●
|
the
selective disclosure rules by issuers of material nonpublic information under Regulation FD.
|
We
will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend
to publish our results of operations through press releases, distributed pursuant to the rules and regulations of Nasdaq. Press
releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information
we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed
with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be
made available to you were you investing in a U.S. domestic issuer.
We
are a “controlled company” within the meaning of the rules of the Nasdaq Stock Market and, as a result, can rely on
exemptions from certain corporate governance requirements that provide protection to shareholders of other companies.
We
are a “controlled company” as defined under the Nasdaq Stock Market corporate governance rules because Jie Zhao, our
Chairman, beneficially owns more than 50% of the total voting power. For so long as we remain a controlled company under that
definition, we are permitted to rely on certain exemptions from corporate governance rules, including an exemption from the rule
that a majority of our board of directors must be independent directors or that we have to establish a nominating committee and
a compensation committee composed entirely of independent directors. As a result, you will not have the same protection afforded
to shareholders of companies that are subject to these corporate governance requirements.
Our
Chairman controls more than 50% of the total voting power of our outstanding ordinary shares and thus his interest may differ
from other shareholders and holders of our ADSs, as he is able to exert significant control over certain actions requiring a shareholder
vote.
Jie
Zhao, our Chairman, controls more than 50% of the total voting power of our outstanding ordinary shares. Consequently, he is able
to exert significant control over certain actions requiring a shareholder vote. As our majority shareholder, Mr. Zhao is able
to elect our board of directors, and determine the outcome of all matters requiring the approval of the holders of a majority
of our outstanding shares, including the sale of our assets or an acquisition of assets. This concentration of ownership in our
shares by Mr. Zhao limits your ability to influence corporate matters and may have the effect of delaying or preventing a third
party from acquiring control over us. Consequently, his interest in such matters may differ from the interest of other shareholders
and holders of our ADSs.
We
will incur increased costs as a result of being a public company, particularly after we cease to qualify as an emerging growth
company.
As
a public company, we expect to incur significant legal, accounting and other expenses that we did not incur as a private company.
The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and Nasdaq, 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. 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 will need
to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures.
We also expect that 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. In addition, we will incur additional costs associated with our public company reporting
requirements. 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. If we were 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.
There
can be no assurance that we will not be a passive foreign investment company, or PFIC, for any taxable year, which could result
in adverse U.S. federal income tax consequences to U.S. investors in our ADSs or ordinary shares.
In
general, a non-U.S. corporation is a PFIC for any taxable year in which (i) 75% or more of its gross income consists of passive
income; or (ii) 50% or more of the average quarterly value of its assets consists of assets that produce, or are held for the
production of, passive income. For purposes of the above calculations, a non-U.S. corporation that owns, directly or indirectly,
at least 25% by value of the shares of another corporation is treated as if it held its proportionate share of the assets of the
other corporation and received directly its proportionate share of the income of the other corporation. Passive income generally
includes dividends, interest, rents, royalties and certain gains. Cash is a passive asset for these purposes. Goodwill is generally
characterized as active or passive asset based on the nature of the income produced in the activity to which the goodwill is attributable.
Based on the expected composition of our income and assets and the value of our assets, including goodwill, which is based on
the price of our ADSs, we do not believe we were a PFIC for the taxable year ended December 31, 2019. However, it is not entirely
clear how the contractual arrangements between our wholly-owned subsidiaries, our VIE and the shareholders of our VIE will be
treated for purposes of the PFIC rules. In addition, the extent to which our goodwill should be characterized as an active asset
is not entirely clear. Furthermore, our PFIC status for any taxable year will depend on the composition of our income and assets
and the value of our assets from time to time (which may be determined, in part, by reference to the market price of our ADSs,
which could be volatile). Accordingly, there can be no assurance that we will not be a PFIC for any taxable year. If we were a
PFIC for any taxable year during which a U.S. taxpayer holds ADSs or ordinary shares, the U.S. taxpayer generally will be subject
to adverse U.S. federal income tax consequences, including increased tax liability on disposition gains and “excess distributions”
and additional reporting requirements. See “Item 10.E. Taxation—U.S. Federal Income Taxation—Passive Foreign
Investment Company Rules.”
ITEM
4.
|
INFORMATION
ON THE COMPANY
|
A.
|
HISTORY AND DEVELOPMENT OF OUR COMPANY
|
We
commenced our commercial operations in May 2015 through Beijing WiMi (previously under the name “WiMi Lightspeed Capital
Investment Management (Beijing) Co., Ltd.”). In February 2016, Beijing WiMi formed a wholly-owned subsidiary, Micro Beauty
Lightspeed Investment Management HK Limited in Hong Kong. In addition, Beijing WiMi acquired 100% equity interest in Shenzhen
Yidian on October 21, 2015, Shenzhen Yitian on August 20, 2015 and Shenzhen Kuxuanyou on August 26, 2015.
We
incorporated WiMi Cayman under the laws of the Cayman Islands as our offshore holding company in August 2018 to facilitate offshore
financing. In September 2018, we established WiMi HK, our wholly-owned Hong Kong subsidiary, and WiMi HK established a wholly-owned
PRC subsidiary, Hologram WiMi.
Due
to restrictions imposed by PRC laws and regulations on foreign ownership of companies that engage in internet and other related
business, Hologram WiMi later entered into a series of contractual arrangements with Beijing WiMi, or our VIE, and its shareholders.
We depend on these contractual arrangements with our VIE, in which we have no ownership interests, and its shareholders to conduct
most aspects of our operations. We have relied and expect to continue to rely on these contractual arrangements to conduct our
business in China. For more details, see “Item 4. Information on the Company—C.
Organizational Structure — Contractual Arrangements with the VIE and its Shareholders”. The shareholders of
our VIE may have potential conflicts of interest with us. See “Item 3.D. Risk Factors—Risks Related to Our Corporate
Structure—Our shareholders or the shareholders of our VIE may have potential conflicts of interest with us, which may materially
and adversely affect our business” for details.
In April 2020, we completed our
initial public offering in which we offered and sold an aggregate of 9,500,000 Class B ordinary shares in the form of
4,750,000 ADSs. The ADSs were sold at an offering price of US$5.50 per ADS generating gross proceeds of approximately
US$26.125 million, and net proceeds of approximately $23.1 million after deducting underwriting commission and other expenses. On April 1, 2020, our ADSs began trading on the Nasdaq
under the symbol “WIMI”.
Our
corporate headquarters is located at No. 6, Xiaozhuang, #101A, Chaoyang District, Beijing, the People’s Republic of China.
Our telephone number at this address is +86-10-5338-4913. Our registered office in the Cayman Islands is located at the office
of Maples Corporate Services Limited at PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our agent for service
of process in the United States is Puglisi & Associates, located at 850 Library Avenue, Suite 204, Newark, DE 19711.
We
are subject to the periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private
issuers. Under the Exchange Act, we are required to file reports and other information with the SEC. Specifically, we are required
to file annually a Form 20-F within four months after the end of each fiscal year. Copies of reports and other information, when
so filed with the SEC, can be inspected and copied at the public reference facilities maintained by the SEC at 100 F Street, N.E.,
Room 1580, Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to
the SEC. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the Commission at 1-800-SEC-0330.
SEC maintains a website (http://www.sec.gov), which contains reports, proxy and information statements, and other information
regarding us that are filed electronically with the SEC.
Capital
Expenditure
Our
capital expenditure amounted to approximately RMB 2.0 million, RMB 0.05 million, and RMB 0.2 million (USD28,000) for the years
ended December 31, 2017, 2018 and 2019, respectively. The capital expenditure for the year ended December 31, 2019 was primarily
used for the purchase of property and equipment, such as office supplies and equipment.
We
offer AR-based holographic services and products to cater to our customers’ needs, all centered upon providing an innovative,
immersive and interactive holographic AR experience for our customers and end users. Our service and product offerings primarily
consist of holographic AR advertising services and holographic AR entertainment products. Approximately 69.3%, 80.5%, and 83.8%
of our revenues were generated by our holographic AR advertising services for the years ended December 31, 2017, 2018, and 2019,
respectively. Approximately 30.7%, 19.5%, and 16.2% of our revenues were generated by our holographic AR entertainment products
for the years ended December 31, 2017, 2018, and 2019, respectively. The core of our business are holographic AR technologies
used in software engineering, content production, cloud and big data. By leveraging our strong technological capabilities and
infrastructure, we are able to deliver superior products and services and conduct our operations in a highly efficient manner.
Holographic
AR Advertising Services
Our
holographic AR advertising software enables users to insert into video footages real or animated three dimensional (“3D”)
objects that integrate seamlessly within the scene of such footages. Our online holographic AR advertising solution embeds holographic
AR ads into films and shows that are hosted by leading online streaming platforms in China. Through our proprietary image and
video recognition technologies, our software enables users to analyze the underlying video footages at a pixel level to identify
ad spaces that can be augmented by 3D objects. Advertisers and their agencies purchase these ad spaces through application programming
interfaces, or APIs, integrated with our systems, specifying their target audience and budgets and typically providing the 3D
models to be embedded in the videos. When the ad space is detected and 3D objects are generated, the 3D objects are embedded into
the underlying streaming videos automatically on a batch-processing basis as determined by our software. For the year ended December
31, 2018, holographic AR ads produced using our software generated a total of approximately 6.6 billion views, representing an
increase of 34.7% from approximately 4.9 billion views for the year ended December 31, 2017. For the year ended December 31, 2019,
holographic AR ads produced using our advertising solutions generated approximately 9.7 billion views, representing an increase
of 47.0% from approximately 6.6 billion views for the year ended December 31, 2018.
The
following diagram illustrates the key steps of our online holographic AR advertising business:
As
compared with traditional forms of digital ads, we believe that ads generated using our holographic AR technology have the following
key benefits:
|
●
|
Engaging
and interactive. Holographic AR ads tend to create a more engaging, memorable experience that likely stimulates the purchase
impulse. Holographic AR ads encourage engagement between the consumers and brands, creating a relationship that is more interactive
than other forms of ads.
|
|
●
|
Natural
and non-disruptive. As compared with traditional banner ads and video-based ads that flash and spin on the screen, holographic
AR ads are naturally blended with the scenes in the films or TV shows, which helps to overcome advertising blindness and create
a natural, non-disruptive viewing experience.
|
|
●
|
Cost-effectiveness
and flexibility. Our technologies identify appropriate ad space that can be used repeatedly for ads of multiple brands.
While video-embedded 3D objects provide substantially the same level of reality as compared to tangible ads, they tend to be more
cost-effective as they save the costs associated with shooting a commercial.
|
Holographic
AR Entertainment Products
Our
holographic AR entertainment products primarily consist of payment middleware software, game distribution platform and holographic
MR software.
Payment
middleware is a software solution that connects mobile apps to payment channels, giving mobile app users convenient access to
a wide range of online payment options. We cooperate with app developers to embed our payment middleware, most of which feature
AR functions, in mobile apps.
Our
advanced payment middleware streamlines the often time-consuming mobile payment process. Our mobile payment middleware facilitates
app developers to build an in-app payment infrastructure that allows micropayments to be made or received through an efficient,
secure system, without any interface redirection. Such mobile payment middleware enables app developers to store users’
payment credentials in a trusted and safe environment and eases user’s burden of repeatedly entering and authenticating
payment information for each transaction.
Our
payment middleware can be fully integrated with various types of mobile apps, especially those employing AR technologies, such
as live streaming, gaming, selfie, photo editing, and video-sharing apps. Currently, our payment middleware supports substantially
all of the major online payment channels in China, and is compatible with the mainstream mobile operating systems.
The
following graphic illustrates the key steps involved in the holographic AR payment middleware services that we provide to app
developers:
We
generate revenues from our mobile payment middleware by sharing revenues with app developers at an agreed-upon percentage. In
addition, in 2018, we launched 233 Game Platform, an online game distribution platform. This platform provides game developers
with technical support and value-added services that may help them target, reach and monetize their audiences. For the year ended
December 31, 2019, over 800 apps were operated on or docked into our 233 Game Platform, which attracted over 260,000 active
members, defined as the number of registered accounts that logged in at least once during a specified time period. We started
generating revenue from our platform in the second quarter of 2019, as we started adding new apps to the platform that gained
polarity with users, and certain existing games became more popular among users.
We
also sell MR software, a comprehensive holographic application platform independently developed by our research and development
team, which includes holographic audio-visual integrated operation, holographic advertising service, holographic media asset management
and holographic data management on the platform level and holographic interactive system, holographic recognition system, holographic
labeling system, holographic tracking system, holographic capture system and holographic analysis system. Our MR software also
includes multiple modules that allow end-users to edit and display holographic AR contents and create their own custom visual
effects.
Our
AR holographic entertainment business is based on users’ demand for entertainment applications in the field of 3D computer
vision. We charge the customers software license fees. With the development and popularization of AR holographic hardware devices,
we expect that there will be more applications in the future for our AR holographic entertainment products.
Our
Technology
We
have developed powerful, cutting-edge holographic AR technologies.
Holographic
Image Processing and Recognition Intelligence Technology
We
insert holographic AR advertisements into online videos based on our imaging detection and recognition technology, template matching
and detection technology, video processing and recognition technology, holographic 3D layer replacement technology in imaging
recognition and dynamic fusion processing technology in imaging tracking. We expect that these technologies will be applied to
our future strategic blueprint, such as the development and application of holographic 3D facial recognition technology and holographic
facial change technology.
Development
and Application in Holographic 3D Facial Recognition Technology
The
development of holographic 3D facial recognition software is based on our holographic imaging featured imaging detection and recognition
technology, template matching holographic imaging detection technology, and deep learning and training based video processing
and recognition technology. Traditional 2D facial recognition technology is a biographic recognition technology based on facial
features, which captures the information from the facial images or facial video streaming, and automatically detects and tracks
the targeted face. By contrast, we believe our holographic 3D facial recognition technology is a biographic recognition technology
consisting of a combination of holographic imaging capture and 3D portrait. We focus on the development and application of our
software technology, and have technologies in AI, machine recognition, machine learning, model theory, and video imaging processing.
Holographic 3D facial recognition technology is a technology using the collection of structured light and infrared light, and
the collected featured points can exceed 30,000 points. By contrast, the collected featured points for traditional 2D facial recognition
technology is less than 1,000 points. Our 3D technology is also expected to be less affected by the surrounding environment and
is expected to overcome many of the issues found in traditional 2D facial recognition technology, such as light, posture, occlusion,
dynamic recognition and facial expression.
Development
and Application of Holographic Facial Change Technology
Holographic
facial change technology is based on our holographic 3D layer replacement technology involving image recognition and dynamic fusion
processing technology based on AI, tracking images in real time and replacing faces with other faces. This technology replaces
faces in video frames, synthesizing the video and adding the original audio. We have validated these technology modules in holographic
AR plug-in advertisement applications and continue to develop and upgrade these technology modules. We believe this technology
will bring new business growth to applications such as celebrity advertising, film distribution, and live video streaming.
Software
Engineering
Since
our inception, we have devoted the majority of our research and development resources to software development. Our software engineering
team is responsible for building the company-wide software platform, supporting the integration of our products and applications
within our cloud infrastructure, as well as developing the holographic AR-related and MR-related software and solutions we license
to our entertainment industry customers.
Our
holographic AR software development services provide customers with the following benefits:
|
●
|
Convenience.
We design our software for simplicity, ease of use and user-friendly experience. Through our software’s intuitive,
visual interface, users can rapidly and easily manage, distribute and implement holographic AR contents.
|
|
●
|
Adaptability.
Our integrated holographic AR software is built with broad compatibility and can run on various computer operating systems,
including Windows, Mac OS and Linux. Customers can install our software in the cloud, on-premises or using a hybrid approach.
|
|
●
|
Functionality
and Intelligence. We continue to leverage our software engineering capabilities to improve our offerings, which allows
for richer software functionality. As our customer base continues to grow, we believe we will be able to further enhance our software
intelligence with the increased volume of data processed.
|
|
●
|
Reliability.
We value the long-term relationship with our customers and provide our customers continuous ancillary technical support
and services. We perform security and code quality reviews before releasing the software to our customers and we also embed mature
security practices throughout the whole life span of our holographic AR software to protect our customers’ data and proprietary
information.
|
Content
Production
Our
leading holographic AR content production capabilities are built around image acquisition, object recognition, automated image
process, and computer vision technologies. Our software engineering team and visualization design team work closely to consistently
advance such visualization-related technologies, and harness them to design and produce innovative holographic AR contents. Through
real-time computer vision algorithms which provide an accurate pose estimation, we are able to perform scene recognition and tracking
within seconds. Such cutting-edge algorithms also allow us to perform visualization of photorealistic high-resolution renderings
of products on a pixel basis. In the course of scene reconstruction, our automated image processing tools can perform noise cleaning
and feature enhancement on the image we initially captured, enabling us to create best-in-class holographic AR designs with an
industry-leading simulation degree.
We
have built a comprehensive holographic AR content library. The formats of our holographic AR contents range from 3D models to
holographic short videos. As of December 31, 2019, we owned over 4,600 ready-to-use AR holographic contents that were available
to be adapted to our holographic AR products and solutions, including animals, cartoon characters, vehicles and foods. Our AR
holographic contents can be applied in various scenarios, such as education, tourism, arts and entertainment, and popular science.
In addition, our content library is also enriched by copyrighted content that we have licensed from third parties. We cooperate
with various content owners, including brands, film producers and talent agencies, to adapt high-quality, popular IPs into holographic
AR formats.
Cloud
We
believe that the next-generation cloud delivery technology provides the flexibility and scalability necessary for holographic
AR experience. Cloud technology is of high importance to build our comprehensive holographic AR ecosystem. We have developed our
cloud architecture to work effectively in a flexible cloud environment that has a high degree of elasticity. Meanwhile, benefiting
from our cloud storage and connecting capabilities, users of our integrated holographic AR software are able to access our large-size
holographic AR content library on their own devices.
Big
Data
We
have developed advanced data analytics capabilities to derive actionable insights from the large amounts of data we collected
from our products and third party sources, enabling us to maintain a solid end-user base in order to collect raw data. Our processing
capabilities enable us to manage extremely large volumes of data and deliver real-time analysis at scale, making it possible for
us to continue to improve and innovate our products and services. Our data mining and user behavioral data analytics technologies
allow us to build and segment context-rich user profiles and apply such analysis in numerous applications. For instance, we have
created over 2,000 user tags by analyzing user data we collected through our holographic AR advertising services. We are also
in the process of developing ads performance tracking and evaluation tools.
Artificial
Intelligence
Our
holographic image processing capabilities are regularly optimized and improved, including two core technologies: holographic AI
facial recognition technology and holographic AI facial change technology. As a result of the development of our video processing
and recognition technology, our holographic AR advertising and holographic imaging services, which are based on image detection,
recognition, template matching, image dynamic fusion and replacement, are currently in a leading position in the industry.
5G+
We
believe that our holographic services will adapt to 5G technology. Due to the high speed and low latency of 5G technology, the
transmission delay of the long-distance communication and data transmission from the system terminal to the service server is
lower than the 4G network transmission delay. Such improvement ensures less stagnation, low delay, high efficiency, and diversity
of the interaction of multiple terminals in holographic AR remote communication and data transmission. We expect our holographic
AR advertising business to develop accordingly.
Our
Customers
We
have a broad and diverse customer base. Currently, our customers mainly consist of advertisers, distribution channels, app developers
and entertainment companies. Our customer base covers a wide range of industries, including manufacturing, real estate, entertainment,
technology, media and telecommunications, travel, education and retails. Our customers typically enter into a master agreement
with us for a term of one year, although they do not necessarily purchase products or services from us during each quarter of
such year. A separate request is submitted by a customer for each order of products or services.
Generally,
we enter into service agreements with customers relating to our holograph AR ad services and our AR SDK payment customers relating
to our AR SDK services. We provide customized holographic MR software and middleware software to distributors under software development
agreements, who subsequently sub-license the customized software to enterprises and individual end users. The software development
agreements entered into between us and the distributors include customization of our integrated holographic AR and MR entertainment
software, ancillary technical training, as well as professional service and support. We charge distributors on a fixed-price basis.
For our AR ad services, we charge service fees based on the number of views. For our AR SDK payment services, we charge a percentage
of the total fees paid by the end users. We generally maintain annual agreements with our customers.
Sales
and Marketing
We
promote our products and services directly through our experienced and creative sales and marketing team by making direct office
visits, attending conferences and industry exhibitions. Customers unfamiliar with our services and products may also consult with
our support team to achieve best solutions. We believe that our sales and marketing team is well respected and helps attracting
more customers.
We
also grow our customer base through word-of-mouth referrals. We focus on continuously improving the quality of our products and
services as we believe satisfied customers are more likely to continue using our products and recommend our products and services
to others.
Intellectual
Property
We
regard our patents, copyrights, trademarks, trade secrets and other intellectual properties as critical to our success. We rely
on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual
property rights. Details of our intellectual properties portfolio as of December 31, 2019 are set out as follows:
|
●
|
Patent:
We had 145 registered patents in China, which covers technologies for image processing and display, model input/output and
3D modeling, 68 pending patent applications with the PRC China National Intellectual Property Administration, and no patent under
the patent cooperation treaty. Three of our 145 registered patents in China are currently registered under the name of individuals
who have signed Intellectual Property Ownership Agreement with us, providing that the ownership of such intellectual properties
invented during their employment in the Company should belong to us, and these patents are also undergoing the transfer process
from the individuals to us. 144 of our 145 registered patents were granted as patent for utility model;
|
|
●
|
Software
copyrights. We maintain a large portfolio of copyright-protected software. We had 237 registered software copyrights in China;
|
|
●
|
Trademarks.
We had 23 registered trademark in China, and no pending trademark application with the PRC State Administration for Industry
and Commerce; and
|
|
●
|
Domain
names. We had 15 registered domain names in China.
|
In
addition to the foregoing protections, we generally control access to and use of our proprietary and other confidential information
through the use of internal and external controls. For example, for external controls, we enter into confidentiality agreements
or agree to confidentiality clauses with our customers and, for internal controls, we adopt and maintain relevant policies governing
the operation and maintenance of our systems and the management of user-generated data.
Competition
There
are many other companies addressing various aspects/verticals of the holographic AR market. The competitive landscape we are faced
with is fragmented and evolving. With respect to our holographic AR advertising products, we compete against both holographic
AR advertisement producers and traditional advertisement producers.
We
believe the principal competitive factors in our market are:
|
●
|
breadth
of use cases supported;
|
|
●
|
product
features and functionality;
|
|
●
|
capability
for customization, configurability, integration, security, scalability and reliability;
|
|
●
|
quality
of technologies and research and development capabilities;
|
|
●
|
ability
to innovate and rapidly respond to customer needs;
|
|
●
|
availability
of holographic compatible, high-quality content;
|
|
●
|
diversified
customer base;
|
|
●
|
relationships
with key participants in holographic AR value chain;
|
|
●
|
sufficient
capital support;
|
|
●
|
platform
extensibility and ability to integrate with other holographic AR infrastructures; and
|
|
●
|
brand
awareness and reputation.
|
We
believe we compete favorably on the basis of the above factors; however, we expect competition to intensify in the future. Our
ability to remain competitive will largely depend on the quality of our applications, the effectiveness of our sales and marketing
efforts, the quality of our customer service and our ability to acquire complementary technologies, products and businesses to
enhance the features and functionality of our applications.
Insurance
We
do not maintain insurance policies covering damages to our Information Technology systems. We also do not maintain business interruption
insurance or general third-party liability insurance, nor do we maintain product liability insurance or key-man insurance. We
consider our insurance coverage to be in line with that of other companies in the same industry of similar size in China.
Regulations
We
are subject to a variety of PRC laws, rules and regulations across a number of aspects of our business. The following is a summary
of the principal PRC laws and regulations relating to our business and operations within the territory of the PRC.
Regulation
on Foreign Investment Restrictions
The
Guidance Catalogue of Industries for Foreign Investment (2017 Revision), or the Catalogue, which is promulgated by the Ministry
of Commerce and the National Development and Reform Commission and governs investment activities in the PRC by foreign investors.
The Catalogue divides industries into three categories—“encouraged,” “restricted,” and “prohibited”
for foreign investment. Industries not listed in the Catalogue are generally deemed as falling into a fourth category, “permitted.”
Industries such as value-added telecommunication services, including Internet information services, are restricted to foreign
investment.
The
Special Administrative Measures for Entrance of Foreign Investment (Negative List) (2018 Version), or the Negative List, which
was promulgated jointly by the Ministry of Commerce and the National Development and Reform Commission on June 28, 2018 and became
effective on July 28, 2018, replaced and partly abolished the Guidance Catalogue of Industries for Foreign Investment (2017 Revision)
regulating the access of foreign investors to China. Pursuant to the Negative List, foreign investors should refrain from making
investing in any of prohibited sectors specified in the Negative List, and foreign investors are required to obtain the permit
for access to other sectors that are listed in the Negative List but not classified as “prohibited”.
On
March 15, 2019, the Foreign Investment Law was formally issued, and become effective on January 1, 2020, on which Regulation for
the Implementation of Foreign Investment Law of the People’s Republic of China and Measures for Reporting of Information
on Foreign Investment become effective. The Foreign Investment Law and its implementation regulation mainly focuses on the foreign
investment promotion, foreign investment protection and foreign investment management. Comparing with the draft Foreign Investment
Law (2015), the Foreign Investment Law does not mention concepts such as “De facto control” and “controlling
PRC companies by contracts or trusts”, nor did it specify the regulation requirements on controlling through contractual
arrangements. Pursuant to Measures for Reporting of Information on Foreign Investment, a foreign investor or foreign-invested
enterprise shall, through the enterprise registration system and the enterprise credit information disclosure system, report investment
information to the competent departments in charge of commerce. The foreign investment information reports include the initial
report, report of changes, report of deregistration, and annual report.
Pursuant
to the Announcement 2016 No. 22 of the National Development and Reform Commission and the Ministry of Commerce dated October 8,
2016, the special entry administration measures for foreign investment apply to restricted and prohibited categories specified
in the Catalogue, and the encouraged categories that are subject to certain requirements relating to equity ownership and senior
management under the special entry administration measures.
Regulations
on AR Industry
On
December 21, 2018, Ministry of Industry and Information Technology issues the Guidance on Accelerating the Development of AR Industry,
which requires that the AR Industry in China shall be promoted and application innovation in AR technology shall be promoted.
Regulations
on Value-added Telecommunication Services
On
September 25, 2000, the State Council promulgated the Telecommunications Regulations of the People’s Republic of China,
or the Telecom Regulations, which was amended on July 29, 2014 and February 6, 2016. The Telecom Regulations is the primary PRC
law governing telecommunication services and sets out the general regulatory framework for telecommunication services provided
by PRC companies. The Telecom Regulations distinguishes between “basic telecommunication services” and “value-added
telecommunication services.” The Telecom Regulations defines value-added telecommunications services as telecommunications
and information services provided through public networks. Pursuant to the Telecom Regulations, commercial operators of value-added
telecommunications services must first obtain an operating license from the MIIT, or its provincial level counterparts.
The
Catalog of Telecommunications Business, or the Catalog, which was issued as an attachment to the Telecom Regulations and
updated in February 21, 2003 and December 28, 2015, further categorizes value-added telecommunication services into two classes:
Class 1 value-added telecommunication services and Class 2 value-added telecommunication services. Information services provided
via cable networks, mobile networks or internet fall within Class 2 value-added telecommunications services.
On
July 3, 2017, the MIIT issued the Measures on the Administration of Telecommunications Business Operating Permits, or the
Telecom License Measures, which became effective on September 1, 2017, to supplement the Telecom Regulations. The Telecom License
Measures sets forth the types of licenses required to operate value-added telecommunications services and the qualifications and
procedures for obtaining such licenses. The Telecom License Measures also provides that an operator providing value-added services
in multiple provinces is required to obtain an inter-regional license, whereas an operator providing value-added services in one
province is required to obtain an intra-provincial license. Any telecommunication services operator must conduct its business
in accordance with the specifications in its license.
Regulations
on Internet Content Providers
The
Administrative Measures on Internet Information Services, or the Internet Content Measures, which was promulgated by the State
Council on September 25, 2000 and amended on January 8, 2011, set out guidelines on the provision of internet information services.
The Internet Content Measures classifies internet information services into commercial internet information services and non-commercial
internet information services. Commercial internet information services refer to services that provide information or services
to internet users with charge. A provider of commercial internet information services must obtain an ICP License.
Regulations
on Foreign Direct Investment in Value-Added Telecommunications Companies
Foreign
direct investment in telecommunications companies in China is governed by the Provisions on the Administration of Foreign-Invested
Telecommunications Enterprises, which was promulgated by the State Council on December 11, 2001 and amended on September 10,
2008 and February 6, 2016. These regulations require that foreign-invested value-added telecommunications enterprises in China
must be established as Sino-foreign equity joint ventures and that the foreign investors may acquire up to 50% equity interests
in such joint ventures. In addition, a major foreign investor in a value-added telecommunications business in China must demonstrate
a good track record and experience in operating value-added telecommunications business. Moreover, foreign investors that meet
these requirements must obtain approvals from the MIIT and the MOFCOM, to provide value-added telecommunication services in China.
On
July 13, 2006, the Ministry of Information Industry, or the MII, released the Notice on Strengthening the Administration
of Foreign Investment in the Operation of Value-added Telecommunications Business, or the MII Notice, pursuant to which, for
any foreign investor to invest in telecommunications business in China, a foreign-invested telecommunications enterprise must
be established and such enterprise must apply for the relevant telecommunications business operation licenses. Furthermore, under
the MII Notice, domestic telecommunications enterprises may not rent, transfer or sell a telecommunications business operation
license to foreign investors in any form, and they may not provide any resources, premises, facilities and other assistance in
any form to foreign investors for their illegal operation of any telecommunications business in China. In addition, under the
MII Notice, the internet domain names and registered trademarks used by a value-added telecommunication service operator shall
be legally owned by such operator or its shareholders.
Regulations
on Infringement upon Intellectual Property Rights via Internet
The
Tort Liability Law of the PRC, which was adopted by the Standing Committee of the National People’s Congress on December
26, 2009 and became effective on July 1, 2010, provides that (i) an online service provider should be held liable for its own
tortious acts in providing online services; (ii) where an online user conducts tortious acts by utilizing online services provided
by the online service provider, the infringed party has the right to request such online service provider to take necessary measures,
including deleting, blocking and disconnecting the access to the infringing content promptly. If the online service provider fails
to take necessary measures in a timely manner upon receipt of notice of such infringement, such online service provider will be
held jointly liable with the relevant online users for the additional damages that should have not been incurred if the online
service provider took proper actions; and (iii) where the online service provider is aware that online users are infringing upon
the civil right or interest of third party and fail to take necessary measures, the online service provider should be jointly
liable for such infringement with the online users.
Regulation
on Intellectual Property Rights
The
PRC has adopted comprehensive legislation governing intellectual property rights, including patents, trademarks, copyrights and
domain names.
Patents
Pursuant
to the PRC Patent Law, most recently amended on December 27, 2008, and its implementation rules, most recently amended on January
9, 2010, patents in China fall into three categories: invention, utility model and design. An invention patent is granted to a
new technical solution proposed in respect of a product or method or an improvement of a product or method. A utility model is
granted to a new technical solution that is practicable for application and proposed in respect of the shape, structure or a combination
of both of a product. A design patent is granted to the new design of a certain product in shape, pattern or a combination of
both and in color, shape and pattern combinations aesthetically suitable for industrial application. Under the PRC Patent Law,
the term of patent protection starts from the date of application. Patents relating to invention are effective for twenty years,
and utility models and designs are effective for ten years from the date of application. The PRC Patent Law adopts the principle
of “first-to-file” system, which provides that where more than one person files a patent application for the same
invention, a patent will be granted to the person who files the application first. Existing patents can become narrowed, invalid
or unenforceable due to a variety of grounds, including lack of novelty, creativity, and deficiencies in patent application. In
China, a patent must have novelty, creativity and practical applicability. Under the PRC Patent Law, novelty means that before
a patent application is filed, no identical invention or utility model has been publicly disclosed in any publication in China
or overseas or has been publicly used or made known to the public by any other means, whether in or outside of China, nor has
any other person filed with the patent authority an application that describes an identical invention or utility model and is
recorded in patent application documents or patent documents published after the filing date. Creativity means that, compared
with existing technology, an invention has prominent substantial features and represents notable progress, and a utility model
has substantial features and represents any progress. Practical applicability means an invention or utility model can be manufactured
or used and may produce positive results. Patents in China are filed with the State Intellectual Property Office, or SIPO. Normally,
the SIPO publishes an application for an invention patent within 18 months after the filing date, which may be shortened at the
request of applicant. The applicant must apply to the SIPO for a substantive examination within three years from the date of application.
Article 20 of the PRC Patent Law provides that, for an invention or utility model completed in China, any applicant (not just
Chinese companies and individuals), before filing a patent application outside of China, must first submit it to the SIPO for
a confidential examination. Failure to comply with this requirement will result in the denial of any Chinese patent for the relevant
invention. This added requirement of confidential examination by the SIPO has raised concerns by foreign companies who conduct
research and development activities in China or outsource research and development activities to service providers in China.
Patent
Enforcement
Unauthorized
use of patents without consent from owners of patents, forgery of the patents belonging to other persons, or engagement in other
patent infringement acts, will subject the infringers to infringement liability. Serious offences such as forgery of patents may
be subject to criminal penalties. When a dispute arises out of infringement of the patent owner’s patent right, Chinese
law requires that the parties first attempt to settle the dispute through mutual consultation. However, if the dispute cannot
be settled through mutual consultation, the patent owner, or an interested party who believes the patent is being infringed, may
either file a civil legal suit or file an administrative complaint with the relevant patent administration authority. A Chinese
court may issue a preliminary injunction upon the patent owner’s or an interested party’s request before instituting
any legal proceedings or during the proceedings. Damages for infringement are calculated as the loss suffered by the patent holder
arising from the infringement, and if the loss suffered by the patent holder arising from the infringement cannot be determined,
the damages for infringement shall be calculated as the benefit gained by the infringer from the infringement. If it is difficult
to ascertain damages in this manner, damages may be determined by using a reasonable multiple of the license fee under a contractual
license. Statutory damages may be awarded in the circumstances where the damages cannot be determined by the above mentioned calculation
standards. The damage calculation methods shall be applied in the aforementioned order. Generally, the patent owner has the burden
of proving that the patent is being infringed. However, if the owner of an invention patent for manufacturing process of a new
product alleges infringement of its patent, the alleged infringer has the burden of proof.
Trademark
Law
The
PRC Trademark Law and its implementation rules protect registered trademarks. The PRC Trademark Office of State Administration
of Industry and Commerce is responsible for the registration and administration of trademarks throughout the PRC. The Trademark
Law has adopted a “first-to-file” principle with respect to trademark registration. In addition, pursuant to the PRC
Trademark Law, counterfeit or unauthorized production of the label of another person’s registered trademark, or sale of
any label that is counterfeited or produced without authorization will be deemed as an infringement to the exclusive right to
use a registered trademark. The infringing party will be ordered to stop the infringement immediately, a fine may be imposed and
the counterfeit goods will be confiscated. The infringing party may also be held liable for the right holder’s damages,
which will be equal to the gains obtained by the infringing party or the losses suffered by the right holder as a result of the
infringement, including reasonable expenses incurred by the right holder for stopping the infringement. If the gains or losses
are difficult to determine, the court may render a judgment awarding damages of no more than RMB3 million.
Software
Copyright Law
On
September 7, 1990, Standing Committee of the National People’s Congress promulgated The Copyright Law of the PRC or the
Copyright Law, which was amended on October 27, 2001 and April 1, 2010. The Copyright Law provides that Chinese citizens, legal
persons, or other organizations shall, whether published or not, enjoy copyright in their works, which include, among others,
works of literature, art, natural science, social science, engineering technology and computer software.
The
Computer Software Copyright Registration Measures or the Software Copyright Measures promulgated by the National Copyright
Administration on April 6, 1992, which was amended on February 20, 2002, regulate registrations of software copyright, exclusive
licensing contracts for software copyright and transfer contracts. The National Copyright Administration of China shall be the
competent authority for the nationwide administration of software copyright registration and the Copyright Protection Centre of
China (the “CPCC”), is designated as the software registration authority. The CPCC shall grant registration certificates
to the Computer Software Copyrights applicants which conforms to the provisions of both the Software Copyright Measures and the
Computer Software Protection Regulations (Revised in 2013).
Regulation
on Domain Name
The
domain names are protected under the Administrative Measures for Internet Domain Names promulgated by MIIT on August 24, 2017,
the effective date of which was November 1, 2017. MIIT is the major regulatory body responsible for the administration of the
PRC Internet domain names, under supervision of which China Internet Network Information Center, or CNNIC, is responsible for
the daily administration of CN domain names and Chinese domain names. On September 25, 2002, CNNIC promulgated the Implementation
Rules of Registration of Domain Name, or the CNNIC Rules, which was renewed on June 5, 2009 and May 29, 2012, respectively. Pursuant
to the Administrative Measures on the Internet Domain Names and the CNNIC Rules, the registration of domain names adopts the “first
to file” principle and the registrant shall complete the registration via the domain name registration service institutions.
In the event of a domain name dispute, the disputed parties may lodge a complaint to the designated domain name dispute resolution
institution to trigger the domain name dispute resolution procedure in accordance with the CNNIC Measures on Resolution of the
Top Level Domains Disputes, file a suit to the People’s Court or initiate an arbitration procedure.
Regulations
on Online Advertising Services
On
April 24, 2015, the Standing Committee of the National People’s Congress enacted the revised Advertising Law of the PRC,
or the Advertising Law, effective on September 1, 2015 which was further amended on October 26, 2018. The Advertising Law increases
the potential legal liability of advertising services providers and strengthens regulations of false advertising. The Advertising
Law sets forth certain content requirements for advertisements including, among other things, prohibitions on false or misleading
content, superlative wording, socially destabilizing content or content involving obscenities, superstition, violence, discrimination
or infringement of the public interest.
On
July 4, 2016, the SAIC issued the Interim Measures on the Administration of Online Advertising, or the SAIC Interim Measures,
which came into effect on September 1, 2016. The Advertising Law and the SAIC Interim Measures require that online advertisements
may not affect users’ normal use of internet and internet pop-up ads must display a “close” sign prominently
and ensure one-key closing of the pop-up windows. The SAIC Interim Measures provide that all online advertisements must be marked
“advertisement” so that consumers can distinguish them from non-advertisement information. Moreover, the SAIC Interim
Measures require that, among other things, sponsored search advertisements shall be prominently distinguished from normal research
results and it is forbidden to send advertisements or advertisement links by email without the recipient’s permission or
induce internet users to click on an advertisement in a deceptive manner.
Regulations
on Internet Security
On
December 28, 2000, the Standing Committee of the National People’s Congress enacted the Decision on the Protection of Internet
Security, as amended on August 27, 2009, which provides that the following activities conducted through the internet are subject
to criminal liabilities: (a) gaining improper entry into any of the computer information networks relating to state affairs, national
defensive affairs, or cutting-edge science and technology; (b) spreading rumor, slander or other harmful information via the internet
for the purpose of inciting subversion of the state political power; (c) stealing or divulging state secrets, intelligence or
military secrets via internet; (d) spreading false or inappropriate commercial information; or (e) infringing on the intellectual
property. The Ministry of Public Security issued the Administrative Measures on Security Protection for International Connections
to Computer Information Networks on December 16, 1997 and amended it on January 8, 2011, which prohibits using internet to leak
state secrets or to spread socially destabilizing content.
On
December 13, 2005, the Ministry of Public Security issued the Provisions on the Technical Measures for the Protection of the Security
of the Internet, which requires that internet services providers shall have the function of backing up the records for at least
60 days. Also, internet services providers shall (a) set up technical measures to record and keep the information as registered
by users; (b) record and keep the corresponding relation between the internet web addresses and Intranet web addresses as applied
by users; (c) record and follow up the net operation and have the functions of security auditing.
On
January 21, 2010, the MIIT promulgated the Administrative Measures for Communications Network Security Protection, which requires
that all communication network operators including telecommunications services providers and internet domain name service providers
divide their own communication networks into units. The unit category shall be classified in accordance with degree of damage
to national security, economic operation, social order and public interest. In addition, the communication network operators must
file the division and ratings of their communication network with MIIT or its local counterparts. If a communication network operator
violates these measures, the MIIT or its local counterparts may order rectification or impose a fine up to RMB30,000 in case such
violation is not duly rectified.
Regulations
on Privacy Protection
On
December 29, 2011, the MIIT promulgated the Several Provisions on Regulation of Order of Internet Information Service Market,
which prohibit internet information service providers from collecting personal information of any user without prior consent.
Internet information service providers shall explicitly inform the users of the means of collecting and processing personal information,
the scope of contents, and purposes. In addition, internet information service providers shall properly keep the personal information
of users, if the preserved personal information of users is divulged or may possibly be divulged, internet information service
providers shall immediately take remedial measures and report any material leak to the telecommunications regulatory authority.
On
December 28, 2012, the Decision on Strengthening Network Information Protection promulgated by the Standing Committee of the National
People’s Congress emphasizes the need to protect electronic information that contains individual identification information
and other private data. The decision requires internet service providers to establish and publish policies regarding the collection
and use of electronic personal information and to take necessary measures to ensure the security of the information and to prevent
leakage, damage or loss.
In
July 2013, the MIIT promulgated the Regulations on Protection of Personal Information of Telecommunications and Internet Users,
or the Regulations on Network Information Protection, effective on September 1, 2013, to enhance and enforce legal protection
over user information security and privacy on the internet. The Regulations on Network Information Protection require internet
operators to take various measures to ensure the privacy and confidentiality of users’ information.
Pursuant
to the Ninth Amendment to the Criminal Law of the PRC issued by the Standing Committee of the National People’s Congress
on August 29, 2015, effective on November 1, 2015, any internet service provider that fails to fulfill the obligations related
to internet information security as required by applicable laws and refuses to take corrective measures, will be subject to criminal
liability for (i) any large-scale dissemination of illegal information; (ii) any severe effect due to the leakage of users’
personal information; (iii) any serious loss of evidence of criminal activities; or (iv) other severe situations, and any individual
or entity that (a) sells or provides personal information to others unlawfully or (b) steals or illegally obtains any personal
information will be subject to criminal liability in severe situations.
On
May 9, 2017, the Supreme People’s Court and the Supreme People’s Procuratorate released the Interpretations of the
Supreme People’s Court and the Supreme People’s Procuratorate on Several Issues Concerning the Application of Law
in the Handling of Criminal Cases Involving Infringement of Citizens’ Personal Information, effective from June 1, 2017,
which clarify several concepts regarding the crime of “infringement of citizens’ personal information” stipulated
by Article 253A of the Criminal Law of the People’s Republic of, including “citizen’s personal information”,
“provision”, and “unlawful acquisition”. Also, the Interpretations specify the standards for determining
“serious circumstances” and “particularly serious circumstances” of this crime.
On
November 7, 2016, the Standing Committee of the National People’s Congress promulgated the Cyber Security Law of the PRC,
or the Cyber Security Law, which came into effect on June 1, 2017. Pursuant to the Cyber Security Law, network operators shall
follow their Cyber Security obligations according to the requirements of the classified protection system for Cyber Security,
including: (a) formulating internal security management systems and operating instructions, determining the persons responsible
for Cyber Security, and implementing the responsibility for Cyber Security protection; (b) taking technological measures to prevent
computer viruses, network attacks, network intrusions and other actions endangering Cyber Security; (c) taking technological measures
to monitor and record the network operation status and Cyber Security incidents; (d) taking measures such as data classification,
and back-up and encryption of important data; and (e) other obligations stipulated by laws and administrative regulations. In
addition, network operators shall follow the principles of legitimacy to collect and use personal information and disclose their
rules of data collection and use, clearly express the purposes, means and scope of collecting and using the information, and obtain
the consent of the persons whose data is gathered.
Regulations
on Online Games
Regulations
Relating to Operation Permits for Online Games
The
Provisional Regulations for the Administration of Online Culture (the “Online Culture Regulations”) which were issued
by the Ministry of Culture (“MOC”) and took effect on April 1, 2011 and were amended on December 15, 2017, apply to
entities engaging in activities related to “online cultural products,” which include cultural products that are produced
specifically for Internet use, such as online music and entertainment, online games, online plays, online performances, online
works of art and web animation, and other online cultural products that through technical means, produce or reproduce music, entertainment,
games, plays and other art works for Internet dissemination. Under the Online Culture Regulations, commercial entities are required
to apply to the relevant local branch of the MOC for an Online Culture Operating Permit if they engage in for-profit Internet
cultural activities, including the production, duplication, importation, release or broadcasting of online cultural products;
the dissemination of online cultural products on the Internet or the transmission of such products via Internet or mobile phone
networks to player terminals, such as computers, phones, television sets and gaming consoles, or Internet surfing service sites
such as Internet cafés; or the holding of exhibition or contests related to online cultural products. The MOC issued the
Circular on Implementation of the Newly Revised Provisional Regulations for the Administration of Online Culture Interim Provisions
on the Administration of Internet Culture on March 18, 2011, which provides that the authorities will temporarily not accept applications
by foreign-invested Internet content providers for operation of Internet culture business (other than online music business).
The
Notice on Adjusting the Scope and Standardizing the Examination and Approval Process of Network Culture Operation License (“Notice”),
issued by the Office of Ministry of Culture and Tourism on May 14, 2019, provides that any network culture operation licenses
whose business scope contains online-games related activities remains valid, while such licenses may not be renewed upon expiration
thereof.
The
Notice of the Ministry of Culture on the Implementation of the Interim Measures for the Administration of Online Games issued
by the MOC and which took effect on July 29, 2010 specify entities regulated by the Online Game Measures and procedures related
to the MOC’s review of the content of online games, and emphasizes the protection of minors playing online games and requests
online game operators to promote real name registration by their players.
The
Notice on Interpretation of the State Commission Office for Public Sector Reform on Several Provisions relating to Animation,
Online Game and Comprehensive Law Enforcement in Culture Market in the ‘Three Provisions’ jointly promulgated by the
MOC, the State Administration of Radio Film and Television, or the SARFT, and the General Administration of Press and Publication
(“GAPP”), which was issued by the State Commission Office for Public Sector Reform (a division of the State Council)
which became effective on September 7, 2009, provides that the GAPP will have responsibility for the examination and approval
of online games to be uploaded on the Internet and that, after such upload, online games will be administered by the MOC.
Regulations
on Examination of Online Game Content
The
Notice Regarding Improving and Strengthening the Administration of Online Game Content (the “Online Game Content Notice”),
issued by the MOC on November 13, 2009, requests online game operators to improve and adapt their game models by (i) mitigating
the predominance of the “upgrade by monster fighting” model, (ii) limiting the use of the “player killing”
model (where one player’s character attempts to kill another player’s character), (iii) limiting in-game marriages
among players, and (iv) improving their compliance with legal requirements for the registration of minors and game time limits.
The
Notice Regarding the Strengthening of Online Game Content Censorship, issued by the MOC on May 14, 2004, mandates the establishment
of a committee under the MOC to screen the content of imported online games and requires that the content of all imported online
games be approved by the MOC.
Regulations
on Online Gambling and Virtual Currency
On
January 25, 2007, the Ministry of Public Security, the MOC, the MIIT and the GAPP jointly issued the Notice on Regulating Operation
Order of Online Games and Inspection of Gambling via Online Games (the “Anti-gambling Notice”). To curtail online
games that involve online gambling while addressing concerns that virtual currency might be used for money laundering or illicit
trade, the notice (a) prohibits online game operators from charging commissions in the form of virtual currency in connection
with winning or losing of games; (b) requires online game operators to impose limits on use of virtual currency in guessing and
betting games; (c) bans the conversion of virtual currency into real currency or property; and (d) prohibits services that enable
game players to transfer virtual currency to other players.
The
Notice on the Reinforcement of the Administration of Internet Cafés and Online Games (the “Internet Cafés
Notice”) jointly issued by the MOC, the PBOC and other governmental authorities in February 15, 2007 with the goal of strengthening
the administration of virtual currency in online games and to avoid any adverse impact on the PRC economy and financial system,
places strict limits on the total amount of virtual currency issued by online game operators and the amount purchased by individual
players and requires a clear division between virtual transactions and real transactions carried out by way of electronic commerce.
The Internet Cafés Notice further provides that virtual currency should only be used to purchase virtual items and prohibits
any resale of virtual currency.
The
Notice on Strengthening the Administration of Online Game Virtual Currency (the “Virtual Currency Notice”) jointly
issued by the MOC and the MOFCOM on June 4, 2009, defines the meaning of the term “virtual currency” and places a
set of restrictions on the trading and issuance of virtual currency. The Virtual Currency Notice also states that online game
operators are not allowed to give out virtual items or virtual currency through lottery base activities, such as lucky draws,
betting or random computer sampling, in exchange for players’ cash or virtual money.
Regulations
on Anti-fatigue Compliance System and Real-name Registration System
On
July 25, 2014, the SAPPRFT issued the Notice on Deepening Implementation of Authentication of Real Names for Anti-addiction System
on Online Games and effected on October 1, 2014, which specifies that subject to the hardware, technology and other factors, the
anti-addiction compliance system applies to all online games excluding mobile games temporarily. The Service Guidance for the
Approval of Publishing Domestic Online Games issued by the SAPPRFT on January 12, 2017 further clarifies that, the introduction
of the adopted anti-addiction system and the evidential documents of the real-name authentication procedures are required for
applying for publishing online games excluding mobile games temporarily.
On
August 30, 2018, the NRTA, the MOE, the NAPP and five other PRC regulatory authorities jointly issued the Notice of Issuance of
the Implementation Program on Comprehensive Prevention and Control of Adolescent Myopia (the “Myopia Prevention Program”),
proposing to limit the number of new online games in operation, and to restrict the time minors spend playing online games. As
of the Latest Practicable Date, the press and publication authorities have not issued any detailed rules to enforce the Myopia
Prevention Program and therefore, its impact on our future operations and financial performance remains unclear.
The
Notice of Ministry of Culture on Regulating Online Game Operation and Strengthening Interim and Ex Post Supervision, issued by
the MOC on December 1, 2016 and which took effect on May 1, 2017, provides that the online game publishers shall require online
game users to register their real names with valid identity documents, and keep user registration information, and shall not provide
recharge or consumer services in game for online game users who login as visitors and also requires that the online game publishers
shall fully comply with the relevant provisions of the Parents’ Guardian Project for Minors Playing Online Games, based
on which, online game operators shall impose money and time limits for minor users in game and take technical measures to screen
the scenes and functions not appropriate for minors.
Regulations
on Employment and Social Welfare
Labor
Contract Law
The
Labor Contract Law of the PRC, or the Labor Contract Law, which was promulgated on January 1, 2008 and amended on December
28, 2012, is primarily aimed at regulating rights and obligations of employer and employee relationships, including the establishment,
performance and termination of labor contracts. Pursuant to the Labor Contract Law, labor contracts shall be concluded in writing
if labor relationships are to be or have been established between employers and the employees. Employers are prohibited from forcing
employees to work above certain time limit and employers shall pay employees for overtime work in accordance to national regulations.
In addition, employee wages shall be no lower than local standards on minimum wages and shall be paid to employees timely.
Social
Insurance and Housing Fund
As
required under the Regulation of Insurance for Labor Injury implemented on January 1, 2004 and amended in 2010, the Provisional
Measures for Maternity Insurance of Employees of Corporations implemented on January 1, 1995, the Decisions on the Establishment
of a Unified Program for Old-Aged Pension Insurance of the State Council issued on July 16, 1997, the Decisions on the
Establishment of the Medical Insurance Program for Urban Workers of the State Council promulgated on December 14, 1998, the
Unemployment Insurance Measures promulgated on January 22, 1999 and the Social Insurance Law of the PRC implemented
on July 1, 2011, employers are required to provide their employees in the PRC with welfare benefits covering pension insurance,
unemployment insurance, maternity insurance, labor injury insurance and medical insurance.
In
accordance with the Regulations on the Management of Housing Fund which was promulgated by the State Council in 1999 and
amended in 2002, employers must register at the designated administrative centers and open bank accounts for depositing employees’
housing funds. Employer and employee are also required to pay and deposit housing funds, with an amount no less than 5% of the
monthly average salary of the employee in the preceding year in full and on time. See “Risk Factors—Risks Related
to Doing Business in China—The enforcement of the PRC Labor Contract Law and other labor-related regulations in the PRC
may adversely affect our business and results of operations.”
Employee
Stock Incentive Plan
Pursuant
to the Notice of Issues Related to the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive
Plan of Overseas Listed Company, or Circular 7, which was issued by the SAFE on February 15, 2012, employees, directors, supervisors,
and other senior management who participate in any stock incentive plan of a publicly-listed overseas company and who are PRC
citizens or non-PRC citizens residing in China for a continuous period of no less than one year, subject to a few exceptions,
are required to register with SAFE through a qualified domestic agent, which may be a PRC subsidiary of such overseas listed company,
and complete certain other procedures. In addition, the SAT has issued certain circulars concerning employee stock options and
restricted shares. Under these circulars, employees working in the PRC who exercise stock options or are granted restricted shares
will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company are required to file documents
related to employee stock options and restricted shares with relevant tax authorities and to withhold individual income taxes
of employees who exercise their stock option or purchase restricted shares. If the employees fail to pay or the PRC subsidiaries
fail to withhold income tax in accordance with relevant laws and regulations, the PRC subsidiaries may face sanctions imposed
by the tax authorities or other PRC governmental authorities.
Regulations
on Taxation
Enterprise
Income Tax
On
March 16, 2007, the Standing Committee of the National People’s Congress promulgated the Enterprise Income Tax Law of the
PRC which was amended on February 24, 2017 and December 29, 2018. On December 6, 2007, the State Council enacted the Implementation
Regulations for the Enterprise Income Tax Law of the PRC (with the Enterprise Income Tax Law of the PRC, collectively called the
PRC EIT Law), which was amended on April 23, 2019. Under the PRC EIT Law, both resident enterprises and non-resident enterprises
are subject to tax in the PRC. Resident enterprises are defined as enterprises that are established in China in accordance with
PRC laws, or that are established in accordance with the laws of foreign countries but are actually or in effect controlled from
within the PRC. Non-resident enterprises are defined as enterprises that are organized under the laws of foreign countries and
whose actual management is conducted outside the PRC, but have established institutions or premises in the PRC, or have no such
established institutions or premises but have income generated from inside the PRC. Under the PRC EIT Law and relevant implementing
regulations, a uniform enterprise income tax rate of 25% is applied. However, if non-resident enterprises have not formed permanent
establishments or premises in the PRC, or if they have formed permanent establishment or premises in the PRC but there is no actual
relationship between the relevant income derived in the PRC and the established institutions or premises set up by them, enterprise
income tax is set at the rate of 10% with respect to their income sourced from inside the PRC. Pursuant to the PRC EIT Law, the
EIT tax rate of a high and new technology enterprise or HNTE, is 15%. According to the Administrative Measures for the Recognition
of HNTEs, effective on January 1, 2008 and amended on January 29, 2016, for each entity accredited as HNTE, its HNTE status is
valid for three years if it meets the qualifications for HNTE on a continuing basis during such period.
Value-added
Tax
The
Provisional Regulations of on Value-added Tax of the PRC were promulgated by the State Council on December 13, 1993 and came into
effect on January 1, 1994 which were subsequently amended on November 10, 2008 and came into effect on January 1, 2009, and were
further amended on February 6, 2016 and November 19, 2017. The Detailed Rules for the Implementation of Provisional Regulations
of on Value-added Tax of the PRC were promulgated by the Ministry of Finance on December 25, 1993 and subsequently amended on
December 15, 2008 and October 28, 2011, or collectively, VAT Law. On November 19, 2017, the State Council promulgated The Order
on Abolishing the Provisional Regulations of the PRC on Business Tax and Amending the Provisional Regulations of on Value-added
Tax of the PRC, or Order 691. According to the VAT Law and Order 691, all enterprises and individuals engaged in the sale of goods,
the provision of processing, repair and replacement services, sales of services, intangible assets, real property and the importation
of goods within the territory of the PRC are the taxpayers of VAT. The VAT rates generally applicable are simplified as 17%, 11%,
6% and 0%, and the VAT rate applicable to the small-scale taxpayers is 3%.
On
April 4, 2018, the Ministry of Finance and the State Administration of Taxation issued the Circular on Adjustment of VAT Rates,
which became effective as of May 1, 2018. According to the Circular on the Adjustment of VAT Rates, relevant VAT rates have been
reduced from May 1, 2018, such as: (i) VAT rates of 17% and 11% applicable to the taxpayers who have VAT taxable sales activities
or imported goods are adjusted to 16% and 10%, respectively; (ii) VAT rate of 11% originally applicable to the taxpayers who purchase
agricultural products is adjusted to 10% and so on.
Dividend
Withholding Tax
The
PRC EIT Law provides that since January 1, 2008, an enterprise income tax rate of 10% will normally be applicable to dividends
declared to non-PRC resident investors which do not have an establishment or place of business in the PRC, or which have such
establishment or place of business but the relevant income is not effectively connected with the establishment or place of business,
to the extent such dividends are derived from sources within the PRC.
Pursuant
to the Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on Incomes, or the Double Tax Avoidance Arrangement and other applicable
PRC laws, if a Hong Kong resident enterprise is determined by the competent PRC tax authority to have satisfied the relevant conditions
and requirements under such 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%. However, based on the Circular
on Certain Issues with Respect to the Enforcement of Dividend Provisions in Tax Treaties, or the SAT Circular 81, issued on February
20, 2009 by the State Administration of Taxation, or the SAT, if the relevant PRC tax authorities determine, in their discretion,
that a company benefits from such reduced income tax rate due to a structure or arrangement that is primarily tax-driven, such
PRC tax authorities may adjust the preferential tax treatment. According to the Circular on Several Issues regarding the “Beneficial
Owner” in Tax Treaties, which was issued on February 3, 2018 by the SAT, effective as of April 1, 2018, when determining
the applicant’s status of the “beneficial owner” regarding tax treatments in connection with dividends, interests
or royalties in the tax treaties, several factors, including without limitation, whether the applicant is obligated to pay more
than 50% of its income in twelve months to residents in third country or region, whether the business operated by the applicant
constitutes the actual business activities, and whether the counterparty country or region to the tax treaties does not levy any
tax or grant tax exemption on relevant incomes or levy tax at an extremely low rate, will be taken into account, and it will be
analyzed according to the actual circumstances of the specific cases. This circular further provides that applicants who intend
to prove his or her status of the “beneficial owner” shall submit the relevant documents to the relevant tax bureau
according to the Announcement on Issuing the Measures for the Administration of Non-Resident Taxpayers’ Enjoyment of the
Treatment under Tax Agreements.
Tax
on Indirect Transfer
On
February 3, 2015, the SAT issued the Circular on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident
Enterprises, or SAT Circular 7. Pursuant to SAT Circular 7, an “indirect transfer” of assets, including equity interests
in a PRC resident enterprise, by non-PRC resident enterprises, may be re-characterized and treated as a direct transfer of PRC
taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding
payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise
income tax. When determining whether there is a “reasonable commercial purpose” of the transaction arrangement, features
to be taken into consideration include, inter alia, whether the main value of the equity interest of the relevant offshore enterprise
derives directly or indirectly from PRC taxable assets; whether the assets of the relevant offshore enterprise mainly consist
of direct or indirect investment in China or if its income is mainly derived from China; and whether the offshore enterprise and
its subsidiaries directly or indirectly holding PRC taxable assets have real commercial nature which is evidenced by their actual
function and risk exposure. According to SAT Circular 7, where the payor fails to withhold any or sufficient tax, the transferor
shall declare and pay such tax to the tax authority by itself within the statutory time limit. Late payment of applicable tax
will subject the transferor to default interest. SAT Circular 7 does not apply to transactions of sale of shares by investors
through a public stock exchange where such shares were acquired on a public stock exchange. On October 17, 2017, the SAT issued
the Circular on Issues of Tax Withholding regarding Non-PRC Resident Enterprise Income Tax, or SAT Circular 37, which further
elaborates the relevant implemental rules regarding the calculation, reporting and payment obligations of the withholding tax
by the non-resident enterprises. Nonetheless, there remain uncertainties as to the interpretation and application of SAT Circular
7. SAT Circular 7 may be determined by the tax authorities to be applicable to our offshore transactions or sale of our shares
or those of our offshore subsidiaries where non-resident enterprises, being the transferors, were involved.
Regulation
on Foreign Exchange
The
principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations, most recently
amended on August 5, 2008. Under the Foreign Exchange Administration Regulations, payments of current account items, such as profit
distributions and trade and service-related foreign exchange transactions can be made in foreign currencies without prior approval
from SAFE, by complying with certain procedural requirements. However, approval from or registration with appropriate government
authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such
as the repayment of foreign currency-denominated loans.
On
March 30, 2015, SAFE issued SAFE Circular No. 19, which took effective and replaced SAFE Circular No. 142 on June 1, 2015. Although
SAFE Circular No. 19 allows for the use of RMB converted from the foreign currency-denominated capital for equity investments
in China, the restrictions continue to apply as to foreign-invested enterprises’ use of the converted RMB for purposes beyond
the business scope, for entrusted loans or for inter-company RMB loans. SAFE promulgated the Notice of the State Administration
of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or Circular
16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against
using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted
loans to a prohibition against using such capital to issue loans to non-associated enterprises. Violations of SAFE Circular 19
or Circular 16 could result in administrative penalties.
On
November 19, 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange Administration Policies on
Foreign Direct Investment which substantially amends and simplifies the current foreign exchange procedure. Pursuant to this circular,
the opening of various special purpose foreign exchange accounts (e.g., pre-establishment expenses accounts, foreign exchange
capital accounts and guarantee accounts), the reinvestment of lawful incomes derived by foreign investors in China (e.g. profit,
proceeds of equity transfer, capital reduction, liquidation and early repatriation of investment), and purchase and remittance
of foreign exchange as a result of capital reduction, liquidation, early repatriation or share transfer in a foreign-invested
enterprise no longer require SAFE approval, and multiple capital accounts for the same entity may be opened in different provinces,
which was not possible before. In addition, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign
Exchange Administration over Domestic Direct Investment by Foreign Investors and the Supporting Documents in May 2013, which specifies
that the administration by SAFE or its local branches over direct investment by foreign investors in the PRC shall be conducted
by way of registration and banks shall process foreign exchange business relating to the direct investment in China based on the
registration information provided by SAFE and its branches.
On
February 13, 2015, SAFE promulgated the Circular on Further Simplifying and Improving the Policies Concerning Foreign Exchange
Control on Direct Investment, or SAFE Circular No. 13, which took effect on June 1, 2015. SAFE Circular No. 13 delegates the authority
to enforce the foreign exchange registration in connection with the inbound and outbound direct investment under relevant SAFE
rules to certain banks and therefore further simplifies the foreign exchange registration procedures for inbound and outbound
direct investment.
Regulation
on Foreign Exchange Registration of Offshore Investment by PRC Residents
On
July 4, 2014, SAFE issued the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore
Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, and its implementation
guidelines. Pursuant to SAFE Circular 37 and its implementation guidelines, PRC residents (including PRC institutions and individuals)
must register with local branches of SAFE in connection with their direct or indirect offshore investment in an overseas special
purpose vehicle, or SPV, directly established or indirectly controlled by PRC residents for the purposes of offshore investment
and financing with their legally owned assets or interests in domestic enterprises, or their legally owned offshore assets or
interests. Such PRC residents are also required to amend their registrations with SAFE when there is a change to the basic information
of the SPV, such as changes of a PRC resident individual shareholder, the name or operating period of the SPV, or when there is
a significant change to the SPV, such as changes of the PRC individual resident’s increase or decrease of its capital contribution
in the SPV, or any share transfer or exchange, merger, division of the SPV. Failure to comply with the registration procedures
set forth in the Circular 37 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore
company, including the payment of dividends and other distributions to its offshore parent or affiliate, the capital inflow from
the offshore entities and settlement of foreign exchange capital, and may also subject relevant onshore company or PRC residents
to penalties under PRC foreign exchange administration regulations.
Regulation
on Dividend Distributions
The
principal regulations governing distribution of dividends paid by wholly foreign-owned enterprises include:
|
●
|
Company
Law of the PRC (1993), as amended in 1999, 2004, 2005 and 2013;
|
|
●
|
Foreign
Investment Enterprise Law of the PRC (1986), as amended in 2000 and 2016; and
|
|
●
|
Administrative
Rules under the Foreign Investment Enterprise Law (1990), as amended in 2001 and 2014.
|
Under
these 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, a wholly foreign-owned enterprise in
China is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general
reserves until the accumulative amount of such reserves reach 50.0% of its registered capital. These reserves are not distributable
as cash dividends. The foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff
welfare and bonus funds. A PRC company is not permitted to distribute any profits until any losses from prior fiscal years have
been offset. Profits retained from prior fiscal years may be distributed together with distributable profits from the current
fiscal year.
Regulation
on Overseas Listings
On
August 8, 2006, six PRC regulatory agencies, namely, the Ministry of Commerce, the State Assets Supervision and Administration
Commission, SAT, SAIC, China Securities Regulatory Commission, or the CSRC, and SAFE, jointly adopted the Regulations on Mergers
and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, which became effective on September 8, 2006
and were amended on June 22, 2009. The M&A Rules purport, among other things, to require that offshore special purpose vehicles,
or SPVs, that are controlled by PRC companies or individuals and that have been formed for overseas listing purposes through acquisitions
of PRC domestic interest held by such PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing
their securities on an overseas stock exchange. On September 21, 2006, the CSRC published a notice on its official website specifying
documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. In our case,
the CSRC approval was considered not required under the M&A Rules for the listing and trading of our ADSs on the Nasdaq Global
Market given that (i) our PRC subsidiary was directly established by us as wholly foreign-owned enterprises, and we have not acquired
any equity interest or assets of a PRC domestic company owned by PRC companies or individuals as defined under the M&A Rules
that are our beneficial owners after the effective date of the M&A Rules, and (ii) no provision in the M&A Rules clearly
classifies the contractual arrangements as a type of transaction subject to the M&A Rules. However, there can be no assurance
that the relevant PRC government agencies, including the CSRC, would reach the same conclusion.
Loans
by Foreign Companies to their PRC Subsidiaries
Loans
made by foreign investors as shareholders in foreign invested enterprises established in China are considered to be foreign debts
and are mainly regulated by the Regulation of the People’s Republic of China on Foreign Exchange Administration, the Interim
Provisions on the Management of Foreign Debts, the Statistical Monitoring of Foreign Debts Tentative Provisions, the Detailed
Rules for the Implementation of Provisional Regulations on Statistics and Supervision of External Debt, and the Administrative
Measures for Registration of Foreign Debts. Pursuant to these regulations and rules, a shareholder loan in the form of foreign
debt made to a PRC entity does not require the prior approval of SAFE, but such foreign debt must be registered with and recorded
by SAFE or its local branches within 15 business days after entering into the foreign debt contract. Under these regulations and
rules, the balance of the foreign debts of a foreign invested enterprise shall not exceed the difference between the total investment
and the registered capital of the foreign invested enterprise, or Total Investment and Registered Capital Balance.
The
Interim Provisions of the State Administration for Industry and Commerce on the Ratio of the Registered Capital to the Total Investment
of a Sino-Foreign Equity Joint Venture Enterprise was promulgated by SAIC on February 17, 1987 and effective on March 1, 1987.
According to these provisions, with respect to a sino-foreign equity join venture, the registered capital shall be (i) no less
than seven-tenths of its total investment, if the total investment is US$3 million or under US$3 million; (ii) no less than one-half
of its total investment, if the total investment is ranging from US$3 million to US$10 million (including US$10 million), provided
that the registered capital shall not be less than US$2.1 million if the total investment is less than US$4.2 million; (iii) no
less than two-fifths of its total investment, if the total investment is ranging from US$10 million to US$30 million (including
US$30 million), provided that the registered capital shall not be less than US$5 million if the total investment is less than
US$12.5 million; and (iv) no less than one-third of its total investment, if the total investment exceeds US$30 million, provided
that the registered capital shall not be less than US$12 million if the total investment is less than US$36 million.
The
Notice of the People’s Bank of China on Matters concerning the Macro-Prudential Management of Full-Covered Cross-Border
Financing, or PBOC Notice No. 9, issued by the PBOC on January 12, 2017, provides that within a transition period of one year
from January 12, 2017, the foreign invested enterprises may adopt the currently valid foreign debt management mechanism, or Current
Foreign Debt Mechanism, or the mechanism as provided in PBOC Notice No. 9, or Notice No. 9 Foreign Debt Mechanism, at their own
discretion. PBOC Notice No. 9 provides that enterprises may conduct independent cross-border financing in RMB or foreign currencies
as required. According to the PBOC Notice No. 9, the outstanding cross-border financing of an enterprise (the outstanding balance
drawn, here and below) shall be calculated using a risk-weighted approach, or Risk-Weighted Approach, and shall not exceed the
specified upper limit, namely: risk-weighted outstanding cross-border financing ≤ the upper limit of risk-weighted outstanding
cross-border financing. Risk-weighted outstanding cross-border financing = Σ outstanding amount of RMB and foreign currency
denominated cross-border financing x maturity risk conversion factor x type risk conversion factor + Σ outstanding foreign
currency denominated cross-border financing x exchange rate risk conversion factor. Maturity risk conversion factor shall be 1
for medium- and long-term cross-border financing with a term of more than one year and 1.5 for short-term cross-border financing
with a term of less than one year. Type risk conversion factor shall be 1 for on-balance-sheet financing and 1 for off-balance-sheet
financing (contingent liabilities) for the time being. Exchange rate risk conversion factor shall be 0.5. The PBOC Notice No.
9 further provides that the upper limit of risk-weighted outstanding cross-border financing for enterprises shall be 200% of its
net assets, or Net Asset Limits. Enterprises shall file with SAFE in its capital item information system after entering into a
cross-border financing agreement, but no later than three business days before making a withdrawal.
Based
on the foregoing, if we provide funding to our wholly foreign owned subsidiaries through shareholder loans, the balance of such
loans shall not exceed the Total Investment and Registered Capital Balance and we will need to register such loans with SAFE or
its local branches in the event that the Current Foreign Debt Mechanism applies, or the balance of such loans shall be subject
to the Risk-Weighted Approach and the Net Asset Limits and we will need to file the loans with SAFE in its information system
in the event that the Notice No. 9 Mechanism applies. Under the PBOC Notice No. 9, after a transition period of one year from
January 11, 2017, the PBOC and SAFE will determine the cross-border financing administration mechanism for the foreign-invested
enterprises after evaluating the overall implementation of PBOC Notice No. 9. As of the date hereof, neither the PBOC nor SAFE
has promulgated and made public any further rules, regulations, notices or circulars in this regard. It is uncertain which mechanism
will be adopted by the PBOC and SAFE in the future and what statutory limits will be imposed on us when providing loans to our
PRC subsidiaries.
C.
|
ORGANIZATIONAL
STRUCTURE
|
The
following diagram illustrates our corporate structure as of the date of this annual report, including our significant subsidiaries
and VIEs.
The
Principal shareholders of Beijing Wimi are Jie Zhao and Minwen Wu. Jie Zhao, our Chairman, beneficially owns 100% of our outstanding
Class A ordinary shares, 46.9% of our outstanding Class B ordinary shares and 82.05% of the outstanding capital stock of Beijing
Wimi. Minwen Wu, the controlling person of Sensefuture Holdings Limited and Sensebright Holdings Limited, beneficially owns approximately
11.6% of our issued and outstanding Class B ordinary shares, and 11.32% of the outstanding capital stock of Beijing Wimi.
Contractual
Arrangements with Our VIE and Its Respective Shareholders
Currently,
substantially all of our users and business operations are located in the PRC and our primary focus is the PRC hologram market,
which we believe possesses tremendous growth potential and attractive monetization opportunities. In addition, we plan to grow
our presence in international markets and become a global holographic enterprise. We believe that our hologram technology is applicable
to global markets and anticipates expanding our business to new markets.
Current
PRC laws and regulations impose certain restrictions or prohibitions on foreign ownership of companies that engage in value-added
telecommunication services, internet audio-video program services and certain other businesses. The Special Administrative Measures
for Entrance of Foreign Investment (Negative List) (2018 Version) provides that foreign investors are generally not allowed to
own more than 50% of the equity interests in a value-added telecommunication service provider other than an e-commerce service
provider, and the Provisions on the Administration of Foreign-Invested Telecommunications Enterprises (2016 Revision) require
that the major foreign investor in a value-added telecommunication service provider in China must have experience in providing
value-added telecommunications services overseas and maintain a good track record. In addition, foreign investors are prohibited
from investing in companies engaged in certain online and culture related businesses. See “Item 3.D. Risk Factors—Risks
Related to Our Corporate Structure—We are subject to changing law and regulations regarding regulatory matters, corporate
governance and public disclosure that have increased both our costs and the risk of non-compliance” and “Item 4.B.
Business Overview— Regulation—Regulations on Foreign Direct Investment in Value Added Telecommunications Companies.”
We are a company incorporated in the Cayman Islands. Hologram WiMi, our PRC subsidiary, is considered foreign-invested enterprises.
To comply with the foregoing PRC laws and regulations, we primarily conduct our business in China through Beijing WiMi, our VIE
and its subsidiaries in the PRC, based on a series of contractual arrangements. As a result of these contractual arrangements,
we exert effective control over our VIE and its subsidiaries, and consolidate their operating results in our consolidated financial
statements under GAAP. These contractual arrangements may not be as effective as direct ownership in providing us with control
over our VIE. If our VIE or its respective shareholders fail to perform their respective obligations under the contractual arrangements,
we could be limited in our ability to enforce the contractual arrangements that give us effective control over our business operations
in the PRC and may have to incur substantial costs and expend additional resources to enforce such arrangements. We may also have
to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and claiming damages, which
we cannot assure will be effective under PRC law. For details of these and other risks associated with our VIE structure, see
“Item 3.D. Risk Factors—Risks Related to Our Corporate Structure.”
The
following is a summary of the currently effective contractual arrangements by and among Hologram WiMi, Beijing WiMi and the shareholders
of Beijing WiMi. These contractual arrangements enable us to (i) exercise effective control over our VIE; (ii) receive substantially
all of the economic benefits of our VIE; (iii) have an exclusive option to purchase the equity interests in our VIE, and (iv)
have an exclusive option to purchase all or part of the assets of our VIE when and to the extent permitted by PRC law.
However,
there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and
rules. If the PRC government finds that the agreements that establish the structure for operating our hologram business do not
comply with PRC government restrictions on foreign investment in our businesses, we could be subject to severe penalties including
being prohibited from continuing operations. See “Item 3.D. 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 regulations relating to the relevant industries, or if these regulations or their interpretation change in the future,
we could be subject to severe penalties or be forced to relinquish our interests in those operations.”
Agreements
that provide us effective control over our VIE
Power
of Attorney. Pursuant to the power of attorney dated November 6, 2018, by Hologram WiMi and each shareholder of Beijing
WiMi, respectively, each shareholder of Beijing WiMi irrevocably authorized Hologram WiMi or any person(s) designated by Hologram
WiMi to exercise such shareholder’s voting rights in Beijing WiMi, including, without limitation, the power to participate
in and vote at shareholder’s meetings, the power to nominate directors and appoint senior management, the power to sell
or transfer such shareholder’s equity interest in Beijing WiMi, and other shareholders’ voting rights permitted by
PRC law and the Articles of Association of Beijing WiMi. The power of attorney remains irrevocable and continuously valid from
the date of execution so long as each shareholder remains as a shareholder of Beijing WiMi.
Equity
Interest Pledge Agreement. Pursuant to the equity interest pledge agreement dated November 6, 2018, by and among Hologram
WiMi, Beijing WiMi and the shareholders of Beijing WiMi, the shareholders of Beijing WiMi pledged all of their equity interests
in Beijing WiMi to Hologram WiMi to guarantee their and Beijing WiMi’s obligations under the contractual arrangements including
the exclusive consulting and services agreement, the exclusive option agreement, the exclusive asset purchase agreement and the
power of attorney and this equity interest pledge agreement, as well as any loss incurred due to events of default defined therein
and all expenses incurred by Hologram WiMi in enforcing such obligations of Beijing WiMi or its shareholders. The shareholders
of Beijing WiMi agree that, without Hologram WiMi’s prior written approval, during the term of the equity interest pledge
agreement, they will not dispose of the pledged equity interests or create or allow any other encumbrance on the pledged equity
interests. We have completed the registration of the equity pledges with the relevant office of SAIC in accordance with the PRC
Property Rights Law.
Spousal
Consent Letters. Pursuant to these letters, the spouses of the applicable shareholders of Beijing WiMi unconditionally
and irrevocably agreed that the equity interest in Beijing WiMi held by them and registered in their names will be disposed of
pursuant to the equity interest pledge agreement, the exclusive option agreement, the exclusive asset purchase agreement and the
power of attorney. Each of their spouses agreed not to assert any rights over the equity interest in Beijing WiMi held by their
respective spouses. In addition, in the event that any spouse obtains any equity interest in Beijing WiMi held by his or her spouse
for any reason, he or she agreed to be bound by the contractual arrangements.
Agreements
that allow us to receive economic benefits from our VIE
Exclusive
Business Cooperation Agreement. Under the exclusive business cooperation agreement between Hologram WiMi and Beijing WiMi,
dated November 6, 2018, Hologram WiMi has the exclusive right to provide to Beijing WiMi consulting and services related to, among
other things, use of software, operation maintenance, product development, and management and marketing consulting. Hologram WiMi
has the exclusive ownership of intellectual property rights created as a result of the performance of this agreement. Beijing
WiMi agrees to pay Hologram WiMi service fee at an amount equal to the consolidated profit minus the loss (if any). This agreement
will remain effective till the date when it is terminated by WiMi WFOE.
Agreements
that provide us with the option to purchase the equity interests in our VIE
Exclusive
Share Purchase Option Agreement. Pursuant to the exclusive share purchase option agreement dated November 6, 2018, by
and among Hologram WiMi, Beijing WiMi and each of the shareholders of Beijing WiMi, each of the shareholders of Beijing WiMi irrevocably
granted Hologram WiMi an exclusive call option to purchase, or have its designated person(s) to purchase, at its discretion, all
or part of their equity interests in Beijing WiMi, and the purchase price shall be the lowest price permitted by applicable PRC
law. Each of the shareholders of Beijing WiMi undertakes that, without the prior written consent of Hologram WiMi or us, they
may not increase or decrease the registered capital, amend its articles of association or change registered capital structure.
This agreement will remain effective for ten years and can be renewed at Hologram WiMi’s sole discretion. Any transfer of
shares pursuant to this agreement would be subject to PRC regulations and to any changes required thereunder.
Agreements
that provide us with the option to purchase the assets in our VIE
Exclusive
Asset Purchase Agreement. Pursuant to the exclusive asset purchase agreement dated November 6, 2018 by Hologram WiMi and
Beijing WiMi, Beijing WiMi irrevocably granted Hologram WiMi an exclusive call option to purchase, or have its designated person(s)
to purchase, at its discretion, all or part of Beijing WiMi’s current or future assets (including intellectual property
rights), and the purchase price shall be the lowest price permitted by applicable PRC law. Beijing WiMi undertakes that, without
the prior written consent of Hologram WiMi, it may not sell, transfer, pledge, dispose of its assets, incur any debts or guarantee
liabilities. It will notify Hologram WiMi any potential litigation, arbitration or administrative procedures regarding the assets,
and defend the assets if necessary. This agreement will remain effective for ten years and can be renewed at Hologram WiMi’s
sole discretion. Any transfer of assets pursuant to this agreement would be subject to PRC regulations and to any changes required
thereunder.
D.
|
PROPERTY,
PLANT AND EQUIPMENT
|
Our
headquarters is located in Beijing, China and we maintain offices in Shenzhen, China, where we currently lease approximately 1,600
square meter of office space in the aggregate. We believe our existing facilities are adequate for our current requirements and
that additional space can be obtained on commercially reasonable terms to meet our future requirements.
ITEM
4A.
|
UNRESOLVED
STAFF COMMENTS
|
Not
applicable.
ITEM
5.
|
OPERATING
AND FINANCIAL REVIEW AND PROSPECTS
|
The
following discussion and analysis should be read in conjunction with our consolidated financial statements, which have been prepared
in accordance with GAAP, included elsewhere in this Annual Report. This discussion contains forward-looking statement that involves
risks and uncertainties. Our actual results and timing of events could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth under “Item 3.D. Risk Factors” and elsewhere
in this annual report.
Overview
We
offer AR-based holographic services and products to cater to our customers’ needs, all centered upon providing an innovative,
immersive and interactive holographic AR experience for our customers and end users. Our offerings primarily consist of holographic
AR advertising services and holographic AR entertainment products. Approximately 69.3%, 80.5%, and 83.8% of our revenues were
generated by our holographic AR advertising services for the years ended December 31, 2017, 2018, and 2019, respectively. Approximately
30.7%, 19.5%, and 16.2% of our revenues were generated by our holographic AR entertainment products for the years ended December
31, 2017, 2018, and 2019, respectively. The core of our business are holographic AR technologies used in software engineering,
content production, cloud and big data. By leveraging our strong technological capabilities and infrastructure, we are able to
deliver superior products and services and conduct our operations in a highly efficient manner.
We
have grown rapidly since our inception. We generate revenues primarily from holographic AR advertising services and holographic
AR entertainment products. Our total revenues increased by RMB 33,242,040, or 17.3%, from RMB 192,029,524 for the year ended December
31, 2017 to RMB 225,271,564 for the year ended December 31, 2018, and further increased by RMB 93,909,860, or 41.7%, to RMB 319,181,424
for the year ended December 31, 2019. Our net income increased by RMB 15,879,821, or 21.7%, from RMB 73,337,971 for the year ended
December 31, 2017, to RMB 89,217,792 for the year ended December 31, 2018, and further increased by RMB 12,986,680, or 14.6%,
to RMB 102,204,472 for the year ended December 31, 2019.
We
expect that our revenues would grow at a slower rate in the first quarter of 2020, as our business, financial condition, and results
of operations may be adversely affected by the outbreak of COVID-19. For a detailed description of the risks associated with COVID-19,
see “Item 3.D. Risk Factors—Risks Related to Our Business and industry—Our business could be materially harmed
by the ongoing coronavirus (COVID-19) pandemic.” Due to the significant uncertainties surrounding the outbreak of COVID-19,
the extent of the business disruption and the related financial impacts on our business cannot be reasonably estimated at this
time.
Key
Factors Affecting Results of operations
Our
results of operations are affected by the factors discussed below.
Our
ability to increase number of customers and average revenue for AR advertising services
Approximately
69.3%, 80.5%, and 83.8% of our revenues were generated by our AR advertising services for the years ended December 31, 2017, 2018,
and 2019, respectively. The number of our customers for our AR advertising services increased from 97 for the year ended December
31, 2017, to 121 for the year ended December 31, 2018, and further increased to 153 for the year ended December 31, 2019. In addition,
average revenue per customer for AR advertising services was approximately RMB 1.4 million, RMB 1.5 million, and RMB1.7 million
for the years ended December 31, 2017, 2018 and 2019, respectively. Our ability to increase our revenues and our profitability
will depend on our ability to continue to increase our customer base and revenue per customer for our AR advertising services.
To achieve this, we strive to increase our marketing efforts and to enhance the quality and capabilities of our technologies.
Investment
in technology and talent
We
believe that a core element of the competitiveness of the holographic AR industry is research and development related to technology
development. The advancement of technology related to holographic AR will take the holographic AR experience, new services, products
and capabilities, to newer stages of development. To retain and attract existing and potential customers, we must continue to
innovate to keep pace with the growth of our business and bring forward cutting-edge technologies. Our current research and development
efforts are primarily focused on enhancing our artificial intelligence technology, holographic AR and image processing technology,
intelligent hardware technology, and photosensitive signal transmission technology to create novel service and product offerings.
China’s
per capita expenditure on education, cultural and recreation
Our
business and results of operations are affected by a number of general factors affecting China’s holographic AR industry,
which include the per capita expenditure on education, culture and recreation in China. The increase in expenditure on education,
culture and recreation boosts the growth of relevant markets, such as entertainment market and consuming electronic device market,
which in turn will increase the market demand of our services and products.
Our
ability to pursue strategic opportunities for growth
We
intend to continue to pursue strategic acquisitions and investments in selective technologies and businesses in the holographic
AR industry that will enhance our technology capabilities. We believe that a solid acquisition and investment strategy may be
critical for us to accelerate our growth and strengthen our competitive position in the future. Our ability to identify and execute
strategic acquisitions and investments will likely have an effect on our operating results over time.
Our
ability to expand our application fields and diversifying customer base
Currently,
the existing applications of holographic AR include primarily the entertainment and advertising industries, which are the industries
we are currently focused on. With increasing awareness and acceptance of this technology, we expect that more applications will
be identified to magnify the value of this technology, such as assistance in surgery and tele-diagnosis, and assistance in training
and education. Our ability to expand our application fields and diversify our customer base may affect our operating results in
the future.
Operating
Efficiency
Our
ability to maintain and increase profitability also depends on our ability to effectively control our costs and expenses. Significant
components of our cost of revenues are the cost paid to channel providers, cost paid to third-party consultants and cost of salaries
(including social security and benefits). Salaries primarily include compensation to our software engineers and operating staffs.
Our ability to negotiate better pricing with channel providers in desktop applications and decrease the use of third-party consultants
has enable us to keep a relatively high gross margin for the three years 2017, 2018 and 2019. Our operating expenses consist of
selling expenses, general and administrative expenses and research and development expenses. For the years ended December 31,
2017, 2018 and 2019, our total operating expenses as a percentage of our total revenues were 18.5%, 17.3% and 18.8%, respectively.
We expect that our expenses will increase as our business continues to grow, and we may incur additional expenses associated with
being a public company. However, we believe that our expenses will grow at a lower rate compared to the growth rate of our revenues.
Key
Components of Our Results of Operations:
Revenues
Our
revenues consist of AR advertising services revenues and AR entertainment revenues. AR advertising services use holographic AR
materials and integrate them into advertisement on the online media platforms or offline displays. We generate revenues when we
completed our performance obligation to deliver related services based on the specific terms of the contract, which are commonly
based on specific action (i.e. cost per impression”(“CPM”) or cost per action (“CPA”)) for online display
and service period for offline display contracts. Over 90% of our contracts with customers are based on CPM. Prior to 2019, our
AR advertising markets were mainly in desktop applications. Starting in the second half of 2019, we began to provide AR advertising
services to short form mobile video streaming market, namely advertising on Tik-Tok or similar medium.
AR
entertainment revenues include revenues generated from software development kit (“SDK”) payment channel services, software
development, mobile games services and technology developments. We generate related revenues when a user completes the payment
transaction for SDK payments, net of payments to content providers. We also generate revenues from sales of software development
services. Revenues generated from mobile games include royalty payments from licensee operators of our mobile games and fees collected
from game developers for using our game portal.
Our
breakdown of revenues for the years ended December 31, 2017, 2018 and 2019, respectively, is summarized below:
|
|
For the Years Ended December 31,
|
|
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
AR advertising
|
|
|
133,078,464
|
|
|
|
181,241,346
|
|
|
|
267,514,061
|
|
|
|
38,346,673
|
|
AR entertainment
|
|
|
58,951,060
|
|
|
|
44,030,218
|
|
|
|
51,667,363
|
|
|
|
7,406,233
|
|
Total revenue
|
|
|
192,029,524
|
|
|
|
225,271,564
|
|
|
|
319,181,424
|
|
|
|
45,752,906
|
|
Cost
of Revenues
For
AR advertising services, the cost of revenues consist of the costs paid to channel providers in accordance with revenue-sharing
arrangements. For AR entertainment, the cost of revenues consist of the shared costs with content providers based on the profit
sharing arrangements, third-party consulting services expenses and compensation expenses for our professionals.
Our
breakdown of cost of revenues for the years ended December 31, 2017, 2018 and 2019, respectively, is summarized below:
|
|
For the Years Ended December 31,
|
|
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Cost of revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
AR advertising
|
|
|
66,148,464
|
|
|
|
81,437,761
|
|
|
|
140,716,036
|
|
|
|
20,170,872
|
|
AR entertainment
|
|
|
13,031,723
|
|
|
|
3,976,300
|
|
|
|
5,451,807
|
|
|
|
781,486
|
|
Total cost of revenues
|
|
|
79,180,187
|
|
|
|
85,414,061
|
|
|
|
146,167,843
|
|
|
|
20,952,358
|
|
Operating
expenses
Operating
expenses include selling, general and administrative and research and development expenses. Selling expenses are mainly salary
and benefit expenses for our sales team and related travel expenses. General and administrative expenses are mainly salary and
benefit of management, professional fees, services fees, rental and other operating expenses of attributable to general and administrative
activities. Research and development expenses are mainly salary and benefits for in house software engineers and payments made
to outside subcontractors.
We
anticipate that our operating expenses will continue to increase as we hire additional personnel and incur additional costs in
connection with the expansion of our business operations as well as becoming a publicly traded company.
Results
of Operations
Our
consolidated results of operations for the years ended December 31, 2017, 2018 and 2019 are summarized below:
|
|
For the Years Ended December 31,
|
|
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Revenues
|
|
|
192,029,524
|
|
|
|
225,271,564
|
|
|
|
319,181,424
|
|
|
|
45,752,906
|
|
Cost of revenues
|
|
|
(79,180,187
|
)
|
|
|
(85,414,061
|
)
|
|
|
(146,167,843
|
)
|
|
|
(20,952,358
|
)
|
Gross profit
|
|
|
112,849,337
|
|
|
|
139,857,503
|
|
|
|
173,013,581
|
|
|
|
24,800,548
|
|
Selling expenses
|
|
|
(1,235,773
|
)
|
|
|
(1,212,400
|
)
|
|
|
(1,924,784
|
)
|
|
|
(275,907
|
)
|
General and administrative expenses
|
|
|
(24,618,898
|
)
|
|
|
(29,822,426
|
)
|
|
|
(39,881,854
|
)
|
|
|
(5,716,845
|
)
|
Research and development expenses
|
|
|
(9,696,322
|
)
|
|
|
(8,020,082
|
)
|
|
|
(18,355,403
|
)
|
|
|
(2,631,147
|
)
|
Income from operations
|
|
|
77,298,344
|
|
|
|
100,802,595
|
|
|
|
112,851,540
|
|
|
|
16,176,649
|
|
Other expense, net
|
|
|
(3,432,362
|
)
|
|
|
(3,509,207
|
)
|
|
|
(7,517,988
|
)
|
|
|
(1,077,663
|
)
|
Income before provision for income taxes
|
|
|
73,865,982
|
|
|
|
97,293,388
|
|
|
|
105,333,552
|
|
|
|
15,098,986
|
|
Provision for income taxes
|
|
|
(528,011
|
)
|
|
|
(8,075,596
|
)
|
|
|
(3,129,080
|
)
|
|
|
(448,536
|
)
|
Net income
|
|
|
73,337,971
|
|
|
|
89,217,792
|
|
|
|
102,204,472
|
|
|
|
14,650,450
|
|
Other comprehensive income (loss)
|
|
|
(250,623
|
)
|
|
|
1,759,288
|
|
|
|
1,589,076
|
|
|
|
227,785
|
|
COMPREHENSIVE INCOME
|
|
|
73,087,348
|
|
|
|
90,977,080
|
|
|
|
103,793,548
|
|
|
|
14,878,235
|
|
Year
Ended December 31, 2019 Compared to Year Ended December 31, 2018
Revenues
Our
revenues increased by approximately RMB 93.9 million, or 41.7%, from approximately RMB 225.3 million for the year ended December
31, 2018 to approximately RMB 319.2 million (USD 45.8 million) for the year ended December 31, 2019, due to an increase of approximately
RMB 86.3 million (USD 12.4 million) in AR advertising revenue and an increase of approximately RMB 7.6 million (USD 1.1 million)
in AR entertainment revenue.
Our
AR advertising revenue increased by approximately RMB 86.3 million, or 47.6%, from approximately RMB 181.2 million for the year
ended December 31, 2018 to approximately RMB 267.5 million (USD 38.3 million) for the year ended December 31, 2019. The increase
was primarily attributable to the increase in the number of advertisers who became our customers as a result of more referrals
from existing customers who were satisfied with our services. The number of our customers for advertising services increased by
32, from 121 for the year ended December 31, 2018 to 153 for the year ended December 31, 2019. Average revenue per customer for
AR advertising services increased from approximately RMB 1.5 million for the year ended December 31, 2018 to approximately RMB
1.7 million for the year ended December 31, 2019. The increase in average revenue was due to the improvement in technologies,
which enabled us to embed more contents in the advertisements. The number of paid impressions through our AR advertising increased
by 47.0% from approximately 6.6 billion in 2018 to approximately 9.7 billion 2019 due to an increase in the number of advertisers.
The increase was also due to the launch of our advertising services in the short form mobile streaming market, where we derived
approximately 15.5% of our AR advertising revenue. Prior to May 2019, most of our AR advertising were from more traditional desktop
markets.
Our
AR entertainment revenue increased by approximately RMB 7.6 million, or 17.3%, from approximately RMB 44.0 million for the year
ended December 31, 2018 to approximately RMB 51.7 million (USD 7.6 million) for the year ended December 31, 2019. The increase
in AR entertainment revenue was primarily attributable to an increase in mobile games service fee revenue recognized in the second
half of 2019 and an increase in MR software revenue due to the upgrade of certain MR software modules during the second half of
2019. Such upgrade is expected to be completed across all MR software modules in 2020.
We
launched the 233 Game Platform, a mobile game distribution platform, in 2018, by migrating users from our desktop games
to such platform. In addition, new users have joined the platform since its launch. As of December 31, 2019, there were over 800
apps operating on such platform and over 260,000 active members. We started generating revenue from such platform in the second
quarter of 2019, although revenue recognized in the first half of 2019 was relatively low. As we continued to add popular apps,
and certain existing games increased in popularity with users, in the second half of 2019, revenue attributable to mobile games
service fees increased.
Cost
of Revenues
Our
total cost of revenues increased by approximately RMB 60.8 million, or 71.1%, from approximately RMB 85.4 million for the year
ended December 31, 2018 to approximately RMB 146.2 million (USD 21.0 million) for the year ended December 31, 2019.
Our
cost of revenues for AR advertising services increased by approximately RMB 59.3 million, or 72.8%, from approximately RMB 81.4
million for the year ended December 31, 2018 to approximately RMB 140.7 million (USD 20.2 million) for the year ended December
31, 2019. The increase in cost of revenues was in line with the increase of AR advertising services revenue. Starting in the second
half of 2019, we started to provide AR advertising services in short form mobile video streaming market. Due to the nature of
the medium, less ad can be placed on a short video based on current technology. In addition, since the market was dominated by
a few major channel providers, the average cost of revenue of AR advertising services from short video streaming market was relatively
higher, compared with that of other AR advertising channels from desktop applications.
Our
cost of revenues for AR entertainment increased by approximately RMB 1.5 million, or 37.1%, from approximately RMB 4.0 million
for the year ended December 31, 2018 to approximately RMB 5.5 million (USD 0.8 million) for the year ended December 31, 2019.
The increase in cost of revenue was in line with increased revenue as we used third party service providers.
Gross
Profit
Our
gross profit increased by approximately RMB 33.1 million, from approximately RMB 139.9 million for the year ended December 31,
2018 to approximately RMB 173.0 million (USD 24.8 million) during the year ended December 31, 2019. The increase was mainly due
to the significant increase in AR advertising revenues during the year ended December 31, 2019. For the years ended December 31,
2018 and 2019, our overall gross margin was 62.1% and 54.2%, respectively. The decrease in gross margin was primarily caused by
the higher average cost of revenue of AR advertising services on short videos market we entered in May 2019.
Our
gross profit and gross profit margin from our major business segments are summarized as follows:
|
|
For the Years ended December 31,
|
|
|
Variance
|
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
Amount/%
|
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
|
|
|
AR advertising
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
99,803,585
|
|
|
|
126,798,025
|
|
|
|
18,175,801
|
|
|
|
26,994,440
|
|
Gross margin
|
|
|
55.1
|
%
|
|
|
47.4
|
%
|
|
|
|
|
|
|
27.0
|
%
|
AR entertainment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
40,053,918
|
|
|
|
46,215,556
|
|
|
|
6,624,747
|
|
|
|
6,161,638
|
|
Gross margin
|
|
|
91.0
|
%
|
|
|
89.4
|
%
|
|
|
|
|
|
|
15.4
|
%
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
139,857,503
|
|
|
|
173,013,581
|
|
|
|
24,800,548
|
|
|
|
33,156,078
|
|
Gross margin
|
|
|
62.1
|
%
|
|
|
54.2
|
%
|
|
|
|
|
|
|
23.7
|
%
|
Our
gross margin for AR advertising services decreased from 55.1% for the year ended December 31, 2018 to 47.4% for the year ended
December 31, 2019 mainly due to higher average cost of revenue for AR advertising services on short videos which we started in
May 2019.
Our
gross margin for AR entertainment services remained relatively stable, at 91.0% and 89.4% for the years ended December 31, 2018
and 2019, respectively.
Operating
Expenses
For
the year ended December 31, 2019, we incurred approximately RMB 60.2 million (USD 8.6 million) in operating expenses, representing
an increase of approximately RMB 21.1 million, or 54.0%, from approximately RMB 39.1 million for the year ended December 31, 2018,
primarily due to significant increases in general and administrative expenses and research and development expenses.
Selling
expenses increased by approximately RMB 0.7 million, or 58.8%, from approximately RMB 1.2 million for the year ended December
31, 2018 to approximately RMB 1.9 million (USD 0.3 million) for the year ended December 31, 2019. The increase was mainly due
to an increase in salary and benefit expenses for our sales team and related travel expenses of approximately RMB 0.7 million.
Selling expenses accounted for 1.0% of total revenue for the years ended December 31, 2018 and 2019, respectively.
General
and administrative expenses increased by approximately RMB 10.1 million, or 33.7%, from RMB 29.8 million for the year ended December
31, 2018 to approximately RMB 39.9 million (USD 5.7 million) for the year ended December 31, 2019. The increase was mainly due
to an increase in professional fees, including audit fees and other professional fees of approximately RMB 6.9 million in relation
to our initial public offering, an increase of travel expenses of approximately RMB 0.7 million, an increase of allowance for
doubtful accounts of approximately RMB 1.6 million and an increase of other office expenses,
including rent and salary of approximately RMB 0.7 million in connection with
our two leases for our offices in 2019.
Research
and development expenses increased by approximately RMB 10.3 million, or 128.9%, from approximately RMB 8.0 million for the year
ended December 31, 2018 to approximately RMB 18.4 million (USD 2.6 million) for the year ended December 31, 2019, as we continued
to focus on developing our technological capabilities in order to maintain our competitive advantage in the AR hologram industry.
Other
income (expenses), net
Total
other expenses, net, were approximately RMB 3.5 million and RMB 7.5 million (USD 1.1 million) for the years ended December 31,
2018 and 2019, respectively.
Other
income included gain from disposal of our investments, government subsidies and input VAT tax credits. For the year ended December
31, 2018, we sold one of the cost-method investments with basis of RMB 50,000 for approximately
RMB 0.4 million (USD 51,000), resulting in a gain from disposal of cost-method investment of approximately
RMB 0.3 million (USD 44,000). There was no disposal of cost-method investment in 2019.
Other
income also included government subsidies, which increased by approximately RMB 0.2 million, from approximately RMB 1.2 million
for the year ended December 31, 2018 to approximately RMB 1.4 million (USD 0.2 million) for the year ended December 31, 2019,
as we applied for, and received, more government grants for new technology and software.
Other
income also included approximately RMB 0.9 million (USD 0.1 million) of input VAT credit that we redeemed during the year
ended December 31, 2019. As part of VAT reform in 2019, a taxpayer in certain service industries was allowed to reclaim additional
10% of input VAT credit against the amount of VAT payable from April 1, 2019 to December 31, 2021.
Finance
expenses, net, mainly consisting of amortization of debt discount and currency exchange gain. The amortization of debt discount
was RMB 5.1 million and RMB 11.5 million (USD 1.7 million) for the years ended December 31, 2018 and 2019, respectively. The increase
in finance expenses was resulted from payment of long-term business acquisition payables. Currency exchange gain amounted to approximately
RMB 0.8 million (USD 0.1 million) for the year ended December 31, 2019.
Interest
income increased from approximately RMB 24,000 for the year ended December 31, 2018 to approximately RMB 1.2 million (USD 0.2
million) for the year ended December 31, 2019. Interest income consisted of bank interest income, which was derived from
funds that we received from the issuance of the preferred shares in the November of 2018 that had an annual interest rate of approximately
1.8%.
Provision
for income taxes
Our
income tax expenses decreased by approximately RMB 5.0 million, or 61.3%, from approximately RMB 8.1 million for the year ended
December 31, 2018 to approximately RMB 3.1 million (USD 0.5 million) for the year ended December 31, 2019. Current income tax
decreased by approximately RMB 5.0 million due to the increased taxable income of Shenzhen Yiruan, Shenzhen Yiyun, Shenzhen Yidian
and Shenzhen Duodian, which received preferential tax treatment due to their status as High and New Technology Enterprises.
Net
income
As
a result of the combination of factors discussed above, our net income increased from approximately RMB 89.2 million for the year
ended December 31, 2018 to approximately RMB 102.2 million (USD 14.7 million) for the year ended December 31, 2019.
Year
Ended December 31, 2018 Compared to Year Ended December 31, 2017
Revenues
Our
total revenues increased by approximately RMB 33.2 million, or 17.3%, from approximately RMB 192.0 million for the year ended
December 31, 2017 to approximately RMB 225.3 million for the year ended December 31, 2018, due to an increase of approximately
RMB 48.2 million in AR advertising revenue, which was partially offset by a decrease of approximately RMB 14.9 million in AR entertainment
revenue.
Our
AR advertising revenue increased by approximately RMB 48.2 million, or 36.2%, from approximately RMB 133.1 million for the year
ended December 31, 2017 to approximately RMB 181.2 million for the year ended December 31, 2018. The increase was primarily attributable
to an increase in the number of advertisers who became our customers as a result of more referrals from existing customers who
were satisfied with our services. The number of our customers for advertising services increased from 97 for the year ended December
31, 2017 to 121 for the year ended December 31, 2018. Average revenue per customer for advertising services increased from approximately
RMB 1.4 million for the year ended December 31, 2017 to approximately RMB 1.5 million for the year ended December 31, 2018, primarily
due to the improvement in technologies, which enabled us to embed more contents in the advertisements. The number of paid impressions
through our AR advertising increased by 34.7%, from 4.9 billion in 2017 to approximately 6.6 billion 2018 due to an increase in
advertisers.
Our
AR entertainment revenue decreased by approximately RMB 14.9 million, or 25.3%, from approximately RMB 58.9 million for the year
ended December 31, 2017 to approximately RMB 44.0 million for the year ended December 31, 2018. The decrease in AR entertainment
revenue was primarily attributable to a decrease in MR software development service fee recognized in the relevant period. In
2018, we planned a major upgrade on software system infrastructure and system coding to update the platform, system and application
layers. The upgrade would improve holographic AR simulation and solve certain issues on delay rate, where it would stabilize the
software interface with other applications. We intended to continue to upgrade and customize our platform according to customers’
needs and we expected to complete a substantial portion of this upgrade in the third quarter of 2019. We had approximately RMB
19 million of uncompleted contracts and we expected to recognize these revenues in the third quarter of 2019, pending final customers’
acceptance. However, there can be no assurance that we will be successful in completing our upgrade timely, or at all, and fulfilling
these contracts and recognizing these revenues within the specific timeframe, if at all.
Cost
of Revenues
Total
cost of revenues increased by approximately RMB 6.2 million, or 7.9%, from approximately RMB 79.2 million for the year ended December
31, 2017 to approximately RMB 85.4 million for the year ended December 31, 2018.
Our
cost of revenues for AR advertising services increased by approximately RMB 15.3 million, or 23.1%, from approximately RMB 66.1
million for the year ended December 31, 2017 to approximately RMB 81.4 million for the year ended December 31, 2018. The increase
of cost of revenues in connection with AR advertising was in line with the increase of AR advertising services revenue. However
increase in cost of revenues was less than the increase in AR advertising revenue, as we were able to negotiate better cost with
our channel providers due to increased sales volume in AR advertising services.
Our
cost of revenue for AR entertainment services decreased by approximately RMB 9.0 million, or 69.5%, from approximately RMB 13.0
million for the year ended December 31, 2017 to approximately RMB 4.0 million for the year ended December 31, 2018. The decrease
in cost of revenues in connection with AR entertainment services was in line with the decrease in AR entertainment revenue, as
we used more our professionals rather than third-party consultants.
Gross
Profit
Our
gross profit increased by approximately RMB 27.0 million, from approximately RMB 112.8 million for the year ended December 31,
2017 to approximately RMB 139.8 million for the year ended December 31, 2018. The increase was mainly due to the significant increase
of AR advertising revenue during the year ended December 31, 2018. For the years ended December 31, 2017 and 2018, our overall
gross margin was 58.8% and 62.1%, respectively. The increase in gross margin was due to the increased gross margins of the two
segments.
Our
gross profit and gross profit margin from our major revenue categories are summarized as follows:
|
|
For the Years ended
December 31,
|
|
|
Variance
|
|
|
|
2017
|
|
|
2018
|
|
|
Amount/%
|
|
|
|
RMB
|
|
|
RMB
|
|
|
|
|
AR advertising
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
66,930,000
|
|
|
|
99,803,585
|
|
|
|
32,873,585
|
|
Gross margin
|
|
|
50.3
|
%
|
|
|
55.1
|
%
|
|
|
4.8
|
%
|
AR entertainment
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
45,919,337
|
|
|
|
40,053,918
|
|
|
|
(5,865,419
|
)
|
Gross margin
|
|
|
77.9
|
%
|
|
|
91.0
|
%
|
|
|
13.1
|
%
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
112,849,337
|
|
|
|
139,857,503
|
|
|
|
27,008,166
|
|
Gross margin
|
|
|
58.8
|
%
|
|
|
62.1
|
%
|
|
|
3.3
|
%
|
Our
gross margin for AR advertising services increased from 50.3% for the year ended December 31, 2017 to 55.1% for the year ended
December 31, 2018 mainly due to our ability to increase revenue and effectively control our cost for the year ended December 31,
2018.
Our
gross margin for AR entertainment increased from 77.9% for the year ended December 31, 2017 to 91.0% for the year ended December
31, 2018, mainly due to an increase in revenues from our SDK payment channel services and mobile games operations, which had higher
gross margins.
Operating
Expenses
For
the year ended December 31, 2018, we incurred approximately RMB 39.1 million in operating expenses, representing an increase of
approximately RMB 3.5 million, or 9.9%, from approximately RMB 35.6 million for the year ended December 31, 2017.
Selling
expenses were approximately RMB 1.2 million for the years ended December 31, 2017 and 2018, respectively. Selling expenses were
mainly salary and benefit expenses for our sales team and related travel expenses. Selling expenses remained fairly stable, representing
approximately 0.64% and 0.54% of our total revenues for the years ended December 31, 2017 and 2018, respectively.
General
and administrative expenses increased by approximately RMB 5.2 million, or 21.1%, from RMB 24.6 million for the year ended December
31, 2017 to approximately RMB 29.8 million for the year ended December 31, 2018. The increase was mainly due an increase of approximately
RMB 2.9 million in professional fees including audit fees and other professional fees in relation to our initial public offering,
an increase of approximately RMB 0.8 million in amortization and depreciation expenses, an increase of approximately RMB 0.8 million
in salary and benefit expenses attributable to the subsidiaries established during the last quarter of 2017. General and administrative
expenses remained fairly consistent, representing approximately 12.8% and 13.2% of our total revenues for the years ended December
31, 2017 and 2018, respectively.
Research
and development expenses decreased by approximately RMB 1.7 million, or 17.3%, from approximately RMB 9.7 million for the year
ended December 31, 2017 to approximately RMB 8.0 million for the year ended December 31, 2018. The decrease was mainly due to
our ability to effectively utilize our R&D capabilities.
Other
income (expenses), net
Total
other expenses, net were approximately RMB 3.4 million and RMB 3.5 million for the years ended December 31, 2017 and 2018, respectively.
Other
income included gain from disposal of our investments. For the year ended December 31, 2018, we sold one of the cost-method investments
with basis of RMB 50,000 in 2018 for RMB 350,000, resulting in a gain from disposal of cost-method investment of RMB 300,000.
We also disposed one of our subsidiaries for RMB 156,225 in November 2017, resulting in RMB 134,774 of gain from disposal of subsidiary.
Other
income also included government subsidies, which increased by approximately RMB 0.6 million in 2018, as we applied and qualified
for more government grants for new technology and software.
Finance
expenses were mainly amortization of debt discount, and amounted to RMB 4,191,002 and RMB 5,124,715 for the years ended December
31, 2107 and 2018, respectively, which resulted from long-term business acquisition payables.
Provision
for income taxes
Our
income tax expenses increased by approximately RMB 7.5 million, or 1,429.4%, from approximately RMB 0.5 million for the year ended
December 31, 2017 to approximately RMB 8.1 million for the year ended December 31, 2018.
Current
income tax increased by approximately RMB 7.6 million due to the increased taxable income of Shenzhen Yiren, Shenzhen Qianhai
and Shenzhen Yidian, whose two years of tax exempt status has expired and are now taxed at a reduced income tax rate of 12.5%.
Net
income
As
a result of the combination of factors discussed above, our net income increased from approximately RMB 73.3 million for the year
ended December 31, 2017, to approximately RMB 89.2 million for the year ended December 31, 2018.
Taxation
Cayman
Islands
The
Cayman Islands currently levy no taxes on individuals or corporations based upon profits, income, gains or appreciation and there
is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by
the government of the Cayman Islands except for stamp duties. which may be applicable on instruments executed in, or after execution,
brought within the jurisdiction of the Cayman Islands. In addition, the Cayman Islands does not impose withholding tax on dividend
payments.
Hong
Kong
WiMi
HK, our wholly-owned Hong Kong subsidiary, and Micro Beauty, the wholly-owned subsidiary of our VIE, are subject to Hong Kong
profits tax at a tax rate of 16.5%. We have not made any provisions for Hong Kong profit tax as there has been no assessable profit
derived from or earned in Hong Kong since their respective inceptions. Under Hong Kong tax laws, WiMi HK is exempted from income
tax on its foreign-derived income. Hong Kong does not impose a withholding tax on dividends.
Seychelles
Skystar,
a company incorporated in Seychelles, is not subject to tax on income generated outside of Seychelles under the current tax laws,
which do not impose withholding tax upon payments of dividends.
PRC
Under
the Enterprise Income Tax Laws of the PRC”(the “EIT Laws”), domestic enterprises and Foreign Investment Enterprises
(the “FIE”) are usually subject to a unified 25% enterprise income tax rate, while preferential tax rates, tax holidays
and tax exemption may be granted on case-by-case basis. EIT grants preferential tax treatment to certain High and New Technology
Enterprises (“HNTEs”). Under this preferential tax treatment, HNTEs are entitled to an income tax rate of 15%, subject
to the requirement that they re-apply for HNTE status every three years. Shenzhen Kuxuanyou obtained the HNTE tax status in October
2015, which reduced its statutory income tax rate to 15% from November 2016 to November 2019. Shengzhen Yiruan, Shenzhen Yiyun,
Shenzhen Yidian and Shenzhen Duodian were qualified as software companies by the local taxing authority and obtained two years
of tax exemption since their respective inception. After their tax exemption period, they can be taxed at a reduced income tax
rate of 12.5% for three years. After the initial 5 years, these companies can apply for the reduced rate on a yearly basis. In
addition, 75% of R&D expenses of Shenzhen Kuxuanyou are subject to additional deduction from pre-tax income and 50% of R&D
expenses of Shenzhen Yiruan are subject to additional deduction from pre-tax income.
Korgas
Shengyou, Korgas Wimi, and Korgas 233 were formed and registered in Korgas in Xinjiang Provence, China from 2016 to 2017, and
Kashi Duodian was formed and registered in Kashi in Xinjiang Provence, China in 2019. These companies are not subject to income
tax for 5 years, and can obtain another two years of tax exempt status and are taxed at reduced income tax rate of 12.5% for three
years, due to the local tax policies to attract companies in various industries.
Shenzhen
Qianhai and Shenzhen Zhiyun were formed and registered in Qianhai District in Guangdong Provence, China in 2015 and 2019, respectively.
These companies are subject to income tax at a reduced rate of 15% due to the local tax policies to attract companies in various
industries.
Certain
subsidiaries of our VIE were formed and registered in Korgas and Kashi, China. These companies can enjoy tax exemption for 5 years
after their respective inceptions, and can be exempted from income tax for another two years and taxed at a reduced income tax
rate of 12.5% for three years, after the initial 5 years’ of tax exemption periods.
Critical
Accounting Policies and Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires
our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and
related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant
to the preparation of our financial statements. These accounting policies are important for an understanding of our financial
condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial
conditions and results of operations and require management’s difficult, subjective, or complex judgment, often as a result
of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the
possibility that future events affecting the estimate may differ significantly from management’s current judgments. While
our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included elsewhere
in this report, we believe the following critical accounting policies involve the most significant estimates and judgments used
in the preparation of our financial statements.
Basis
of Presentation and Principals of Consolidation
Basis
of presentation
The
accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted
in the United States of America (“U.S. GAAP”) for information pursuant to the rules and regulations of the Securities
Exchange Commission.
Principles
of consolidation
The
consolidated financial statements include the financial statements of our company and our subsidiaries, which include the wholly-
foreign owned enterprise (“WFOE”) and variable interest entities (“VIEs”) over which we exercise control and,
when applicable, entities for which we have a controlling financial interest or is the primary beneficiary. All transactions and
balances among us and our subsidiaries have been eliminated upon consolidation.
Use
of Estimates and Assumptions
The
preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date
of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Significant
accounting estimates reflected in our consolidated financial statements include the useful lives of property and equipment and
intangible assets, impairment of long-lived assets and goodwill, allowance for doubtful accounts, provision for contingent liabilities,
revenue recognition, and deferred taxes and uncertain tax position. Actual results could differ from these estimates.
Goodwill
Impairment Testing
We
perform annual goodwill impairment analysis as of December 31 with the assistance of independent valuation expert in accordance
with the subsequent measurement provisions of FASB ASC Topic 350, Intangibles—Goodwill and Other. This impairment analysis
compares the fair values of our reporting units to their related carrying values. If a reporting unit carrying value exceeds its
fair value, we then calculate the reporting unit’s implied fair value of goodwill and impairment charges are recorded for any
excess of the goodwill carrying value over the implied fair value of goodwill.
The
reporting units’ fair values are determined by income approach where projected future cash flows discounted at rates commensurate
with the risks involved, (“Discounted Cash Flow” or “DCF” of the income approach). This approach is supplemented
by the market approach, (Guideline Company Method) to ensure the typical multiple such as EBITDA was within range of comparable
companies.
Assumptions
used in a DCF analysis require the exercise of significant judgment, including judgment about appropriate discount rates and terminal
values, growth rates, and the amount and timing of expected future cash flows. The forecasted cash flows are based on current
plans and for years beyond that plan, the estimates are based on assumed growth rates. We believe that our assumptions are consistent
with the plans and estimates used to manage the underlying businesses. The discount rates, which are intended to reflect the risks
inherent in future cash flow projections, used in a DCF analysis are based on estimates of the weighted-average cost of capital
“WACC”) of a market participant. Such estimates are derived from our analysis of peer companies and consider
the industry weighted average return on debt and equity from a market participant perspective and adjusted for our specific risks.
We
have four reporting units that have goodwill. The following table categorizes our goodwill by reporting unit as of December 31,
2019 according to the level of excess between the reporting’ unit’s fair value and carrying value and we believe that
no reporting units are at risk of failing “Step 1” of a goodwill impairment analysis.
Segment
|
|
Reporting
Unit
|
|
Fair Value
Exceeds
Carrying Value
|
|
|
Net Goodwill as of
December 31, 2018
|
|
|
Net Goodwill as of
December 31, 2019
|
|
|
|
|
|
|
|
|
(in RMB thousands)
|
|
AR advertising services
|
|
AR advertising services unit
|
|
|
148
|
%
|
|
|
137,060
|
|
|
|
137,060
|
|
AR Entertainment
|
|
AR application and technology solutions unit
|
|
|
176
|
%
|
|
|
92,990
|
|
|
|
92,990
|
|
AR Entertainment
|
|
SDK payment services unit
|
|
|
167
|
%
|
|
|
87,909
|
|
|
|
87,909
|
|
AR Entertainment
|
|
MR software unit
|
|
|
174
|
%
|
|
|
33,375
|
|
|
|
34,121
|
|
|
|
|
|
|
|
|
|
|
351,334
|
|
|
|
352,080
|
|
We
also performed sensitivity analysis on revenue growth rates and discount rates which shows there were no signs of impairment if
actual revenue dropped to 80% of the forecast or the discount rate increases to 25% from 18.5% for all our reporting units.
Revenue
recognition
We
adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (ASC Topic 606) for the
year ended December 31, 2019, using the modified retrospective method for contracts that were not completed as of December 31,
2018. The ASU requires the use of a new five-step model to recognize revenue from customer contracts. The five-step model requires
that we (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine
the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will
not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue
when (or as) we satisfy our performance obligation.
Prior
to 2019, we recognize revenue when all of the following have occurred: (i) persuasive evidence of an arrangement exists, (ii)
delivery has occurred or services have been rendered, (iii) the price or fees are fixed or determinable, and (iv) the ability
to collect is reasonably assured. Revenue is presented in the consolidated statements of income and comprehensive income net of
sales taxes. We do not offer rights of refund of previously paid or delivered amounts, rebates, rights of return or price protection.
In all instances, we limit the amount of revenue recognized to the amounts for which we have the right to bill our customers.
The
application of the five-step model to the revenue streams compared to the prior guidance did not result in significant changes
in the way we record our revenue. Upon adoption, we evaluated our revenue recognition policy for all revenue streams within the
scope of the ASU under previous standards, using the five-step model under the new guidance, and confirmed that there were no
differences in the pattern of revenue recognition.
(i)
AR Advertising Services
AR
advertisements are the use holographic materials integrated into advertisement on the online media platforms or offline display.
Our performance obligation is to identify advertising spaces and embed holographic AR images or videos into films, shows and short
form videos that are hosted by online streaming platforms in China. Revenue is recognized at the time when the related services
have been delivered based on the specific terms of the contract, which are commonly based on specific action (i.e. cost per impression
(“CPM”) or cost per action (“CPA”) for online display and service period for offline display contracts.
We
enter into advertising contracts with advertisers where the amounts charged per specific action are fixed and determinable, the
specific terms of the contracts were agreed on by us, the advertisers and channel providers, and collectability is probable. Revenue
is recognized on a CPM basis as impressions or clicks are delivered while revenue on a CPA basis is recognized once agreed actions
are performed or service period is completed.
We
consider ourselves as provider of the services as we have control of the specified services and products at any time before they
are transferred to the customers, which is evidenced by (1) we are primarily responsible to our customers for products and services
offered where the products were designed in house and we have customer services team to directly serve the customers; and (2)
we have discretion in establish pricing. Therefore, we act as the principal of these arrangements and report revenue earned and
costs incurred related to these transactions on a gross basis.
(ii)
AR Entertainment
Our
AR entertainment services mainly include three sub categories: SDK payment channel services, software development and mobile games
operations and technology developments.
a.
SDK Payment Channel Services
Our
SDK payment channel services enable game players and app users to make online payments through Alipay, Unipay or Wechat pay, etc.,
to various online content providers. When game players and app users make payments in the game or app, the SDK payment channel
will automatically populate payment services for the users to fulfill payments.
We
charge a fee for the payment channel services, the pricing of which is based on the pre-determined rates specified in the contract.
Our performance obligation is to facilitate payment services and we recognize SDK payment channel service revenue at the time
when a user completes a payment transaction via a payment channel and is entitled to payment. Related fees are generally billed
monthly, based on a per transaction basis. We believe that our promise to customer is to facilitate the services of third party,
instead of providing the payment services ourselves, as we not have control of the services provided or serve the users directly,
and we do not have the discretion in establishing pricing. Therefore, revenue from SDK payment service is recorded on a net basis.
b.
MR software development services
Our
MR software development service contracts are primarily on a fixed price basis, which require us to perform services for MR application
design, content development and integrating based on customers’ specific needs. These services also require significant
production and customization. The required customization work period is generally less than one year. We currently do not have
any modification of contract and the contracts currently do not have any variable consideration.
The
software customization, application design, upgrades and integration are considered as one performance obligation. The promises
to transfer software, customization and upgrades are not separately identifiable as the customers do not obtain benefits from
these services on its own.
Our
MR software development service contracts are generally recognized over time during the contract period as we have no alternative
use of the customized software and application without incurring significant additional costs. Revenue is recognized based on
our measurement of progress towards completion based on input or output methods. Input methods are used only when there is a direct
correlation between hours incurred and the end product delivered, while output method is used when we could appropriately measure
the customization progress towards completion. Assumptions, risks and uncertainties inherent in the estimates used to measure
progress could affect the amount of revenues, receivables and deferred revenues at each reporting period. We have a long history
of developing various MR software, and we believe we can reasonably estimate the progress toward completion on each fixed price
customized contracts.
c.
Mobile Games Services
We
generate revenue from jointly operated mobile game publishing services and the licensed out games. In accordance with ASC 606,
Revenue Recognition: Principal Agent Considerations, we evaluate agreements with the game developers, distribution channels and
payment channels in order to determine whether or not we act as the principal or as an agent in the arrangement with each party
respectively. The determination of whether to record the revenues gross or net is based on whether our promise to our customers
is to provide the products or services, or to facilitate a sale by a third party. The nature of the promise depends on whether
we control the products or services prior to transferring it to our customers. Control is evidenced if we are primarily responsible
for fulling the provision of services and have discretion in establishing the selling price. When we control the products or services,
our promise is to provide and deliver the products and we record the revenues on a gross basis. When we do not control the products,
our promise is to facilitate the sale and we record the revenue on a net basis.
—Jointly
operated mobile game publishing services
We
offer publishing services for mobile games developed by third-party game developers. We act as a distribution channel that publishes
the games on our own app or a third-party owned app or website, named game portals. Through these game portals, game players can
download the mobile games to their mobile devices and purchase coins, the virtual currency, for in game premium features to enhance
their game playing experience. We enter into contracts with third-party payment platforms for collection services offered to game
players who have purchased coins. The third-party game developers, third party payment platforms and the co-publishers are entitled
to profit sharing based on a prescribed percentage of the gross amount charged to the game players. Our obligation in the publishing
services is completed at the time when the game players makes a payment to purchase coins.
With
respect to the publishing services arrangements between us and the game developer, we considered that we do not control the services,
as (i) developers are responsible for providing the game product desired by the game players; (ii) the hosting and maintenance
of game servers for running the online mobile games are the responsibilities of the third party platforms; (iii) the developers
or third party platforms have the right to change the pricing of in-game virtual items. Our responsibilities are publishing, providing
payment solutions and market promotion services, and thus we view the game developers as our customers and consider ourselves
as the facilitator of the game developers in the arrangements with game players. Accordingly, we record the game publishing service
revenue from these games, net of amounts paid to the game developers.
—Licensed
out mobile games
We
also license third parties to operate our mobile games developed internally through mobile portal and receives revenue based royalty
payments from the third-party licensee operators on a monthly basis. Our performance obligation is to provide mobile games to
game operators, which enable players of the mobile games to make in game purchases, and we recognize revenue at the time when
game players complete the purchases. We record revenues on a net basis, as we do not have the control of the services provided,
nor do we have the primary responsibility for fulfillment or the right to change the pricing of the game services.
d.
Technology developments
Our
technology development contract requires us to design applications based on customers’ specific needs. The duration of the
design period usually lasts for approximately 3 months or less. Revenues are generally recognized at a point in time where we
have transferred control of the asset upon completion of the design and after the acceptance by our customer with no more future
obligation of the design project.
Contract
balances
We
record receivable related to revenue when we have an unconditional right to invoice and receive payment. Payments received from
customers before all of the relevant criteria for revenue recognition are met are recorded as deferred revenues.
Contract
costs
Contract
costs represent costs incurred in advance of revenue recognition arising from direct costs in respect of the revenue contracts
according to the customer’s requirements prior to the delivery of services, and such deferred costs will be recognized upon
the recognition of the related revenue. Estimated contract costs are based on the budgeted service hours, which are updated based
on the progress toward completion on a monthly basis. Pursuant to the contract terms, we have an enforceable right on payments
for the work performed. Provisions for estimated losses, if any, on uncompleted contracts are recorded in the period in which
such losses become probable based on the current contract estimates. We reviewed impairment of contract costs on December 31,
2019 and determined that all contract costs were recoverable.
Accounts
receivable, net
Accounts
receivable include trade accounts due from customers. Accounts are considered overdue after 90 days. Management reviews our receivables
on a regular basis to determine if the bad debt allowance is adequate, and provides allowance when necessary. The allowance is
based on management’s best estimates of specific losses on individual customer exposures, as well as the historical trends
of collections. Account balances are charged off against the allowance after all means of collection have been exhausted and the
likelihood of collection is not probable.
Intangible
assets, net
Our
intangible assets with definite useful lives primarily consist of copyrights, non-compete agreements, and technology know-hows.
Identifiable intangible assets resulting from the acquisitions of subsidiaries accounted for using the purchase method of accounting
are estimated by management based on the fair value of assets received. We amortize our intangible assets with definite useful
lives over their estimated useful lives and reviews these assets for impairment. We typically amortizes our intangible assets
with definite useful lives on a straight-line basis over the shorter of the contractual terms or the estimated useful lives of
five to ten years.
Income
taxes
We
account for current income taxes in accordance with the laws of the relevant tax authorities. The charge for taxation is based
on the results for the fiscal year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates
that have been enacted or substantively enacted by the balance sheet date.
Deferred
taxes is accounted for using the asset and liability method in respect of temporary differences arising from differences between
the carrying amount of assets and liabilities in the consolidated financial statements and the corresponding tax basis used in
the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences.
Deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which deductible
temporary differences can be utilized. Deferred tax is calculated using tax rates that are expected to apply to the period when
the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it
is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the
relevant taxing authorities.
An
uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would
be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount
of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more
likely than not” test, no tax benefit is recorded. No penalties and interest incurred related to underpayment of income
tax are classified as income tax expense in the period incurred. PRC tax returns filed in 2017 to 2019 are subject to examination
by any applicable tax authorities.
Recent
Issued Accounting Pronouncements
For
detailed discussion on recent accounting pronouncements, see Note 2 to the consolidated financial statements included elsewhere
in this annual report.
B.
|
LIQUIDITY
AND CAPITAL RESOURCES
|
As
of December 31, 2019, we had cash and cash equivalents of approximately RMB 129.0 million (USD 18.5 million). Our working capital
was approximately RMB 55.4 million (USD 7.9 million) as of December 31, 2019. In assessing our liquidity, we monitor and analyze
our cash on-hand and our operating and capital expenditure commitments. To date, we have financed our working capital requirements
through cash flow generated from operations, debt and equity financings and capital contributions from our existing shareholders.
We
completed our initial public offering in April, 2020 and received net proceeds of approximately USD 23.1 million. We believe our
current working capital is sufficient to support our operations for the next twelve months. We may, however, need additional cash
resources in the future if we experience changes in business conditions or other developments, or if we find and wish to pursue
opportunities for investment, acquisition, capital expenditure or similar actions. If we determine that our cash requirements
exceed the amount of cash and cash equivalents we have on hand at the time, we may seek to issue equity or debt securities or
obtain credit facilities. The issuance and sale of additional equity would result in further dilution to our shareholders. The
incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict
our operations. Our obligation to bear credit risk for certain financing transactions we facilitate may also strain our operating
cash flow. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.
Although
we consolidate the results of our VIE and its subsidiaries, we only have access to cash balances or future earnings of our VIE
and its subsidiaries through our contractual arrangements with our VIE.
Current
foreign exchange and other regulations in the PRC may restrict our PRC entities in their ability to transfer their net assets
to the Company and its subsidiaries in Cayman Islands, and Hong Kong. However, these restrictions have no impact on the ability
of these PRC entities to transfer funds to the Company as we have no present plans to declare dividend which we plan to retain
our retained earnings to continue to grow our business. In addition, these restrictions have no impact on the ability for us to
meet our cash obligations as all of our current cash obligations are due within the PRC.
To
utilize the proceeds we received from our initial public offering, we may make additional capital contributions to our PRC subsidiary,
establish new PRC subsidiaries and make capital contributions to these new PRC subsidiaries, or make loans to the PRC subsidiaries.
However, most of these uses are subject to PRC regulations. Foreign direct investment and loans must be approved by and/or registered
in accordance with the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, as amended, and its local branches. The
total amount of loans we can make to our PRC subsidiary cannot exceed statutory limits and must be registered with the local counterpart
of SAFE. The statutory limit for the total amount of foreign debts of a foreign-invested company is the difference between the
amount of total investment as approved by the Ministry of Commerce or its local counterpart and the amount of registered capital
of such foreign-invested company.
We
are permitted under PRC laws and regulations to provide funding to our PRC subsidiaries only through loans or capital contributions,
and to our consolidated VIEs only through loans, and only if we satisfy the applicable government registration and approval requirements.
The relevant filing and registration processes for capital contributions typically take approximately eight weeks to complete.
The filing and registration processes for loans typically take approximately four weeks or longer to complete. While we currently
see no material obstacles to completing the filing and registration procedures with respect to future capital contributions and
loans to our PRC subsidiaries or VIEs, we cannot assure you that we will be able to complete these filings and registrations on
a timely basis, or at all. See “Item 3.D. Risk Factors—Risks Related to Doing Business in China—PRC regulation
of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion
may delay or prevent us from using the proceeds we receive from our offshore financing activities to make loans to or make additional
capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and our ability to fund
and expand our business.” Additionally, while there is no statutory limit on the amount of capital contribution that we
can make to our PRC subsidiaries, loans provided to our PRC subsidiaries and consolidated VIEs in the PRC are subject to certain
statutory limits. With respect to our PRC subsidiaries, the maximum amount of the loans that they can acquire in aggregate from
outside China as of December 31, 2019 is (i) approximately RMB 698 million (USD 100 million) under the total investment minus
registered capital approach; or (ii) approximately RMB 296 million (USD 42.4 million) under the net asset approach. We are able
to use all of the net proceeds from this offering for investment in our PRC operations by funding our PRC subsidiaries through
capital contributions which is not subject to any statutory limit on the amount under PRC laws and regulations. See “Item
4. Regulation—Loans by Foreign Companies to their PRC Subsidiaries.” We expect the net proceeds from this offering
to be used in the PRC will be in the form of RMB and, therefore, our PRC subsidiaries and consolidated VIEs will need to convert
any capital contributions or loans from U.S. dollars into Renminbi in accordance with applicable PRC laws and regulations.
The
following table summarizes the key components of our cash flows for the years ended December 31, 2017, 2018 and 2019.
|
|
For the Years Ended December 31
|
|
|
|
2017
|
|
|
2018
|
|
|
2019
|
|
|
2019
|
|
|
|
RMB
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Net cash provided by operating activities
|
|
|
108,057,941
|
|
|
|
99,452,205
|
|
|
|
143,955,544
|
|
|
|
20,635,238
|
|
Net cash used in investing activities
|
|
|
(118,364,263
|
)
|
|
|
(98,597,356
|
)
|
|
|
(126,479,892
|
)
|
|
|
(18,130,198
|
)
|
Net cash (used in)/provided by financing activities
|
|
|
(3,800,000
|
)
|
|
|
137,493,993
|
|
|
|
(40,974,000
|
)
|
|
|
(5,873,398
|
)
|
Effect of exchange rate change on cash and cash equivalents
|
|
|
(234,124
|
)
|
|
|
937,466
|
|
|
|
599,384
|
|
|
|
85,917
|
|
Net change in cash and cash equivalents
|
|
|
(14,340,446
|
)
|
|
|
139,286,308
|
|
|
|
(22,898,964
|
)
|
|
|
(3,282,411
|
)
|
Cash and cash equivalents, beginning of year
|
|
|
27,002,080
|
|
|
|
12,661,634
|
|
|
|
151,947,942
|
|
|
|
21,780,904
|
|
cash and cash equivalents, end of year
|
|
|
12,661,634
|
|
|
|
151,947,942
|
|
|
|
129,048,978
|
|
|
|
18,498,463
|
|
Operating
activities
Net
cash provided by operating activities was approximately RMB 144.0 million (USD 20.6 million) for the year ended December 31, 2019,
as compared to approximately RMB 99.5 million for the year ended December 31, 2018 and approximately RMB 108.1 million for the
year ended December 31, 2017.
Net
cash provided by operating activities for the year ended December 31, 2019 was primarily attributable to net income of approximately
RMB 102.2 million (USD 14.7 million) with non-cash depreciation and amortization expenses of approximately RMB 13.9 million (USD
2.0 million), provision for doubtful accounts of approximately RMB 1.6 million (USD 0.2 million) and amortization of debt discount
of RMB 11.5 million (USD 1.7 million), which was partially offset by deferred tax benefits of approximately RMB 1.5 million (USD
0.2 million). Cash inflow was also attributable to (i) the collection of accounts receivable of approximately RMB 9.1 million
(USD 1.3 million), (ii) the decrease of RMB 5.3 million (USD 0.8 million) in contract costs as we recognized some of the costs
incurred for revenue that had not met recognition criteria, (iii) the increase of approximately RMB 5.7 million (USD 0.8 million)
in accounts payable, (iv) the increase of approximately RMB 0.3 million (USD 46,000) in deferred revenues, and (v) the increase
of other payables and accrued liabilities of approximately RMB 0.4 million (USD 64,000). Cash inflow was partially offset by (i)
the increase of prepayments of approximately RMB 3.1 million (USD 0.4 million), as we had to make more advances to secure advertising
channels for advertising in short form mobile video streaming market, (ii) the increase of approximately RMB 0.4 million (USD
58,000) in prepaid expenses and deposits, and (iii) the increase of approximately RMB 1.1 million (USD 0.2 million) in taxes payable
as we made more tax payments in 2019.
Net
cash provided by operating activities was approximately RMB 99.5 million for the year ended December 31, 2018. Net cash provided
by operating activities for the year ended December 31, 2018 was primarily attributable to net income of approximately RMB 89.2
million with non-cash depreciation and amortization expense of approximately RMB 13.5 million and amortization of debt discount
of RMB 5.1 million, which was partially offset by non-cash deferred tax benefits of RMB 1.5 million. The cash inflow was also
attributable to (i) the increase of approximately RMB 7.7 million in accounts payable, and (ii) the increase of taxes payable
of approximately RMB 8.1 million due to more income tax and VAT incurred as a result of increase in revenues and expiration of
tax exempt status for some of our subsidiaries. Cash inflow was offset by (i) the increase of approximately RMB 11.3 million in
account receivable, as we expanded our operations by providing more credit sales, (ii) the increase of approximately RMB 2.3 million
in prepaid expenses and other current assets, and (iii) the increase of approximately RMB 8.4 million in contract costs.
Net
cash provided by operating activities was approximately RMB 108.1 million for the year ended December 31, 2017. Net cash provided
by operating activities for the year ended December 31, 2017 was primarily attributable to net income of approximately RMB 73.3
million with non-cash depreciation and amortization expense of approximately RMB 12.8 million and amortization of debt discount
of RMB 4.2 million, which was partially offset by recovery of doubtful accounts of approximately RMB 0.1 million and deferred
tax benefits of RMB 1.5 million. Cash inflow was also attributable to (i) the increase of approximately RMB 5.0 million in prepaid
expenses and other current assets, the increase of approximately RMB 17.1 million in accounts payable, and (ii) the increase of
approximately RMB 2.9 million in taxes payable. The cash inflow was partially offset by (i) the increase of approximately RMB
2.2 million in accounts receivable, which was consistent with our revenue increase, and (ii) the increase of contract costs of
RMB 3.2 million, which were costs incurred for revenues that have not met recognition criteria.
Investing
activities
Net
cash used in investing activities was approximately RMB 126.5 million (USD 18.1 million) for the year ended December 31, 2019,
compared to net cash used in investing activities of approximately RMB 98.6 million for the year ended December 31, 2018 and approximately
RMB 118.4 million for the year ended December 31, 2017.
Cash
used in investing activities for the year ended December 31, 2019 was mainly due to payments for cost method investments of approximately
RMB 3.9 million (USD 0.6 million), the repayments for the business acquisition payables to the related parties of approximately
RMB 122.4 million (USD 17.6 million), and purchases of property, plant and equipment of approximately RMB 0.2 million (USD 28,000).
Cash
used in investing activities for the year ended December 31, 2018 was mainly due to the repayments of business acquisition payables
to former shareholders of Skystar, Shenzhen Kuxuanyou, Shenzhen Yidian and Shenzhen Yitian in the amount of RMB 98.9 million and
purchases of property, plant and equipment of approximately RMB 47,000.
Cash
used in investing activities for the year ended December 31, 2017 was mainly due to the net payment for the Skystar acquisition
of approximately RMB 18.0 million, repayments of business acquisition payables to related parties in the amount of RMB 98.7 million
and purchases of property, plant and equipment of approximately RMB 2.0 million. The cash outflow was partially offset by the
proceeds from sale of cost method investment of approximately RMB 0.1 million and cash acquired from acquisition in the amount
of approximately RMB 0.2 million.
Financing
activities
Cash
used in financing activities was approximately RMB 41.0 million (USD 5.9 million) for the year ended December 31, 2019, compared
with cash provided by financing activities of approximately RMB 137.5 million for the year ended December 31, 2018 and cash used
in financing activities of approximately RMB 3.8 million for the year ended December 31, 2017.
For
the year ended December 31, 2019, cash used in financing activities was mainly the repayment of approximately RMB 125.3 million
(USD 18.0 million) to Jie Zhao, our Chairman, for loans we made from 2016 to 2018, and the repayment of RMB 4.2 million (USD 0.6
million) to Enweiliangzi Investment Co. (which is under common control of Jie Zhao). Cash provided by financing activities for
the year ended December 31, 2019 was due to the additional loans we received Jie Zhao in the amount of RMB 13.0 million (USD 1.9
million). The loans are free of interest and collateral, and are due in 2020 and 2021. We also borrowed loans from Shanghai Junei
Internet Co. (which is under common control of Jie Zhao) in the amount of RMB 75.5 million (USD 10.8 million), which has an annual
interest rate of 7% and is due in 2020 and 2021.
For
the year ended December 31, 2018, cash provided by financing activities was mainly due to proceeds from issuance of Series A convertible
preferred shares of approximately RMB 137.7 million and proceeds from related party loans of approximately RMB 14.6 million, consisting
of approximately RMB 10.4 million from Jie Zhao and approximately RMB 4.2 million from Enweiliangzi Investment Co. (which is under
common control of Jie Zhao) for cash flow purpose. The loans are free of interest and collateral, and are due in 2020 and 2021.
The inflow of cash flow was offset by our repayment to Jie Zhao of approximately RMB 14.8 million.
For
the year ended December 31, 2017, cash used in financing activities was mainly repayment of RMB 33.8 million to Jie Zhao, our
Chairman from a loan we made in 2016. The loans are free of interest and collateral and are due in 2021. Cash provided by financing
activities for the year ended December 31, 2017 was mainly due to the capital contribution from our shareholders in the amount
of RMB 30.0 million.
Commitments
and Contingencies
In
the normal course of business, we are subject to loss contingencies, such as legal proceedings and claims arising out of its business,
that cover a wide range of matters, including, among others, government investigations and tax matters. In accordance with ASC
No. 450-20, “Loss Contingencies”, we will record accruals for such loss contingencies when it is probable that a liability
has been incurred and the amount of loss can be reasonably estimated.
Off-Balance
Sheet Arrangements
We
have no off-balance sheet arrangements including arrangements that would affect our liquidity, capital resources, market risk
support and credit risk support or other benefits.
Contractual
Obligations
As
of December 31, 2019, the future minimum payments under certain of our contractual obligations were as follows:
|
|
|
|
|
Payments Due In
|
|
|
|
Total
RMB
|
|
|
Less than 1 year
|
|
|
1 - 2 years
|
|
|
3 - 5 years
|
|
|
Thereafter
|
|
Contractual obligations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating leases obligations
|
|
|
4,117,685
|
|
|
|
2,478,329
|
|
|
|
1,639,356
|
|
|
|
—
|
|
|
|
—
|
|
Loans—related parties
|
|
|
87,025,789
|
|
|
|
70,987,603
|
|
|
|
16,038,186
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
|
91,143,474
|
|
|
|
73,465,932
|
|
|
|
17,677,542
|
|
|
|
—
|
|
|
|
—
|
|
Holding
Company Structure
WiMi
Cayman is a holding company with no material operations of its own. We conduct our operations primarily through our PRC subsidiary,
our VIE and its subsidiaries in China. As a result, WiMi Cayman’s ability to pay dividends depends upon dividends paid by
our PRC subsidiary. If our existing PRC subsidiary or any newly formed ones incur debt on their own behalf in the future, the
instruments governing their debt may restrict their ability to pay dividends to us. In addition, our wholly foreign-owned subsidiary
in China is permitted to pay dividends to us only out of its retained earnings, if any, as determined in accordance with PRC accounting
standards and regulations. Under PRC law, each of our PRC subsidiary, our VIE and its subsidiaries in China is required to set
aside at least 10% of its after-tax profits each year, if any, to fund certain statutory reserve funds until such reserve funds
reach 50% of its registered capital. In addition, our wholly foreign-owned subsidiary in China may allocate a portion of its after-tax
profits based on PRC accounting standards to enterprise expansion funds and staff bonus and welfare funds at its discretion, and
our variable interest entity may allocate a portion of its after-tax profits based on PRC accounting standards to a discretionary
surplus fund at its discretion. The statutory reserve funds and the discretionary funds are not distributable as cash dividends.
Remittance of dividends by a wholly foreign-owned company out of China is subject to examination by the banks designated by SAFE.
Our PRC subsidiary has not paid dividends and will not be able to pay dividends until it generates accumulated profits and meets
the requirements for statutory reserve funds.
Inflation
Since
our inception, inflation in China has not materially affected our results of operations. According to the National Bureau of Statistics
of China, the year-over-year percent changes in the consumer price index for December 2017, 2018 and 2019 were increases of 1.8%,
1.9% and 2.5%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China
experiences higher rates of inflation in the future.
C.
|
RESEARCH
AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
|
We
have focused on and will continue to focus on investment in our technology system. Our research and development expenses were
approximately RMB9.7 million, RMB8.0 million, and RMB18.4 million (USD2.6 million) for the years ended December 31, 2017, 2018,
and 2019, respectively.
We
believe that a core element of the competitiveness of the holographic AR industry is research and development related to technology
development, and we rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure
to protect our intellectual property rights. For details of our intellectual property portfolio, please refer to Item 4 B. Business
Overview—Intellectual Property”.
Other
than as disclosed in the foregoing disclosures and elsewhere in this Annual Report, we are not aware of any trends, uncertainties,
demands, commitments or events for the year ended December 31, 2019 that are reasonably likely to have a material adverse effect
on our net revenue, income, profitability, liquidity or capital resources, or that would cause our disclosed financial information
to be not necessarily indicative of future operating results or financial conditions.
E.
|
OFF-BALANCE
SHEET ARRANGEMENTS
|
We
have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect
on our financial condition that is material to investors. In particular, we (i) have not entered into any financial guarantees
or other commitments to guarantee the payment obligations of any unconsolidated entity; (ii) have not entered into any derivative
contracts that are both indexed to our own stock and classified in stockholders’ equity, or not reflected in our statement
of financial position; and (iii) do not have any retained or contingent interest in assets transferred to an unconsolidated entity
that serves as credit, liquidity or market risk support to such entity.
F.
|
TABULAR
DISCLOSURE OF CONTRACTUAL OBLIGATIONS
|
We
have entered into twenty non-cancellable operating lease agreements for office spaces. Our commitment for minimum lease payments
under these operating leases as of December 31, 2019, for the next five years is as follow:
|
|
Minimum lease payment
|
|
Twelve months ending December 31,
|
|
RMB
|
|
|
USD
|
|
2020
|
|
|
2,478,329
|
|
|
|
355,255
|
|
2021
|
|
|
1,639,356
|
|
|
|
234,993
|
|
Thereafter
|
|
|
—
|
|
|
|
—
|
|
Total minimum payments
|
|
|
4,117,685
|
|
|
|
590,248
|
|
See
the section headed “Forward-looking Statements” at the beginning of this annual report.
ITEM
6.
|
DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES
|
A.
|
DIRECTORS
AND SENIOR MANAGEMENT
|
The
following table sets forth certain information concerning our directors and executive officers as of the date of this annual report.
Directors
and Executive Officers
|
|
Age
|
|
Position/Title
|
Jie
Zhao
|
|
44
|
|
Chairman
|
Fanhua
Meng
|
|
45
|
|
Chief
Executive Officer and Director
|
Hongtao
Zhao
|
|
44
|
|
Independent
Director
|
Yuanyuan
Liu
|
|
37
|
|
Independent
Director
|
Yanghua
Yang
|
|
32
|
|
Chief
Financial Officer
|
Chengwei
Yi
|
|
44
|
|
Chief
Technology Officer and Director
|
Shuo
Shi
|
|
38
|
|
Chief
Operating Officer
|
David
Diamond
|
|
70
|
|
Independent
Director
|
Michael
W. Harlan
|
|
59
|
|
Independent
Director
|
Jie
Zhao, founder of our company, has been serving as the Chairman of our board of directors since November 2018 and has also
been serving as the Chairman of board of directors of our VIE, Beijing WiMi, since its founding in July 2015. He has more than
10 years of experience in company management. From February 2008 to May 2015, Mr. Zhao served as Director of Xiamen Xiangtong
Animation Co., Ltd., a mobile animation company in China. Mr. Zhao served as Director of Shenzhen WeiXun YiTong Technology Co.,
Ltd., a mobile internet company in China from December 2004 to December 2012. Previously, Mr. Zhao served as a software developer
of AsiaInfo Beijing Co., Ltd., a company specializing in computer system in China, from October 2002 to December 2004. Mr. Zhao
received a bachelor’s degree from Wuhan University of Technology in China and a master’s degree from Tsinghua University
in China.
Fanhua
Meng has been serving as our Chief Executive Officer and General Manager since August 2018 and has also been serving as
General Manager of our VIE, Beijing WiMi, since October 2015. He has more than 10 years of experience in company management and
platform operation and management. From November 2012 to May 2015, Mr. Meng served as General Manager of Beijing Tonglian Tiandi
Technology Co., Ltd., a mobile internet company in China. Mr. Meng served as General Manager of Beijing Zhangxing Infinite Technology
Co., Ltd., a cellphone application and gaming company in China from August 2007 to September 2012. Previously, Mr. Meng served
as Vice General Manager of Shanghai Lingdian Software Co., Ltd., a software company in China, from April 2003 to June 2007. In
addition, Mr. Meng worked for Tianjin New Century Machinery Manufacture Co., Ltd. in China between September 1997 and July 2000.
Mr. Meng received a bachelor’s degree from Dongbei University in China, an MBA degree from Nankai University and an EMBA
degree from China Europe International Business School in China.
Hongtao
Zhao has been serving as our independent director since May 2019. Mr. Zhao has served as Vice General Manager at Ping
An Caizhi Investment Management Co., Ltd, an investment management firm in China, since April 2017. Mr. Zhao has more than 17
years of experience in capital management. He served as Investment Director of Zhongxin Rongchuang Capital Management Co., Ltd.,
an asset management firm in China, from April 2015 to April 2017. He served as Vice President of Beijing Grain Group Industrial
Fund, an investment fund in China, from July 2012 to April 2015. From January 2009 to May 2012, Mr. Zhao served as Senior Manager
of Beijing Dagong International Credit Evaluation Co., Ltd., a credit evaluation institution in China. Mr. Zhao received a bachelor’s
degree from Ningxia University in China and a master’s degree from Peking University in China.
Yuanyuan
Liu has been serving as our independent director since May 2019. Ms. Liu has served as Executive Director of Hangzhou
Youxiang Investment Management Co., Ltd., an investment management firm in China, since October 2017. Ms. Liu served as Deputy
Secretary General of Equity Investment Committee in Shengshijing Asset Management Group Co., Ltd., an asset management firm in
China, from November 2014 to September 2017. From August 2013 to November 2014, Ms. Liu worked for Beijing Jingtian & Gongcheng
Law Firm in China. From April 2010 to August 2013, Ms. Liu worked for Beijing Kangda Law Firm in China. She received a bachelor’s
degree from Qufu Normal University in China and a master’s degree from Renmin University in China.
Yanghua
Yang has served as our Chief Financial Officer since September 2018 and has also served as Chief Financial Officer of
our VIE, Beijing WiMi, since January 2018. From April 2015 to December 2017, Mr. Yang served as Vice General Manager of Beijing
Tianhou Dide Investment Management LLP, a venture capital firm in China. Previously, Mr. Yang served as project manager at BDO
USA, LLP in China from July 2013 to April 2015. Mr. Yang received a bachelor’s degree from Hainan University in China in
2013.
Chengwei
Yi has been serving as our Chief Technology Officer and as a director since September 2018 and has also been serving as
Technology Director of our VIE, Beijing WiMi, since August 2015. Mr. Yi has been serving as General Manager of Shenzhen Yitian
Internet Co., Ltd., a mobile internet company in China, since September 2014. He has 16 years of experience in the internet and
mobile internet industry and has engaged in mobile value-added services, mobile internet advertising, mobile games, mobile applications
and other businesses focusing on product development, operation and promotion. He received a bachelor’s degree from Shenyang
University of Technology. Mr. Yi is also an EMBA candidate from China Europe International Business School.
Shuo
Shi has been serving as our Chief Operating Officer since September 2018 and has also been serving as Vice General Manager
of our VIE, Beijing WiMi, since February 2017. He has more than 10 years of experience in sales marketing, internet management
and culture media. From February 2014 to December 2016, Mr. Shi served as Secretary-General of Shenzhen Three-Dimension Film Association,
an association specializing in 3D film making in China. Previously, Mr. Shi served as Vice General Manager in Shenzhen Stereoscopic
Internet Culture Media Company, a culture media company in China, from November 2011 to February 2014. Mr. Shi received a bachelor’s
degree from Renmin University in China in 2006.
David
Diamond, has been serving as our independent director since April 7, 2020. He has been serving as the head of National
Life Sciences and Technology Practice of Mayer Hoffman McCann P.C., an accounting firm, since 2005. From January 2005 to December
2018, Mr. Diamond served as a partner of Mayer Hoffman McCann P.C. and has more than 30 years of experience in the accounting
industry. Mr. Diamond previously served as a member of the board of directors of Kreston International and San Diego Venture Group.
Mr. Diamond received a bachelor’s degree from University of the Witwatersrand. Due to his extensive accounting experience,
we believe Mr. Diamond’s is well qualified to serve as a Director.
Michael
W. Harlan, has been serving as our independent director since April 7, 2020. He has been serving as a member of the board
of directors of Brewer Crane Holdings, LLC, a construction services company, since July 2018. Mr. Harlan has also served as the
Chairman and Chief Executive Officer of TruHorizon Environmental Solutions, an environmental solutions company, since September
2013. Moreover, Mr. Harlan has served as President of Harlan Capital Advisors, LLC, a business consulting firm, since September
2011. In addition, Mr. Harlan has served as a member of the board of directors of Waste Connection, Inc. (NYSE: WCN), a publicly-traded
solid waste management firm, since its founding in 1997. From June 2015 to February 2017, Mr. Harlan served as a member of the
board of directors of Yulong Eco-Materials Limited (NASDAQ: YECO), a manufacturer of eco-friendly building products in China.
Mr. Harlan served as a member of the board of directors of Travis Trailer and Body, Inc. a leading manufacturer of specialized
trailers used in the construction, environmental services, agriculture and energy industries, from August 2013 to September 2016.
From May 2007 to August 2011, Mr. Harlan served as President and Chief Executive Officer of U.S. Concrete, Inc. (NASDAQ: USCR).
Mr. Harlan also served as Executive Vice President and Chief Operating Officer of U.S. Concrete, Inc. from November 2004 to May
2007. Mr. Harlan received a bachelor’s degree from University of Mississippi. Due to his extensive operational experience
in the public companies, we believe Mr. Harlan’s is well qualified to serve as a Director.
Compensation
In
2019, we paid an aggregate cash compensation of approximately RMB569,970 (US$81,702 ) to our directors and executive officers.
We have not set aside or accrued any amount to provide pension, retirement or other similar benefits to our directors and executive
officers. Our PRC subsidiaries and consolidated VIEs are required by law to make contributions equal to certain percentages of
each employee’s salary for his or her pension insurance, medical insurance, unemployment insurance and other statutory benefits
and a housing provident fund.
Employment
Agreements
We
have entered into employment agreements with each of our executive officers. Each of our executive officers is employed for an
unspecified time period, which can be terminated upon both parties’ agreement or by law. We may terminate an executive officer’s
employment for cause at any time without advance notice in certain events. We may terminate an executive officer’s employment
by giving a prior written notice or by paying certain compensation. An executive officer may terminate his or her employment at
any time by giving a prior written notice.
Each
executive officer has agreed to hold, unless expressly consented to by us, at all times during and within one year after the termination
of his or her employment agreement, in strict confidence and not to use, any of our confidential information or the confidential
information of our customers and suppliers.
Our
board of directors consists of seven directors, including four independent directors, Hongtao Zhao and Yuanyuan Liu, David Diamond,
and Michael W. Harlan. A director is not required to hold any shares in our company to qualify to serve as a director. The Corporate
Governance Rules of the Nasdaq generally require that a majority of an issuer’s board of directors must consist of independent
directors.
A
director who is in any way, whether directly or indirectly, interested in a contract or transaction or proposed contract or transaction
with our company is required to declare the nature of his or her interest at a meeting of our directors. A general notice given
to the directors by any director to the effect that he or she is a member of any specified company or firm and is to be regarded
as interested in any contract or transaction which may thereafter be made with that company or firm shall be deemed a sufficient
declaration of interest in regard to any contract so made or transaction so consummated. Subject to the Nasdaq rules and disqualification
by the chairman of the relevant board meeting, a director may vote in respect of any contract or proposed contract or arrangement
notwithstanding that he/she may be interested therein and if he/she does so, his/her vote shall be counted and he/she may be counted
in the quorum at any meeting of the directors at which any such contract or proposed contract or arrangement is considered. Our
board of directors may exercise all of the powers of our company to borrow money, to mortgage or charge its undertaking, property
and uncalled capital, or any part thereof, and to issue debentures, debenture stock or other securities whenever money is borrowed
or as security for any debt, liability or obligation of our company or of any third party.
Committees
of the Board of Directors
We
have established three committees under the board of directors, an audit committee, a compensation committee and a nominating
and corporate governance committee. We have adopted a charter for each of the three committees. Each committee’s members
and functions are described below.
Audit
Committee. Our audit committee consists of three members, and is chaired by David Diamond. We have determined that David
Diamond, Hongtao Zhao and Yuanyuan Liu satisfy the requirements of Rule 5605(a)(2) of the Listing Rules of the Nasdaq and meet
the independence standards under Rule 10A 3 under the Securities Exchange Act of 1934, as amended. We have determined that David
Diamond qualifies as an “audit committee financial expert.” The audit committee oversees our accounting and financial
reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other
things:
|
●
|
reviewing
and recommending to our board for approval, the appointment, re-appointment or removal of the independent auditor, after considering
its annual performance evaluation of the independent auditor;
|
|
●
|
approving
the remuneration and terms of engagement of the independent auditor and pre approving all auditing and non-auditing services permitted
to be performed by our independent auditors at least annually;
|
|
●
|
obtaining
a written report from our independent auditor describing matters relating to its independence and quality control procedures;
|
|
●
|
reviewing
with the independent registered public accounting firm any audit problems or difficulties and management’s response;
|
|
●
|
discussing
with our independent auditor, among other things, the audits of the financial statements, including whether any material information
should be disclosed, issues regarding accounting and auditing principles and practices;
|
|
●
|
reviewing
and approving all proposed related party transactions, as defined in Item 404 of Regulation S K under the Securities Act;
|
|
●
|
reviewing
and recommending the financial statements for inclusion within our quarterly earnings releases and to our board for inclusion
in our annual reports;
|
|
●
|
discussing
the annual audited financial statements with management and the independent registered public accounting firm;
|
|
●
|
reviewing
the adequacy and effectiveness of our accounting and internal control policies and procedures and any special steps taken to monitor
and control major financial risk exposures;
|
|
●
|
at
least annually, reviewing and reassessing the adequacy of the committee charter;
|
|
●
|
approving
annual audit plans, and undertaking an annual performance evaluation of the internal audit function;
|
|
●
|
establishing
and overseeing procedures for the handling of complaints and whistleblowing;
|
|
●
|
meeting
separately and periodically with management and the independent registered public accounting firm;
|
|
●
|
monitoring
compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures
to ensure proper compliance; and
|
|
●
|
reporting
regularly to the board.
|
Compensation
Committee. Our compensation committee consists of two members, and is chaired by Hongtao Zhao. We have determined
that Hongtao Zhao and Yuanyuan Liu satisfy the “independence” requirements of Rule 5605(a)(2) of the Listing Rules
of the Nasdaq. The compensation committee assists the board in reviewing and approving the compensation structure, including all
forms of compensation, relating to our directors and executive officers. Our chief executive officer may not be present at any
committee meeting during which their compensation is deliberated upon. The compensation committee is responsible for, among other
things:
|
●
|
overseeing
the development and implementation of compensation programs in consultation with our management;
|
|
●
|
at
least annually, reviewing and approving, or recommending to the board for its approval, the compensation for our executive officers;
|
|
●
|
at
least annually, reviewing and recommending to the board for determination with respect to the compensation of our non-executive
directors;
|
|
●
|
at
least annually, reviewing periodically and approving any incentive compensation or equity plans, programs or other similar arrangements;
|
|
●
|
reviewing
executive officer and director indemnification and insurance matters;
|
|
●
|
overseeing
our regulatory compliance with respect to compensation matters, including our policies on restrictions on compensation plans and
loans to directors and executive officers;
|
|
●
|
at
least annually, reviewing and reassessing the adequacy of the committee charter;
|
|
●
|
selecting
compensation consultant, legal counsel or other adviser only after taking into consideration all factors relevant to that person’s
independence from management; and
|
|
●
|
reporting
regularly to the board.
|
Nominating
and Corporate Governance Committee. Our nominating and corporate governance committee consists of two members, and is
chaired by Hongtao Zhao. We have determined that Hongtao Zhao and Yuanyuan Liu satisfy the “independence” requirements
of Rule 5605(a)(2) of the Listing Rules of the Nasdaq. The nominating and corporate governance committee assists the board in
selecting individuals qualified to become our directors and in determining the composition of the board and its committees. The
nominating and corporate governance committee is responsible for, among other things:
|
●
|
recommending
nominees to the board for election or re-election to the board, or for appointment to fill any vacancy on the board;
|
|
●
|
reviewing
annually with the board the current composition of the board with regards to characteristics such as independence, knowledge,
skills, experience, expertise, diversity and availability of service to us;
|
|
●
|
developing
and recommending to our board such policies and procedures with respect to nomination or appointment of members of our board and
chairs and members of its committees or other corporate governance matters as may be required pursuant to any SEC or Nasdaq rules,
or otherwise considered desirable and appropriate;
|
|
●
|
selecting
and recommending to the board the names of directors to serve as members of the audit committee and the compensation committee,
as well as of the nominating and corporate governance committee itself;
|
|
●
|
at
least annually, reviewing and reassessing the adequacy of the committee charter;
|
|
●
|
developing
and reviewing at least annually the corporate governance principles adopted by the board and advising the board with respect to
significant developments in the law and practice of corporate governance and our compliance with such laws and practices; and
|
|
●
|
evaluating
the performance and effectiveness of the board as a whole.
|
Duties
and Functions of Directors
Under
Cayman Islands law, our directors owe fiduciary duties to our company, including a duty of loyalty, a duty to act honestly and
a duty to act in what they consider in good faith to be in our best interests. Our directors must also exercise their powers only
for a proper purpose. Our directors also owe to our company a duty to exercise the skill they actually possess and such care and
diligence that a reasonable prudent person would exercise in comparable circumstances. It was previously considered that a director
need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his
knowledge and experience. However, English and Commonwealth courts have moved towards an objective standard with regard to the
required skill and care and these authorities are likely to be followed in the Cayman Islands. In fulfilling their duty of care
to us, our directors must ensure compliance with our memorandum and articles of association, as amended and restated from time
to time. Our company has the right to seek damages if a duty owed by our directors is breached. In limited exceptional circumstances,
a shareholder may have the right to seek damages in our name if a duty owed by our directors is breached. In accordance with our
second amended and restated articles of association, the functions and powers of our board of directors include, among others,
(i) convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings, (ii) declaring
dividends, (iii) appointing officers and determining their terms of offices and responsibilities, and (iv) approving the transfer
of shares of our company, including the registering of such shares in our share register. In addition, in the event of an equality
of votes, the chairman of our board of directors has a second or casting vote.
Terms
of Directors and Officers
Our
officers are appointed by and serve at the discretion of the board of directors and may be removed by our board of directors.
Our directors may be appointed by a resolution of our board of directors, or by an ordinary resolution of our shareholders. Our
directors are not subject to a term of office and hold office until such time as they are removed from office by ordinary resolution
of the shareholders. A director will be removed from office automatically if, among other things, the director (i) becomes bankrupt
or makes any arrangement or composition with his creditors; (ii) dies or is found by our company to be of unsound mind; (iii)
resigns by notice in writing to our company; (iv) without special leave of absence from our board of directors, is absent from
three consecutive meetings of the board and the board resolves that his office be vacated; or (v) is removed from office pursuant
to any other provisions of our post offering amended and restated memorandum and articles of association.
We
had 115, 122 and 147 full-time employees, respectively, as of December 31, 2017, 2018, and 2019. As of the date of this annual
report, all of our employees are based in China.
The
following table sets forth the number of our employees as of December 31, 2019:
Function
|
|
Number of
full-time
employees
|
|
Research and Development
|
|
|
81
|
|
Business and Marketing
|
|
|
42
|
|
Administrative, Human Resources and Finance
|
|
|
24
|
|
Total
|
|
|
147
|
|
Under
PRC law, we participate in various employee social security plans that are organized by municipal and provincial governments for
our PRC-based full-time employees, including pension, unemployment insurance, childbirth insurance, work-related injury insurance,
medical insurance and housing fund. We are required under PRC law to make contributions monthly to employee benefit plans for
our PRC-based full-time employees at specified percentages of the salaries, bonuses and certain allowances of such employees,
up to a maximum amount specified by the local governments in China.
We
enter into labor contracts and standard confidentiality and intellectual property agreements with our key employees. We believe
that we maintain a good working relationship with our employees, and we have not experienced any labor disputes. None of our employees
are represented by labor unions.
The
following table sets forth information concerning the beneficial ownership of our ordinary shares on an as-converted basis as
of the date of this annual report by:
|
●
|
each
of our directors and executive officers; and
|
|
●
|
each
person known to us to beneficially own more than 1% of our ordinary shares.
|
We
have adopted a dual-class ordinary share structure. The calculations in the table below are based on 118,111,133 ordinary shares
outstanding as of the date of this report, consisting of 20,115,570 Class A ordinary shares and 97,995,563 Class B ordinary shares.
Beneficial
ownership is determined in accordance with the rules and regulations of the SEC. In computing the number of shares beneficially
owned by a person and the percentage ownership of that person, we have included shares that the person has the right to acquire
within 60 days, including through the exercise of any option, warrant, or other right or the conversion of any other security.
These shares, however, are not included in the computation of the percentage ownership of any other person.
|
|
Class A
Ordinary
Shares
|
|
|
Class B
Ordinary
Shares
|
|
|
Voting
Power
|
|
|
|
Number
|
|
|
%
|
|
|
Number
|
|
|
%
|
|
|
%***
|
|
Directors and Executive Officers:†
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jie Zhao(1)
|
|
|
20,115,570
|
|
|
|
100.0
|
%
|
|
|
45,936,340
|
|
|
|
46.9
|
%
|
|
|
82.6
|
%
|
Fanhua Meng(2)
|
|
|
—
|
|
|
|
|
|
|
|
1,000,000
|
|
|
|
1.0
|
%
|
|
|
*
|
|
Chengwei Yi
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Shuo Shi
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Yanghua Yang
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Hongtao Zhao
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Yuanyuan Liu
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
All directors and officers as a group:
|
|
|
20,115,570
|
|
|
|
100.0
|
%
|
|
|
46,936,340
|
|
|
|
47.9
|
%
|
|
|
82.6
|
%
|
Principal Shareholders:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vital Success Global Ltd.(3)
|
|
|
—
|
|
|
|
—
|
|
|
|
30,936,330
|
|
|
|
31.6
|
%
|
|
|
10.3
|
%
|
Wonderful Seed Ltd.(4)
|
|
|
—
|
|
|
|
—
|
|
|
|
15,000,010
|
|
|
|
15.3
|
%
|
|
|
5.0
|
%
|
Sensefuture Holding Limited(5)
|
|
|
—
|
|
|
|
—
|
|
|
|
10,460,480
|
|
|
|
10.7
|
%
|
|
|
3.5
|
%
|
Sensebright Holding Limited(5)
|
|
|
—
|
|
|
|
—
|
|
|
|
748,450
|
|
|
|
*
|
|
|
|
*
|
|
Asean China Investment Fund IV L.P.(6)
|
|
|
—
|
|
|
|
—
|
|
|
|
7,176,841
|
|
|
|
7.3
|
%
|
|
|
2.4
|
%
|
Asean China Investment Fund (US) IV L.P.(7)
|
|
|
—
|
|
|
|
—
|
|
|
|
1,434,292
|
|
|
|
1.5
|
%
|
|
|
0.5
|
%
|
Guosheng Holdings Limited(8)
|
|
|
—
|
|
|
|
—
|
|
|
|
18,000,000
|
|
|
|
18.4
|
%
|
|
|
6.0
|
%
|
Kingsoway Group (HK) Limited(9)
|
|
|
—
|
|
|
|
—
|
|
|
|
1,496,910
|
|
|
|
1.5
|
%
|
|
|
0.5
|
%
|
Notes:
*
|
Less than 1% of our total outstanding shares.
|
**
|
For each person and group included in this column,
percentage ownership is calculated by dividing the number of shares beneficially owned by such person or group by the sum
of (i) 118,111,133 , being the number of ordinary shares outstanding (consisting of 20,115,570 Class A ordinary shares and
97,995,563 Class B ordinary shares) as of the date of this annual report on an as-converted basis.
|
|
|
***
|
For each person and group included in this column, percentage
of voting power is calculated by dividing the voting power beneficially owned by such person or group by the voting power of all
of our ordinary shares as a single class.
|
|
|
†
|
The business address of our directors and executive
officers is No. 6, Xiaozhuang, #101A, Chaoyang District, Beijing, the People’s Republic of China, 100020.
|
|
|
(1)
|
The number of ordinary shares beneficially owned represents
20,115,570 Class A ordinary shares held by Wimi Jack Holdings Ltd., 30,936,330 Class B ordinary shares held by Vital Success Global
Ltd. and 15,000,010 Class B ordinary shares held by Wonderful Seed Limited. Both Vital Success Global Limited and Wonderful Seed
Limited are ultimately controlled by Zhao—Vital Success Personal Trust and Zhao—Wonderful Seed Personal Trust, respectively.
Jie Zhao is the settlor of Zhao—Vital Success Personal Trust, and the settlor and the sole beneficiary of Zhao—Wonderful
Seed Personal Trust. Jie Zhao exercises voting and dispositive power of the securities held by Wimi Jack Holdings Ltd., Vital
Success Global Ltd. and Wonderful Seed Limited.
|
|
|
(2)
|
The number of Class B ordinary shares beneficially owned
represents 1,000,000 Class B ordinary shares held by Wimi Holdings Ltd. Fanhua Meng exercises voting and dispositive power of
the Class B ordinary shares held by Wimi Holdings Ltd.
|
|
|
(3)
|
Jie Zhao exercises voting and dispositive power of the
securities held by such entity. Jie Zhao has appointed Zhao-Virtual Zone Trust as the beneficiary of the trust.
|
|
|
(4)
|
Jie Zhao exercises voting and dispositive power of the
securities held by such entity.
|
|
|
(5)
|
Minwen Wu exercises voting and dispositive power over
the shares held by such entities.
|
|
|
(6)
|
Represents 7,176,841 shares of Class B ordinary shares.
Based on the information provided to the Company, the general partner of such entity is ACIF GP Ltd.
|
|
|
(7)
|
Represents 1,434,292 shares of Class B ordinary shares.
Based on the information provided to the Company, the general partner of such entity is UOB Capital Partners LLC.
|
|
|
(8)
|
Xinyu Fu exercises voting and dispositive power over
the shares held by such entity.
|
|
|
(9)
|
Mengjuan Liu exercises voting and dispositive power
over the shares held by such entity.
|
As
of the date of this annual report, 9,500,000 of our Class B ordinary shares are held by one record holder in the United States,
which is the depositary of our ADS program, representing 8.0% of our total issued and outstanding ordinary shares as of such date.
We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.
ITEM
7.
|
MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
|
Please
refer to “Item 6. Directors, Senior Management and Employees —6.E. Share Ownership.”
B.
|
RELATED
PARTY TRANSACTIONS
|
Transactions
with Related Parties
a)
Loans—related party
We
received loans from our major shareholder, Jie Zhao, in the amount of RMB 161,800,000 in 2016, RMB 3,950,000 in 2018 and RMB 13,000,000
(USD 1,863,479) in 2019. We repaid parts of such loans in the amount of RMB 33,800,000 in 2017, RMB 14,826,000 in 2018 and RMB
125,274,000 (USD 17,957,341) in 2019. We also borrowed USD 952,500 (RMB 6,431,993) in 2018 from Jie Zhao. We borrowed RMB 4,200,000
from Enweiliangzi Investment Co. (which is under common control of Jie Zhao) in 2018 and repaid the full balance in 2019. The
loans are interest and collateral free, and are due in 2020 and 2021. We borrowed RMB 75,500,000 (USD 10,822,510) from Shanghai
Junei Internet Co. (which is under common control of Jie Zhao) in 2019 for cash flow purpose. The loan has an annual interest
rate of 7% and is due in 2020 and 2021. During the year ended December 31, 2019, interest expenses related to this loan, included
in finance expenses, amounted to RMB 290,208 (USD 41,600).
Name of Related Party
|
|
Relationship
|
|
Nature
|
|
December 31,
2018
|
|
|
December 31,
2019
|
|
|
December 31,
2019
|
|
|
|
|
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Jie Zhao
|
|
Chairman of Wimi Cayman
|
|
Loan
|
|
|
117,124,000
|
|
|
|
4,850,000
|
|
|
|
695,221
|
|
Jie Zhao*
|
|
Chairman of Wimi Cayman
|
|
Loan
|
|
|
6,431,993
|
|
|
|
6,675,789
|
|
|
|
956,938
|
|
Shanghai Junei Internet Co.
|
|
Under common control of Jie Zhao
|
|
Loan
|
|
|
—
|
|
|
|
75,500,000
|
|
|
|
10,822,510
|
|
Enweiliangzi Investment Co.
|
|
Under common control of Jie Zhao
|
|
Loan
|
|
|
4,200,000
|
|
|
|
—
|
|
|
|
—
|
|
Total:
|
|
|
|
|
|
|
127,755,993
|
|
|
|
87,025,789
|
|
|
|
12,474,669
|
|
Current portion of shareholder loan
|
|
|
|
|
—
|
|
|
|
70,987,603
|
|
|
|
10,175,683
|
|
Shareholder loan—non-current
|
|
|
|
|
127,755,993
|
|
|
|
16,038,186
|
|
|
|
2,298,986
|
|
b)
Other payables—related party
|
|
Relationship
|
|
Nature
|
|
December 31,
2018
|
|
|
December 31,
2019
|
|
|
December 31,
2019
|
|
|
|
|
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Beijing Tianhoudide Investment Management, LLP
|
|
Under the common control of Jie Zhao
|
|
Business expense payable
|
|
|
1,065
|
|
|
|
—
|
|
|
|
—
|
|
c)
Business acquisition payables—related parties
Business
acquisition payables resulted from the Beijing WiMi’s acquisitions of Shenzhen Kuxuanyou Technology Co., Ltd., Shenzhen
Yitian Internet Technology Co., Ltd., Shenzhen Yidian Network Technology Co., Ltd., in 2015 and Micro Beauty’s acquisition
of Skystar in 2017.
Name of related party
|
|
Relationship
|
|
December 31,
2018
|
|
|
December 31,
2019
|
|
|
December 31,
2019
|
|
|
|
|
|
RMB
|
|
|
RMB
|
|
|
USD
|
|
Xie Jinlong
|
|
Former shareholder of Shenzhen Kuxuanyou(a) and its current General Manager
|
|
|
20,139,056
|
|
|
|
—
|
|
|
|
—
|
|
Yi Chengwei
|
|
Former shareholder Shenshen Yitian and(b) CTO of Wimi Cayman
|
|
|
50,828,374
|
|
|
|
—
|
|
|
|
—
|
|
Meng Xiaojuan
|
|
Former shareholder and legal representative of Shenzhen Yidian(c)
|
|
|
15,485,681
|
|
|
|
—
|
|
|
|
—
|
|
Gao Zhixia
|
|
Former shareholder and legal representative of Skystar(d)
|
|
|
24,436,303
|
|
|
|
—
|
|
|
|
—
|
|
Total:
|
|
|
|
|
110,889,414
|
|
|
|
—
|
|
|
|
—
|
|
Current portion of business acquisition payable
|
|
|
|
|
(34,086
|
)
|
|
|
—
|
|
|
|
—
|
|
Business acquisition payable non-current
|
|
|
|
|
110,855,328
|
|
|
|
—
|
|
|
|
—
|
|
(a)
|
Beijing WiMi acquired Shenzhen Kuxuanyou, in 2015 to
acquire 100% of the capital stock of Shenzhen Kuxuanyou for an aggregate consideration of RMB 113 million (approximately USD 17.2
million) to be made over six years. Jinlong Xie became a related party to the Company after the acquisition. Beijing WiMi paid
RMB 23,000,000 in 2017, RMB 23,120,000 in 2018 and RMB 22,480,000 in 2019. As of December 31, 2019, the total business acquisition
payable was paid off.
|
(b)
|
Beijing WiMi acquired Shenzhen Yitian in 2015 to acquire
100% of the capital stock of Shenzhen Yitian for an aggregate consideration of RMB 192.0 million (approximately USD 28 million)
to be made over six years. Yi Chengwei became a related party to the Company after the acquisition. Beijing WiMi paid RMB 25,700,000
in 2017, RMB 33,720,000 in 2018 and RMB 56,680,000 in 2019. As of December 31, 2019, the total business acquisition payable was
paid off.
|
|
|
(c)
|
Beijing WiMi acquired Shenzhen Yidian in 2015 to acquire
100% of the capital stock of Shenzhen Yidian for an aggregate consideration of RMB 168.0 million (approximately USD 24.5 million)
to be made over six years. Meng Xiaojuan became a related party to the Company after the acquisition. Beijing WiMi paid RMB 50,000,000
in 2017, RMB 29,350,000 in 2018 and RMB 17,050,000 in 2019. As of December 31, 2019, the total business acquisition payable was
paid off.
|
|
|
(d)
|
Gao Zhixia became a related party to the Company after
the acquisition of Skystar in 2017. The Company paid RMB 17,967,355 in 2017, RMB 12,710,784 in 2018 and RMB 26,805,592 (USD 3,842,435)
in 2019. As of December 31, 2019, the total business acquisition payable was paid off.
|
The
amount of business acquisition payable reported in the consolidated balance sheets at carrying value, which approximates fair
value as the rate of amortization of investment payment discount used were similar to interest rate charged by the bank in the
PRC. Debt discount, net of accumulated amortization, totaled RMB 11,995,672 and nil as of December 31, 2018 and 2019, respectively,
are recognized as a reduction of business acquisition payable. Amortization expense related to the debt discount, included in
finance expenses, was RMB 4,191,002, RMB 5,124,715 and RMB 11,544,479 (USD 1,654,838) for the years ended December 31, 2017, 2018
and 2019, respectively.
Contractual
Arrangements
See
“Item 4. Information on the Company—C. Organizational Structure.”
Employment
Agreements
See
“Item 6. Directors, Senior Management and Employees—6.B. Compensation—Employment Agreements.”
C.
|
INTERESTS
OF EXPERTS AND COUNSEL
|
Not
applicable.
ITEM
8.
|
FINANCIAL
INFORMATION
|
A.
|
CONSOLIDATED
STATEMENTS AND OTHER FINANCIAL INFORMATION
|
Our
audited consolidated financial statements are set forth beginning on page F-1, which can be found after Item 19.
Legal
Proceedings
We
are currently not a party to any legal, arbitration, or administrative proceedings that our management believes could have a material
adverse effect on our business, financial position or results of operations. We may from time to time be subject to various legal
or administrative claims and proceedings arising in the ordinary course of business or otherwise. Litigation or any other legal
or administrative proceeding, regardless of the outcome, is likely to result in substantial cost and diversion of our resources,
including our management’s time and attention.
Dividend
Information
We
currently have no plan to declare or pay any dividends in the near future on our shares or ADSs, as we currently intend to retain
most, if not all, of our available funds and any future earnings to operate and expand our business.
Our
board of directors has discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands law.
In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended
by our board of directors. Under Cayman Islands law, a Cayman Islands company may pay a dividend out of either profit or share
premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to
pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to pay dividends, the
form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial
condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends on
our ordinary shares, we will pay those dividends which are payable in respect of the underlying Class B ordinary shares represented
by the ADSs to the depositary, as the registered holder of such Class B ordinary shares, and the depositary then will pay such
amounts to the ADS holders in proportion to the underlying Class B ordinary shares represented by the ADSs held by such ADS holders,
subject to the terms of the deposit agreement, including the fees and expenses payable thereunder.
We
are a holding company incorporated in the Cayman Islands. We rely principally on dividends from our PRC subsidiaries for our cash
requirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiaries
to pay dividends to us. See “Item 3. Key Information—3.D. Risk Factors—Risk Related to Doing Business in China—Governmental
control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.”
Except
as otherwise disclosed in this report, we have not experienced any significant changes since the date of the annual financial
statements included herein.
ITEM
9.
|
THE
OFFER AND LISTING
|
A.
|
OFFER
AND LISTING DETAILS
|
Our
ADSs have been listed on the Nasdaq Global Market since April 1, 2020 under the symbol “WIMI.” Each ADS represents
two Class B ordinary shares, US$0.0001 per share. As of the date of this annual report, no significant trading suspensions had
occurred.
Not
applicable.
See
“Offer and Listing Details” above.
Not
applicable.
Not
applicable.
Not
applicable.
ITEM
10.
|
ADDITIONAL
INFORMATION
|
Not
applicable.
B.
|
Memorandum
and Articles of Association
|
We
are a Cayman Islands company and our affairs are governed by our second amended and restated memorandum and articles of association,
as amended from time to time and the Companies Law of the Cayman Islands and the common law of the Cayman Islands.
We
incorporate by reference into this annual report our second amended and restated memorandum and articles of association, the form
of which was filed as Exhibit 3.2 to our registration statement on Form F-1 (File Number 333-232392) filed with the Securities
and Exchange Commission on July 24, 2019. Our shareholders adopted our second amended and restated memorandum and articles of
association by a special resolution on July 24, 2019, which became effective immediately prior to completion of our initial public
offering of ADSs representing our Class B ordinary shares.
Other
than transactions and contracts that are described under Item 7 “Major Shareholders and Related Party Transactions”,
we have not entered into any material contracts outside the ordinary course of our business within the two years immediately preceding
the date of this annual report.
Item
4. Information on the Company—B. Business Overview—Regulations—Regulation on Foreign Exchange” and “Item
4. Information on the Company—B. Business Overview—Regulations—Regulation on Dividend Distributions.”
Cayman
Islands Taxation
The
Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation, and
there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us or
holders of our ADSs or Class B ordinary shares levied by the government of the Cayman Islands, except for stamp duties which may
be applicable on instruments executed in, or after execution brought within the jurisdiction of the Cayman Islands. The Cayman
Islands is not party to any double tax treaties that are applicable to any payments made to or by our company. There are no exchange
control regulations or currency restrictions in the Cayman Islands.
Payments
of dividends and capital in respect of our ADSs or Class B ordinary shares will not be subject to taxation in the Cayman Islands
and no withholding will be required on the payment of a dividend or capital to any holder of our ADSs or Class B ordinary shares,
nor will gains derived from the disposal of our ADSs or Class B ordinary shares be subject to Cayman Islands income or corporation
tax.
People’s
Republic of China Taxation
Under
the PRC EIT Law, which became effective on January 1, 2008 and amended on February 24, 2017, an enterprise established outside
the PRC with “de facto management bodies” within the PRC is considered a “resident enterprise” for PRC
enterprise income tax purposes and is generally subject to a uniform 25% enterprise income tax rate on its worldwide income. Under
the implementation rules to the PRC EIT Law, a “de facto management body” is defined as a body that has material and
overall management and control over the manufacturing and business operations, personnel and human resources, finances and properties
of an enterprise.
In
addition, the SAT Circular 82 issued by the SAT in April 2009 specifies that certain offshore incorporated enterprises controlled
by PRC enterprises or PRC enterprise groups will be classified as PRC resident enterprises if the following are located or resident
in the PRC: (a) senior management personnel and departments that are responsible for daily production, operation and management;
(b) financial and personnel decision making bodies; (c) key properties, accounting books, company seal, minutes of board meetings
and shareholders’ meetings; and (d) half or more of the senior management or directors having voting rights. Our company
is a company incorporated outside the PRC. As a holding company, its key assets are its ownership interests in its subsidiaries,
and its key assets are located, and its records (including the resolutions of its board of directors and the resolutions of its
shareholders) are maintained, outside the PRC. As such, we do not believe that our company meets all of the conditions above or
is a PRC resident enterprise for PRC tax purposes. For the same reasons, we believe our other entities outside of China are not
PRC resident enterprises either. However, the tax resident status of an enterprise is subject to determination by the PRC tax
authorities and uncertainties remain with respect to the interpretation of the term “de facto management body.” There
can be no assurance that the PRC government will ultimately take a view that is consistent with us. If the PRC tax authorities
determine that our Cayman Islands holding company is a PRC resident enterprise for PRC enterprise income tax purposes, a number
of unfavorable PRC tax consequences could follow. For example, a 10% withholding tax would be imposed on dividends we pay to our
non-PRC enterprise shareholders (including the ADS holders). In addition, nonresident enterprise shareholders (including the ADS
holders) may be subject to PRC tax on gains realized on the sale or other disposition of ADSs or Class B ordinary shares, if such
income is treated as sourced from within the PRC. Furthermore, if we are deemed a PRC resident enterprise, dividends paid to our
non-PRC individual shareholders (including the ADS holders) and any gain realized on the transfer of ADSs or Class B ordinary
shares by such shareholders may be subject to PRC tax at a rate of 20% (which, in the case of dividends, may be withheld at source
by us). These rates may be reduced by an applicable tax treaty, but it is unclear whether non-PRC shareholders of our company
would be able to claim the benefits of any tax treaties between their country of tax residence and the PRC in the event that we
are treated as a PRC resident enterprise. See “Risk Factors—Risks Related to Doing Business in China—We may
be classified as a ‘PRC resident enterprise’ for PRC enterprise income tax purposes, which could result in unfavorable
tax consequences to us and our non-PRC shareholders and ADS holders and have a material adverse effect on our results of operations
and the value of your investment.”
U.S.
Federal Income Taxation
The
following are the material U.S. federal income tax consequences to the U.S. Holders (as defined below) of owning and disposing
of the ADSs or Class B ordinary shares, but this discussion does not purport to be a comprehensive description of all of the tax
considerations that may be relevant to a particular person’s decision to acquire the ADSs or Class B ordinary shares.
This
discussion applies only to a U.S. Holder that acquires the ADSs in this offering and holds the ADSs or Class B ordinary shares
as capital assets for U.S. federal income tax purposes. In addition, it does not describe all of the tax consequences that may
be relevant in light of a U.S. Holder’s particular circumstances, including the alternative minimum tax, the Medicare contribution
tax on net investment income and tax consequences applicable to U.S. Holders subject to special rules, such as:
|
●
|
certain
financial institutions;
|
|
●
|
dealers
or traders in securities that use a mark-to-market method of tax accounting;
|
|
●
|
persons
holding ADSs or Class B ordinary shares as part of a straddle, conversion transaction, integrated transaction or similar transaction;
|
|
●
|
persons
whose functional currency for U.S. federal income tax purposes is not the U.S. dollar;
|
|
●
|
entities
classified as partnerships for U.S. federal income tax purposes and their partners;
|
|
●
|
tax-exempt
entities, including “individual retirement accounts” or “Roth IRAs”;
|
|
●
|
persons
that own or are deemed to own ADSs or Class B ordinary shares representing 10% or more of our voting power or value; or
|
|
●
|
persons
holding ADSs or Class B ordinary shares in connection with a trade or business outside the United States.
|
If
a partnership (or other entity that is classified as a partnership for U.S. federal income tax purposes) owns ADSs or Class B
ordinary shares, the U.S. federal income tax treatment of a partner will generally depend on the status of the partner and the
activities of the partnership. Partnerships owning ADSs or Class B ordinary shares and their partners should consult their tax
advisers as to the particular U.S. federal income tax consequences of owning and disposing of ADSs or Class B ordinary shares.
This
discussion is based on the Internal Revenue Code of 1986, as amended, or the Code, administrative pronouncements, judicial decisions,
final, temporary and proposed Treasury regulations, and the income tax treaty between the United States and the PRC, or the Treaty,
all as of the date hereof, any of which is subject to change, possibly with retroactive effect. This discussion is also based,
in part, on representations by the depositary and assumes that each obligation under the deposit agreement and any related agreement
will be performed in accordance with its terms.
As
used herein, a “U.S. Holder” is a beneficial owner of the ADSs or Class B ordinary shares that is, for U.S. federal
income tax purposes:
|
●
|
a
citizen or individual resident of the United States;
|
|
●
|
a
corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States, any state
therein or the District of Columbia; or
|
|
●
|
an
estate the income of which is includible in gross income for U.S. federal income tax purposes regardless of its source; or
|
|
●
|
a
trust, if (i) a court within the United States is able to exercise primary supervision over the administration of the trust and
one or more United States persons (as defined in the Code) have authority to control all substantial decisions of the trust or
(ii) it has a valid election in effect under Treasury Regulations to be treated as a United States person.
|
In
general, a U.S. Holder who owns American depositary shares should be treated as the owner of the underlying shares represented
by those ADSs for U.S. federal income tax purposes. Accordingly, no gain or loss will be recognized if a U.S. Holder exchanges
ADSs for the underlying Class B ordinary shares represented by those ADSs.
The
U.S. Treasury has expressed concern that parties to whom American depositary shares are released before the underlying shares
are delivered to the depositary (a “pre-release”), or intermediaries in the chain of ownership between holders of
American depositary shares and the issuer of the security underlying the American depositary shares, may be taking actions that
are inconsistent with the claiming of foreign tax credits by holders of American depositary shares. These actions would also be
inconsistent with the claiming of the favorable rates of tax, described below, applicable to dividends received by certain non-corporate
holders. Accordingly, the creditability of PRC taxes, and the availability of the reduced tax rates for dividends received by
certain non-corporate U.S. Holders, each described below, could be affected by actions taken by such parties or intermediaries.
U.S.
Holders should consult their tax advisers concerning the U.S. federal, state, local and non-U.S. tax consequences of owning and
disposing of ADSs or Class B ordinary shares in their particular circumstances.
You
should consult your own tax advisors about the consequences of the acquisition, ownership and disposition of the Class B ordinary
shares or ADSs, including the relevance to your particular situation of the considerations discussed below and any consequences
arising under non-U.S., state, local or other tax laws.
Except
as described below under “—Passive Foreign Investment Company Rules,” this discussion assumes that we are not,
and will not become, a PFIC, for any taxable year.
Taxation
of Distributions
Distributions
paid on the ADSs or Class B ordinary shares, other than certain pro rata distributions of ADSs or Class B ordinary shares, will
be treated as dividends to the extent paid out of our current or accumulated earnings and profits, as determined under U.S. federal
income tax principles. Because we do not maintain calculations of our earnings and profits under U.S. federal income tax principles,
it is expected that distributions generally will be reported to U.S. Holders as dividends. Dividends will not be eligible for
the dividends-received deduction generally available to U.S. corporations under the Code. Subject to applicable limitations and
the discussion above regarding concerns expressed by the U.S. Treasury, dividends paid to certain non-corporate U.S. Holders may
be taxable at favorable rates. Non-corporate U.S. Holders should consult their tax advisers regarding the availability of these
favorable rates in their particular circumstances.
Dividends
will be included in a U.S. Holder’s income on the date of the U.S. Holder’s, or in the case of ADSs, the depositary’s,
receipt. The amount of any dividend income paid in foreign currency will be the U.S. dollar amount calculated by reference to
the spot rate in effect on the date of receipt, regardless of whether the payment is in fact converted into U.S. dollars on such
date. If the dividend is converted into U.S. dollars on the date of receipt, a U.S. Holder generally should not be required to
recognize foreign currency gain or loss in respect of the amount received. A U.S. Holder may have foreign currency gain or loss
if the dividend is converted into U.S. dollars after the date of receipt.
Dividends
will be treated as foreign-source income for foreign tax credit purposes. As described in “—People’s Republic
of China Taxation”, dividends paid by us may be subject to PRC withholding tax. For U.S. federal income tax purposes, the
amount of the dividend income will include any amounts withheld in respect of PRC withholding tax. Subject to applicable limitations,
which vary depending upon the U.S. Holder’s circumstances, and subject to the discussion above regarding concerns expressed
by the U.S. Treasury, PRC taxes withheld from dividend payments (at a rate not exceeding the applicable rate provided in the Treaty
in the case of a U.S. Holder that is eligible for the benefits of the Treaty) generally will be creditable against a U.S. Holder’s
U.S. federal income tax liability. The rules governing foreign tax credits are complex and U.S. Holders should consult their tax
advisers regarding the creditability of foreign tax credits in their particular circumstances. In lieu of claiming a credit, a
U.S. Holder may elect to deduct such PRC taxes in computing its taxable income, subject to applicable limitations. An election
to deduct foreign taxes instead of claiming foreign tax credits must apply to all foreign taxes paid or accrued in the taxable
year.
Sale
or Other Taxable Disposition of ADSs or Class B ordinary shares
A
U.S. Holder will generally recognize capital gain or loss on a sale or other taxable disposition of ADSs or Class B ordinary shares
in an amount equal to the difference between the amount realized on the sale or disposition and the U.S. Holder’s tax basis
in the ADSs or Class B ordinary shares disposed of, in each case as determined in U.S. dollars. The gain or loss will be long-term
capital gain or loss if, at the time of the sale or disposition, the U.S. Holder has owned the ADSs or Class B ordinary shares
for more than one year. Long-term capital gains recognized by non-corporate U.S. Holders may be subject to tax rates that are
lower than those applicable to ordinary income. The deductibility of capital losses is subject to limitations.
As
described in “—People’s Republic of China Taxation” gains on the sale of ADSs or Class B ordinary shares
may be subject to PRC taxes. A U.S. Holder is entitled to use foreign tax credits to offset only the portion of its U.S. federal
income tax liability that is attributable to foreign-source income. Because under the Code capital gains of U.S. persons are generally
treated as U.S.-source income, this limitation may preclude a U.S. Holder from claiming a credit for all or a portion of any PRC
taxes imposed on any such gains. However, U.S. Holders that are eligible for the benefits of the Treaty may be able to elect to
treat the gain as PRC-source and therefore claim foreign tax credits in respect of PRC taxes on such disposition gains. U.S. Holders
should consult their tax advisers regarding their eligibility for the benefits of the Treaty and the creditability of any PRC
tax on disposition gains in their particular circumstances.
Passive
Foreign Investment Company Rules
In
general, a non-U.S. corporation is a PFIC for any taxable year in which (i) 75% or more of its gross income consists of passive
income or (ii) 50% or more of the average quarterly value of its assets consists of assets that produce, or are held for the production
of, passive income. For purposes of the above calculations, a non-U.S. corporation that owns, directly or indirectly, at least
25% by value of the shares of another corporation is treated as if it held its proportionate share of the assets of the other
corporation and received directly its proportionate share of the income of the other corporation. Passive income generally includes
dividends, interest, rents, royalties and certain gains. Cash is a passive asset for these purposes.
Based
on the expected composition of our income and assets and the value of our assets, including goodwill, which is based on the expected
price of the ADSs in this offering, we do not expect to be a PFIC for our current taxable year. However it is not entirely clear
how the contractual arrangements between us and our VIE will be treated for purposes of the PFIC rules, and we may be or become
a PFIC if our VIE is not treated as owned by us for these purposes. Because the treatment of our contractual arrangements with
our VIE is not entirely clear, because we will hold a substantial amount of cash following this offering, and because our PFIC
status for any taxable year will depend on the composition of our income and assets and the value of our assets from time to time
(which may be determined, in part, by reference to the market price of the ADSs, which could be volatile), there can be no assurance
that we will not be a PFIC for our current taxable year or any future taxable year.
If
we were a PFIC for any taxable year and any of our subsidiaries, VIE or other companies in which we own or are treated as owning
equity interests were also a PFIC (any such entity, a “Lower-tier PFIC”), U.S. Holders would be deemed to own a proportionate
amount (by value) of the shares of each Lower-tier PFIC and would be subject to U.S. federal income tax according to the rules
described in the subsequent paragraph on (i) certain distributions by a Lower-tier PFIC and (ii) dispositions of shares of Lower-tier
PFICs, in each case as if the U.S. Holders held such shares directly, even though the U.S. Holders did not receive the proceeds
of those distributions or dispositions.
In
general, if we were a PFIC for any taxable year during which a U.S. Holder holds ADSs or Class B ordinary shares, gain recognized
by such U.S. Holder on a sale or other disposition (including certain pledges) of its ADSs or Class B ordinary shares would be
allocated ratably over that U.S. Holder’s holding period. The amounts allocated to the taxable year of the sale or disposition
and to any year before we became a PFIC would be taxed as ordinary income. The amount allocated to each other taxable year would
be subject to tax at the highest rate in effect for individuals or corporations, as appropriate, for that taxable year, and an
interest charge would be imposed on the resulting tax liability for each such year. Furthermore, to the extent that distributions
received by a U.S. Holder in any year on its ADSs or Class B ordinary shares exceed 125% of the average of the annual distributions
on the ADSs or Class B ordinary shares received during the preceding three years or the U.S. Holder’s holding period, whichever
is shorter, such distributions would be subject to taxation in the same manner. In addition, if we were a PFIC (or with respect
to a particular U.S. Holder were treated as a PFIC) for a taxable year in which we paid a dividend or for the prior taxable year,
the favorable tax rates described above with respect to dividends paid to certain non-corporate U.S. Holders would not apply.
Alternatively,
if we were a PFIC and if the ADSs were “regularly traded” on a “qualified exchange,” a U.S. Holder could
make a mark-to-market election that would result in tax treatment different from the general tax treatment for PFICs described
in the preceding paragraph. The ADSs would be treated as “regularly traded” for any calendar year in which more than
a de minimis quantity of the ADSs were traded on a qualified exchange on at least 15 days during each calendar quarter. The Nasdaq
Global Market, where the ADSs are expected to be listed, is a qualified exchange for this purpose. If a U.S. Holder makes the
mark-to-market election, the U.S. Holder generally will recognize as ordinary income any excess of the fair market value of the
ADSs at the end of each taxable year over their adjusted tax basis, and will recognize an ordinary loss in respect of any excess
of the adjusted tax basis of the ADSs over their fair market value at the end of the taxable year (but only to the extent of the
net amount of income previously included as a result of the mark-to-market election). If a U.S. Holder makes the election, the
U.S. Holder’s tax basis in the ADSs will be adjusted to reflect the income or loss amounts recognized. Any gain recognized
on the sale or other disposition of ADSs in a year in which we are a PFIC will be treated as ordinary income and any loss will
be treated as an ordinary loss (but only to the extent of the net amount of income previously included as a result of the mark-to-market
election, with any excess treated as capital loss). If a U.S. Holder makes the mark-to-market election, distributions paid on
ADSs will be treated as discussed under “—Taxation of Distributions” above. U.S. Holders will not be
able to make a mark-to-market election with respect to our Class B ordinary shares, or with respect to any shares of a Lower-tier
PFIC, because such shares will not trade on any stock exchange.
If
we are a PFIC for any taxable year during which a U.S. Holder owns ADSs or Class B ordinary shares, we will generally continue
to be treated as a PFIC with respect to the U.S. Holder for all succeeding years during which the U.S. Holder owns the ADSs or
Class B ordinary shares, even if we cease to meet the threshold requirements for PFIC status.
If
we were a PFIC for any taxable year during which a U.S. Holder owned any ADSs or Class B ordinary shares, the U.S. Holder would
generally be required to file annual reports with the Internal Revenue Service. U.S. Holders should consult their tax advisers
regarding the determination of whether we are a PFIC for any taxable year and the potential application of the PFIC rules to their
ownership of ADSs or Class B ordinary shares.
Information
Reporting and Backup Withholding
Payments
of dividends and sales proceeds that are made within the United States or through certain U.S.-related financial intermediaries
may be subject to information reporting and backup withholding, unless (i) the U.S. Holder is a corporation or other “exempt
recipient” and (ii) in the case of backup withholding, the U.S. Holder provides a correct taxpayer identification number
and certifies that it is not subject to backup withholding. The amount of any backup withholding from a payment to a U.S. Holder
will be allowed as a credit against the U.S. Holder’s U.S. federal income tax liability and may entitle it to a refund,
provided that the required information is timely furnished to the Internal Revenue Service.
HOLDERS
OF OUR COMPANY’S ADSS SHOULD CONSULT WITH THEIR OWN TAX ADVISORS REGARDING THE APPLICATION OF THE U.S. FEDERAL INCOME TAX
LAWS TO THEIR PARTICULAR SITUATIONS AS WELL AS ANY TAX CONSEQUENCES RESULTING FROM PURCHASING, HOLDING OR DISPOSING OF THE ADSS,
INCLUDING THE APPLICABILITY AND EFFECT OF THE TAX LAWS OF ANY STATE, LOCAL OR FOREIGN JURISDICTION AND INCLUDING ESTATE, GIFT,
AND INHERITANCE LAWS.
F.
|
Dividends
and Paying Agents
|
Not
applicable.
Not
applicable.
We
previously filed with the SEC registration statement on Form F-1 (File Number 333-232392), as amended, to register our Class B
ordinary shares in relation to our initial public offering. We also filed with the SEC related registration statement on Form
F-6 (File Number 333-232665), as amended, to register the ADSs representing our Class B ordinary shares.
We
are subject to the periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private
issuers. Under the Exchange Act, we are required to file reports and other information with the SEC. Specifically, we are required
to file annually a Form 20-F within four months after the end of each fiscal year. Copies of reports and other information, when
so filed with the SEC, can be inspected and copied at the public reference facilities maintained by the SEC at 100 F Street, N.E.,
Room 1580, Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to
the SEC. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the Commission at 1-800-SEC-0330.
The SEC also maintains a web site at www.sec.gov that contains reports, proxy and information statements, and other information
regarding registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private issuer, we are exempt
from the rules of the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and our executive
officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained
in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial
statements with the SEC as frequently or as promptly as U.S. companies whose securities are registered under the Exchange Act.
I.
|
Subsidiary
Information
|
Not
applicable.
ITEM
11.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
Credit
Risk
Credit
risk is controlled by the application of credit approvals, limits and monitoring procedures. We manage credit risk through in-house
research and analysis of the Chinese economy and the underlying obligors and transaction structures. We identify credit risk collectively
based on industry, geography and customer type. In measuring the credit risk of our sales to our customers, we mainly reflect
the “probability of default” by the customer on its contractual obligations and considers the current financial position
of the customer and the exposures to the customer and its likely future development.
Liquidity
Risk
We
are also exposed to liquidity risk which is risk that we are unable to provide sufficient capital resources and liquidity to meet
our commitments and business needs. Liquidity risk is controlled by the application of financial position analysis and monitoring
procedures. When necessary, we will turn to other financial institutions and related parties to obtain short-term funding to meet
the liquidity shortage.
Foreign
Exchange Risk
While
our reporting currency is the RMB, we have one operating entity’s functional currency is HK dollar and two operating entities’
functional currency is USD. As a result, we are exposed to foreign exchange risk as our results of operations may be affected
by fluctuations in the exchange rate among HK dollar, USD and RMB. If the RMB appreciates against the HK dollar and USD, the value
of our HKD or USD revenues, earnings and assets as expressed in our RMB financial statements will decline. We have not entered
into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.
ITEM
12.
|
DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES
|
None
None
None
D.
|
American
Depositary Shares
|
Fees
and Charges Our ADS holders May Have to Pay
The
depositary may charge each person to whom ADSs are issued, including, without limitation, issuances against deposits of shares,
issuances in respect of share distributions, rights and other distributions, issuances pursuant to a stock dividend or stock split
declared by us or issuances pursuant to a merger, exchange of securities or any other transaction or event affecting the ADSs
or deposited securities, and each person surrendering ADSs for withdrawal of deposited securities or whose ADSs are cancelled
or reduced for any other reason, $5.00 for each 100 ADSs (or any portion thereof) issued, delivered, reduced, cancelled or surrendered,
as the case may be. The depositary may sell (by public or private sale) sufficient securities and property received in respect
of a share distribution, rights and/or other distribution prior to such deposit to pay such charge.
The
following additional charges shall be incurred by the ADR holders and beneficial owners of ADSs, by any party depositing or withdrawing
shares or by any party surrendering ADSs and/or to whom ADSs are issued (including, without limitation, issuance pursuant to a
stock dividend or stock split declared by us or an exchange of stock regarding the ADSs or the deposited securities or a distribution
of ADSs), whichever is applicable:
|
●
|
a
fee of U.S.$1.50 per ADR or ADRs for transfers of certificated or direct registration ADRs;
|
|
●
|
a
fee of up to U.S.$0.05 per ADS held upon which any cash distribution made pursuant to the deposit agreement;
|
|
●
|
an
aggregate fee of up to U.S.$0.05 per ADS per calendar year (or portion thereof) for services performed by the depositary in administering
the ADRs (which fee may be charged on a periodic basis during each calendar year and shall be assessed against ADR holders as
of the record date or record dates set by the depositary during each calendar year and shall be payable in the manner described
in the next succeeding provision);
|
|
●
|
a
fee for the reimbursement of such fees, charges and expenses as are incurred by the depositary and/or any of its agents (including,
without limitation, the custodian and expenses incurred on behalf of ADR holders in connection with compliance with foreign exchange
control regulations or any law, rule or regulation relating to foreign investment) in connection with the servicing of the shares
or other deposited securities, the sale of securities (including, without limitation, deposited securities), the delivery of deposited
securities or otherwise in connection with the depositary’s or its custodian’s compliance with applicable law, rule
or regulation (which fees and charges shall be assessed on a proportionate basis against ADR holders as of the record date or
dates set by the depositary and shall be payable at the sole discretion of the depositary by billing such ADR holders or by deducting
such charge from one or more cash dividends or other cash distributions);
|
|
●
|
a
fee for the distribution of securities (or the sale of securities in connection with a distribution), such fee being in an amount
equal to the $0.05 per ADS issuance fee for the execution and delivery of ADSs which would have been charged as a result of the
deposit of such securities (treating all such securities as if they were shares) but which securities or the net cash proceeds
from the sale thereof are instead distributed by the depositary to those ADR holders entitled thereto;
|
|
●
|
stock
transfer or other taxes and other governmental charges;
|
|
●
|
SWIFT,
cable, telex and facsimile transmission and delivery charges incurred at your request in connection with the deposit or delivery
of shares, ADRs or deposited securities;
|
|
●
|
transfer
or registration fees for the registration of transfer of deposited securities on any applicable register in connection with the
deposit or withdrawal of deposited securities; and
|
|
●
|
fees
of any division, branch or affiliate of the depositary utilized by the depositary to direct, manage and/or execute any public
and/or private sale of securities under the deposit agreement.
|
JPMorgan
Chase Bank, N.A. and/or its agent may act as principal for such conversion of foreign currency.
Fees
and Other Payments Made by the Depositary to Us
In
2019, we did not receive any payment from the depository for expenses incurred in connection with the establishment and maintenance
of the ADS program.